If your retirement seems just around the corner, join the crowd. But watch for these missteps that can trip up even well-considered retirement plans.
By Liz Pulliam Weston
As baby boomers near their retirement years—the first boomer turns 60 on Jan. 1—they’re discovering what previous retirees have been complaining about for years.
There’s lots of information on how to plan for retirement, but not nearly enough on how to plan retirement itself.
The stakes are perilously high. Errors made in the years surrounding retirement can haunt you for life. You can end up with less money, or less retirement, than you’d planned. Or you can face big tax bills that could have been avoided had you known better.
Here, according to retirement income experts, are some of the most common mistakes and how to avoid them:
Underestimating your life expectancy
Financial planners used to routinely create retirement plans that stopped at age 85, because the chances seemed pretty good their clients would be dead by then. (The average life expectancy at age 65 is 10.3 years for men, 12.4 years for women.)
But averages don’t tell the tale. You may be in better health than the average Joe or Jane, take better care of yourself or have better genes. Even if you don’t, your spouse might; Fidelity Investments has found that the chances of one member of a couple living past 90 are about 50%.
So now more planners are using 90 or 95 as the projected age of death, and you might want to project even longer: MSN Money’s Life Expectancy Calculator can help.
By the way, the longer you live, the more you’ll benefit from delaying the start of your Social Security checks. Although you can start receiving checks as early as age 62, the amount of your checks increases the longer you wait, up until age 70. An analysis by T. Rowe Price financial planner Christine Fahlund found that if you expect to live until at least 80, you’d be better off waiting until after age 65 to start drawing benefits.
Assuming you’ll be able to work as long as you want
The baby boomers are famous for proclaiming that they’ll work past retirement age; an AARP study last year found 79% predicted they would continue working at least part of the time during their retirement years.
How they’ll actually feel once they’re in their 60s and 70s, though, is an open question. Right now, the typical retirement age is 62, according to the Employee Benefit Research Institute, and 40% of retirees say they left the workplace earlier than they’d planned, often because of illness, disability or layoffs.
In fact, 42% of women over 65 and 38% of men in the same age group have disabilities, according to the U.S. Census Bureau. Only 12% of people over 65 are still in the work force (16.9% of men, 8.9% of women).
Many people find that even without chronic health problems, their energy begins declining in their late 60s and 70s, although a few are able to work into their 80s or even 90s.
So if you’re counting on part-time work to supplement your retirement income, don’t count on it for long. You may be the exception, but it’s smart to plan as if your working years won’t continue indefinitely.
Failing to factor in health-care costs
I’ve heard from folks who didn’t bother to check health-care premiums until after they took early retirement—and then were stunned by the four-figure monthly premiums they were asked to pay.
Employers increasingly are eliminating retiree health coverage, and you can’t get Medicare coverage until you’re 65. Even then, there are plenty of costs the government program doesn’t cover. Fidelity projects the average couple will need nearly $200,000 at regular retirement age just to pay for out-of-pocket medical costs for the rest of their lives.
Long-term care costs can be particularly devastating. A 65-year-old man faces a 27% chance of needing long-term care, said actuarial expert Christopher Raham, while the same age woman has a 32% chance.
“Together, a couple has a 50% chance of having a long-term care ‘event’,” said Raham, a senior actuarial adviser for Ernst & Young in Atlanta and head of the company’s retirement income innovation team. “And the average cost is about $150,000.”
Buying long-term care insurance in your 50s or 60s can help you cover the expense if you can’t “self insure” by building up a sufficient nest egg.
If you plan to retire before you qualify for Medicare, make sure you investigate your private health insurance options and have enough income to pay the premiums. If you don’t, you might want to delay retirement a few more years until you do.
Locking in poor returns
There are a number of ways retirees can do this, but two of the most common are certificates of deposit and immediate annuities.
CDs typically offer interest rates that aren’t much higher than the rate of inflation. Add in taxes, and you’re often losing purchasing power. While CDs can be a part of your investment strategy in retirement, most retirees will need the long-term growth offered by stocks and stock mutual funds. The proportion of your portfolio that should be in stocks depends on your age, your risk tolerance and your growth needs, but many planners say the minimum for most people should be 50%.
