If you are looking forward to retirement, you aren’t alone. Most people look forward to the day where they can leave their day job, pursue a hobby, explore, relax, and enjoy their time the way they want to. Increasingly, however, fewer and fewer people are able to actually do this. The sad truth is that most people don’t have enough saved to retire at their current lifestyle. Some don’t even have enough to retire at all and will be required to continue working in order to supplement their meager retirement income. This bleak future may not be yours. You may have taken strides to build out your retirement portfolio during your prime working years, and now you get to relax on the fruits of your labor. That being said, there are many mistakes that can be made in retirement that can detrimentally affect your savings.
It’s never too early to begin planning financial goals for your time in retirement. Many people who do plan for retirement don’t take their plan a step further and consider long-term goals during their life in retirement. This creates a shaky foundation for long-term financial security. Once you retire, you’ll have to make decisions about your healthcare, Social Security, withdrawal rates, and how your portfolio is allocated. All of these decisions can have a big impact on the growth or decline of your assets in retirement. While we’d all like to think of retirement as a golden time of relaxation, we must also remember that life happens. Unexpected events can create challenges if they haven’t been prepared for ahead of time with a retirement plan. Keep reading to explore the benefits of saving for retirement early.
In this article, we’ll take a look at some of the key financial mistakes to avoid in retirement. These money mistakes include decisions about when to begin drawing on your Social Security, how you allocate your portfolio, as well as planning ahead for healthcare costs. A broad overview of these topics will help illustrate the complexities surrounding each decision. Financial decisions made dealing with short-term problems during retirement can have a big impact on your long-term financial security. This is especially true in retirement, where most people have limited opportunity for future growth. This article isn’t focused solely on encouraging preparation for future expenses. Rather, it is centered on identifying the areas where many retirees run into problems so that you can make an informed decision that is best for your unique financial situation. By learning why retirement planning is important and mistakes you can avoid by planning ahead, you will be able to better equip yourself as your near your goal retirement age.
Drawing From Social Security Too Early
One of the most common financial mistakes many people make in retirement planning is drawing on their Social Security at the wrong time. Most often, individuals choose to draw on their Social Security too early. This can have a number of different impacts on your long-term financial health, so it is especially important to work with your financial advisor to determine when the optimal time is for you to start receiving Social Security benefits.
If you aren’t familiar with how Social Security works, here’s a brief breakdown. The Social Security benefits you receive are based on “credits”. These credits currently correlate to the period of time during which you are earning income and paying Social Security tax. You can earn up to four credits per year, provided you have earned over $5,280 of qualifying income during that year. Once you reach 40 credits or the equivalent of 10 working years, you are considered fully vested in Social Security and are eligible for the maximum retirement benefit.
Assuming you are fully vested in Social Security, you can begin receiving benefits as soon as you turn 62. The latest you can begin claiming benefits is 70, but you might be wondering why you would wait until after the age that most people retire. Social Security has criteria known as full retirement age, which is 67 if you were born after 1960. If you begin receiving Social Security benefits before your full retirement age, your benefits will be reduced by a fraction of a percent for each extra month you are receiving benefits. In contrast, if you wait until after your full retirement age to begin collecting Social Security, your benefit amount will go up slightly.
There is an additional layer to this that is also important to consider. Your Social Security benefits are calculated based on your 35 highest earning years. If you choose to collect your benefits early, it removes a number of years from this calculation during which you are probably still working. If you chose to delay receiving Social Security benefits until after you hit your full retirement age, the actual benefit received would be greater because you had more earning years and you chose to wait until your full retirement age. If you then chose to wait until you were 70, your Social Security benefit would be even higher.
Although not everyone has the flexibility to choose when to begin receiving Social Security benefits, there are some very good reasons to wait at least until you hit full retirement age. Since Social Security is a cornerstone of many people’s retirement fund, it makes sense to maximize your benefit provided you have other sources of income that will allow you to do so. For some individuals, retiring and working a part-time job for a few years until after your full retirement age can help them maximize their benefit. Other individuals that have strong additional revenue streams may not need to continue working, but rather would simply need to wait to begin receiving Social Security benefits.
