Are you really as prepared for retirement as you think you are? The recent National Retirement Risk Index (NRRI) suggests that 52% of Americans are at risk of not being able to maintain their current standard of living when they retire – but 57% of Americans have realistically assessed their retirement situation, whether they are on track or behind. This was calculated through a study by the Center for Retirement Research at Boston College.
The "at-risk" percentage by NRRI standards has increased by eight percentage points since the 2004 survey. Are you one of the reasons why? See if any of these eight categories of retirement misunderstanding apply to you.
- Misunderstanding Risk – If you can't accept the risk of losing money in a retirement account, you will be limited to investments with very low returns. Inflation will rise faster than the value of your nest egg. You shouldn't invest beyond your level to tolerate risk – but, without suitable growth, be realistic about how much more of your current salary you'll have to devote to retirement to meet your future needs.
- Wealth Illusion – "Wealth illusion" refers to being fooled by a large current balance in a retirement account without realizing how little that balance may provide over time. Seemingly large balances can give workers a false sense of security. The principle also applies to the value of stocks, bonds, savings accounts, and home values.
- Misunderstanding Defined Benefit and Defined Contribution – A defined benefit plan (traditional pension) provides a predictable monthly income. Match up the monthly income with your expected average monthly expenses, and determine whether or not your plan increases with inflation to keep your purchasing power constant. Just because you have a guaranteed monthly income in retirement doesn't mean that it's sufficient.
- Home Values – Home ownership can affect retirement perception in several ways. Owning your own home can give you an erroneous sense of retirement wealth if you don't intend to sell/downsize or tap into the equity with a reverse mortgage. Conversely, if you plan to move to a retirement destination with high costs, make sure you take those costs into account as you assess your retirement readiness.
- Lack of Financial Education – The study chose a college degree as a factor of misperception, assuming that college education increases the likelihood of planning skills and higher income – and the danger of being overly concerned about finances.
- Household Types – Changes in household type are more likely to cause retirement problems. How would your retirement funding be affected by having more children, or by the loss or disability of a family member? Planning provides a starting point – but you must regularly re-evaluate retirement needs, especially when major life events occur.
- Income Effects – Lower lifetime earnings equates to lower Social Security benefits. This doubles your hardship – you must devote a greater percentage of your paycheck to retirement funds to compensate for lower benefits at retirement. If you don't realize that and correct early, when you can take the greatest advantage of compounding over time, you may fall short of your goals.
- Youth – If you are just starting out on your career, retirement planning is probably the furthest thing from your mind. By starting a retirement plan early and optimizing your contributions, you gain the extra benefits of compounding and will develop proper retirement planning habits.
A defined contribution plan, such as a 401(k), requires you to put in enough funds to have a suitably sized nest egg to meet your retirement needs. If you don't understand compounding interest and the time value of money, you may not contribute enough, not start early enough, or fail to give your retirement funds sufficient priority.
While a college degree may increase the likelihood that you are properly assessing retirement, there are plenty of graduates who can't handle financial planning – just as there are savvy planners who didn't graduate from college but are well versed in life skills. Don't hesitate to seek help if you don't understand retirement planning regardless of your education level.
The best way to insure you meet your retirement goals is to set a realistic annual budget for retirement. Lay out your expected expenses and income sources and see how they match up. MoneyTips offers a retirement calculator to help you run various scenarios and determine whether or not you are on track. Be sure to include significant padding for things like increased medical expenses.
Don't let false perceptions of wealth derail your retirement plans. Educate yourself on retirement options and start planning now, and you'll strike the best balance between preparing for a comfortable retirement and enjoying life in the working years.
Regardless of where you plan to retire, the number one factor in ensuring that you can retire on your terms is your 401(k). Make sure that your 401(k) is maximizing its potential with this free analysis that checks your fees, fund mix, and other factors to help you hit your retirement goals.