Immediate annuities offer a similar pitfall. They’re great in concept—a way to lock in a lifetime stream of income in return for a lump-sum payment to an insurance company. The problem is that the payments you get typically reflect the prevailing interest rates at the time you purchase the annuity. If you buy an immediate annuity now, you could be locking in rates that are still near record lows, which is why leading financial planner Ross Levin of Accredited Investors, Inc. doesn’t currently recommend them for his clients.
If the concept of an immediate annuity intrigues you, you have some choices, Raham said. You could wait a few years to see if you can get a better rate and a higher payout. Or you could “dollar-cost average” by splitting your annuity money into slices, and using each slice to buy an annuity each year for the next few years.
Tapping tax-deferred accounts too soon, or too late
You’re allowed to start tapping regular IRAs and 401(k)s at age 59 1/2 without penalty, but distributions aren’t required from these accounts until the year after you turn 70 1/2. (Roth IRAs have no mandatory distribution requirements.) The conventional advice is that you should avoid taking withdrawals from your tax-deferred retirement plans for as long as possible so that your savings can continue to grow.
This is still good advice for the vast majority of folks who are in danger of outliving their nest eggs, said Jonathan Guyton, a financial planner in Edina, Minn. But more affluent couples could face a problem. If they delay taking retirement distributions and one spouse dies, the other will likely face much higher taxes than had the withdrawals been started earlier.
Guyton uses the example of a couple, aged 80, who has an annual income of $30,000 plus $600,000 in an IRA earning 7% annually. The minimum distributions required by law would total $454,000 over the next 10 years. With a joint tax return, those distributions are taxed at 15%, for a total bill of $68,000.
If one spouse dies, however, the same minimum distributions will be required but the surviving spouse won’t be able to take advantage of joint filing tax brackets or exemptions. That means the spouse will be pushed into the 25% bracket and pay a total of $114,000 in taxes, or 68% more.
This couple could have reduced and spread out the tax bill by starting distributions earlier, Guyton said.
Knowing whether you should delay or speed up tapping into your funds is a tricky proposition, which is why you might want to hire a CPA or savvy financial planner to help with the calculations and projections.
Withdrawing too much—or too little
Are you confused about how much you can take out of your nest egg without running out of cash? The bad news: you’re not alone.
What constitutes a “sustainable” or “safe” withdrawal rate is the object of a lot of controversy in the financial-planning world these days. Many planners are persuaded by the research of CFP Bill Bengen, who has shown that a 3% to 4% withdrawal rate is safest. (You can read more about this approach in “Make your money last in retirement.”)
But Minnesota planner Ty Bernicke argues that such low withdrawal rates may unnecessarily delay or impoverish retirements. As I wrote in “Are you saving too much for retirement?,” Bernicke believes spending declines as people age, which means retirees could safely withdraw more from their accounts initially and naturally cut back as they get older.
If you’re the belt-and-suspenders type, you might go for a low initial withdrawal rate to ensure your money lasts as long as you do. If you’re more of a risk-taker, you could opt for a higher payout rate with the understanding that you may need to cut back your spending sharply later.
Failing to get a second opinion
You’re a confirmed do-it-yourselfer who built a sizable retirement fund by the dint of your own sweat and investment savvy. Or you’ve been with the same adviser decades, and have been pretty happy with the results. Or you simply haven’t thought about planning for retirement income; your whole focus has been on investing.
Whatever your situation, you could benefit from a thoughtful, independent review of your retirement plan.
Today’s distribution rules and strategies for retirement accounts are mind-numbingly complex. It’s easy to make a mistake, but often tough to fix those errors. Do-it-yourselfers often “don’t know what they don’t know,” Raham said.
Furthermore, most of today’s financial advisors have been focused on helping folks accumulate income for retirement, and may not be up to date on the best ways to tap that income, said CPA Ed Slott, author of “The Retirement Savings Time Bomb…and How to Defuse It.”
It can be well worth seeking out an objective expert to review your retirement plans. Some sources to try include the National Association of Personal Financial Advisors, which represents fee-only planners; the American Institute of Certified Public Accounts for a referral to a CPA with a specialty in personal finance; or the Garrett Planning Network, which represents planners who charge by the hour. Make sure your adviser has experience counseling retirees and has stayed up to date with the latest changes in tax law regarding retirement plans.