Fail to Prepare for Healthcare Costs
Most people tend to underestimate how much their healthcare costs are going to be during retirement. To be sure, estimating your future healthcare needs is challenging. However, as a general rule for your financial plan, you’ll probably need more than you think. Part of this is due to the fact that people are living longer than ever. While this is great for you because it will allow you to enjoy retirement for longer, you’ll also need to face the hard reality of rising healthcare costs as you get older. Additionally, you won’t be on an employer-sponsored healthcare plan any longer. This should also be factored into your projected healthcare costs. The average couple that will retire today is estimated to need approximately $280,000 to cover their healthcare costs through retirement. When you consider that the mean retirement savings of families in the United States is only $5,000, you can begin to see the scope of the problem.
Once you hit retirement, you’ll have to transition off of employer-sponsored healthcare and onto Medicare. One of the mistakes some people make is not making this transition once they retire. Most individuals enroll in Medicare Part B and Medicare Part D during retirement. You’ll have a window of time to enroll in these once you hit 65. If you fail to do so, you may incur penalties and higher premiums which will add up over time. Because of this, it is important to do your research early and enroll in the Medicare plans that are right for you once you hit 65. At the same time, you’ll also want to ensure you have a sufficient level of savings set aside to cover your healthcare costs throughout your retirement.
Most people think that once you near retirement you should shift your portfolio completely into bonds. This misconception can lead to trouble down the road. Ideally, you’ll want a mix of stocks and bonds throughout the time you are in retirement. Many people shy away from this course of action due to the fact that market volatility can have a very real impact on their portfolio, and lacking the security of ongoing employment during this volatility can be frightening.
While market volatility is a real concern and is one reason why you want to maintain some of your portfolio allocated into bonds, you will probably want a portion of your portfolio to remain invested in stocks. While market volatility can result in short-term money losses, over longer horizons a retirement portfolio that remains heavily invested in equities will outperform a portfolio that was more conservatively invested. This doesn’t mean that you shouldn’t consider more conservative investment strategies for when you are retired. Rather, given the length of time that you will be drawing from your retirement account, you may want to consider whether remaining predominantly in equities is right for you.
Many people spend too much once they enter retirement. This is natural, given the fact that they have more time on their hands. The first few years of retirement are usually the time when retirees go on vacation, visit the places they’ve always wanted to, and generally live the good life. While this is an aspiration we all share, it must be done in recognition of your means. Too many people get into financial trouble later in their retirement due to overspending in the first couple of years after they retire.
What this risk highlights is the strong need for a comprehensive budget in retirement. Before retiring you should have a pretty good idea of what your projected expenses will be. You should also have a firm understanding of whether your retirement portfolio will support the quality of life you are expecting. If it won’t, it may be time to realign your expectations to your financial situation. Retirement is an excellent time to downsize and simplify, which can have the added benefit of reducing expenses and increasing your financial security as you grow older.
Withdrawing from your retirement portfolio at too high of a rate can be problematic as well. Remember, each year people are living longer. The conventional wisdom of a 4% withdrawal rate simply doesn’t apply in every situation. Your retirement portfolio may sustain a 4% withdrawal rate over 30 years, while another person may only sustain a 3% withdrawal rate over the same time period. What is important is to keep in mind your unique financial situation, needs, and the health of your portfolio when determining how much you should be withdrawing for retirement. Access to additional revenue streams, such as income from real estate, pensions, or Social Security should also be factored in.
Avoiding some of these common financial mistakes in retirement largely comes down to planning. You’ll have to anticipate some of the expenses you might face during retirement. This is especially true with regards to healthcare costs, which are rising every year. Added onto this the fact that people are living longer every year, and you can see the need to begin saving for retirement healthcare costs early on. While healthcare costs during retirement are a key consideration, they are far from the only financial hurdle many will face during retirement.
Understanding when to begin receiving Social Security benefits is an important question that every retiree will face in financial planning. Although there may be exigent circumstances that require you to begin receiving Social Security benefits as soon as you hit 62, there are strong financial incentives for waiting to receive Social Security benefits until the point you hit full retirement age or later. Doing so will allow you to receive your maximum benefit possible, which is a boon in the latter years of retirement. However, delaying Social Security will require additional revenue streams to support you in your early retirement years. An alternative some people pursue is working part-time for the first few years after they retire.
The absolute best way to avoid financial mistakes in retirement is to work closely with your financial advisor in the years leading up to retirement, as well as when you are retired. Your financial advisor can guide you through the choices that will allow you to maximize your financial well-being during the time you are retired, including the extent to which you should stay invested in equities during retirement. This is an important consideration that can have a large impact on the health of your portfolio in the latter years of retirement. Working closely with your financial advisor can help you create the financial stability in retirement that you have been working so hard for, while also allowing you to avoid common financial mistakes that can detrimentally affect your retirement.