Financial planning for retirement has always been a combination of science, statistics, assumptions, and outright guesswork. The simple truth is that none of us really knows how much money we will need in retirement. Even if we can assess our own situation correctly, it is impossible to know exactly the value of our assets that far into the future or how long until we leave this world.
While planning retirement finances, it is easy to fall prey to harmful myths about retirement. Here are six of those myths to avoid.
1. Delay Retirement Savings Until Income Is Higher – It is very difficult to save for retirement early in your working career when you have so many expenses to deal with. You may be buying a home and starting a family, and it will require all of your assets to handle these new responsibilities.
Certainly, it is important to take care of your family, and a house may be a wise purchase – but failure to plan or put anything away for retirement in the early years negates the tremendous advantage of compound interest over time. If you have a 401(k) with employer matching, failure to take advantage of this is literally turning down free money.
2. Health Care Will Be Covered – Medicare is a fine program, but there are many things that Medicare does not cover, such as copays and deductibles, dental care, vision care, and long-term care. Prescription drugs may be covered depending on your plan. AARP estimated in 2012 that average out-of-pocket costs for Medicare recipients is around $4,600 per year, and since health care costs are outpacing inflation, that is has and will probably continue to increase.
3. You Need Around 80% of Your Annual Pre-Retirement Income During Retirement – According to the Employee Benefit Research Institute, 52% of retirees annually spend 95% or more of their pre-retirement annual income. It is human nature to be optimistic and not leave enough money budgeted for contingencies and unexpected expenses, which are even more likely as you age – consider the health care costs alone.
It is also common to underestimate the costs of travel and hobbies that you will be undertaking with your greater free time in retirement. The bottom line is to build in a healthy contingency as you plan – then double it just to be sure. Then you will probably be closer to your actual needs.
4. Investments In Retirement Must be Conservative – Conservative is a relative term, and the correct portfolio ratio for you depends on your needs. Certainly, if your conservative investments cannot beat inflation, you may want to consider increasing your equity position.
It is true that you have limited time to recover from losses in riskier investments, but the alternative is to dial back your spending and retirement goals. You must decide which is more important for you.
5. Retirement Tax Brackets Will Be Lower – It should be, based on retirement income, but by the time you retire, who knows what the tax rates will be? If your house is paid off you may also be losing your biggest tax deduction as well. With the increased national debt and political swings, it is not a huge stretch to see tax rates going up significantly, even for seniors.
If you are concerned about this, you would be well served to establish a Roth IRA or a Roth 401(k) with after-tax dollars at today's potentially "lower" rate. Another option is to overfund a life insurance policy as cash values can be also be used to provide a tax-free income in retirement.
6. The Retirement Years Won’t Last Too Long – IRS actuarial tables may be based on an average lifespan of 75-85 years, but that is an average. Does longevity run in your family? Include that in your planning calculations.
It isn’t a bad idea to extend your lifespan estimate anyway, with today’s improvements in medical technology. You could face the double financial whammy of longer life expectancy, with higher costs associated with keeping that life expectancy going.
We hope that dispelling these myths will help you plan your retirement accordingly – however, the final decisions are up to you.
Brad is a Registered Representative with, and Securities and Advisory Services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC. CA Insurance License #: 0B22199.
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