| Avoid These Common Retirement Mistakes
By: Nicholas Breit, CFA, CFP®, Senior Consultant, The Wealth Office™
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| Saving for retirement and subsequently navigating through retirement can be a daunting task. While countless websites and books are devoted to retirement planning, the reality remains that Americans still struggle to sufficiently plan for retirement. A survey by the Employee Benefit Research Institute (“EBRI”) found that 60% of workers did not know how much money they needed to fund their retirement. The following discourse highlights several common retirement pitfalls and solutions to avoid taking such costly missteps.
Retiring Too Early/Underestimating Retirement Expenses
One of the biggest challenges with retirement planning is factoring in life expectancy and how long your retirement assets will need to last. According to the Social Security Administration:
• A 65-year-old male is expected to live, on average, until age 84.
• A 65-year-old female is expected to live, on average, until age 86.
• Roughly 25% of 65-year-olds will live at least to age 90 and nearly 10% will live past age 95.
Given the potential for longer life expectancies, it is even more imperative to formulate a thorough plan to account for a retirement that could potentially span 30 or more years. In conjunction with life expectancy, retirement expenses play a critical role as well. A common rule of thumb suggests one should target 70% to 80% of pre-retirement income for retirement expenses, however this general rule may or may not be applicable to each individual’s particular situation. Experts generally agree that spending increases slightly at retirement (extra time for vacations, home projects, etc. initially) and then declines as retirees age.
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| Considerations:
• Run retirement projections far in advance of your actual retirement date to evaluate whether you currently have sufficient retirement savings. Retiring too early can be a very costly mistake if you find yourself too short on retirement savings. You may need to adjust your expectations (retirement date and/or retirement withdrawals) if you are facing a savings shortfall.
• Use the years leading up to retirement as an opportunity to monitor your annual expenses to help refine your projections for retirement expenses and the corresponding level of assets needed for retirement.
• Avoid estimating a spending level that is unrealistically low, as your actual retirement expenses will likely be fairly constant (and perhaps only slightly lower) over time.
Underestimating Future Healthcare Expenses
While you might be in good physical shape at age 60 or 65, there is no guarantee that good health will continue into your 70s and beyond. Many retirees mistakenly assume that Medicare will pick up the tab for future healthcare expenses. While it is true that Medicare generally pays for a portion of doctor visits, hospitalizations and prescriptions, additional out-of-pocket medical expenses will undoubtedly exist.
A 2014 Fidelity study estimated that a couple retiring at age 65 is expected to incur $220,000 of healthcare costs, on average, during their retirement years. That estimate might even be too conservative when factoring in potential long-term care expenses. According to the Department of Health and Human Services (“HHS”), nearly 70% of Americans over age 65 will need long-term care services at some point during their lifetime. Furthermore, a 2014 Genworth Cost of Care Survey estimated the cost of a room at a nursing home facility to fall between $77,000 and $88,000 per year.
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| Considerations:
• Retirement projections should factor in an estimate of realistic future healthcare expenses; based on the figures provided above, it is best if you can adequately plan for a $200,000 – $250,000 cushion for healthcare costs.
Investing Too Conservatively (or Too Risky) for Retirement
With the potential for a 30+ year retirement, it is important to keep in mind that your retirement assets need some level of sustained grow in order to provide for your retirement needs. Some retirees falsely assume that, because they are no longer earning a regular paycheck, their portfolio should shift to a much more conservative allocation in retirement. Yet, running out of money in retirement is a real risk and consequently, retirees should subscribe to a level of risk commensurate with their retirement needs.
We often advise our clients to “assume only the risk you must.” While the safety and security of Treasuries might sound alluring, most cannot achieve their retirement objectives with the yield offered by Treasury securities. Uncertain and volatile markets can be a challenging experience for retirees, but a suitable level of risk and a long-term view are necessary to successfully achieve retirement objectives.
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| Considerations:
• Evaluate your portfolio from a “Three Levers” perspective – what are your expected inflows (sources of income) and your expected outflows (required portfolio distributions in retirement)? In light of these anticipated inflows and outflows, determine a target investment return (and level of risk) that will satisfy your retirement needs and objectives.
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| • With a thoughtfully constructed allocation in place, do not allow short-term market developments to change or influence your long-term plans. The bear market of late 2007-early 2009 presented a challenging environment for all investors, but fleeing the equity markets for the safety of cash and Treasury bonds during the pullback would have resulted in missing out on the resulting recovery that followed. Similarly, avoid chasing performance and unduly ratcheting up risk during a particularly strong period for equities (or another risky asset class) in an attempt to generate additional return.
• Recognize your own behavioral biases (such as overconfidence bias, hindsight bias, recency bias, etc.) and evaluate how these biases have impacted your past investment decisions and performance. These biases can lead to investment decisions that are often ill-timed and thus costly to long-term performance. In recognizing and acknowledging these behavioral biases, you are better equipped to avoid repeating the same mistakes in the future.
Taking Social Security Too Early
The Full Retirement Age (“FRA”) for Social Security was typically age 65; however, the Full Retirement Age has increased for individuals born in 1938 or later and gradually adjusting up to age 67 for those born after 1959. Retirees have flexibility in choosing when they begin collecting their Social Security benefits. Such benefits can be collected as early as age 62 (at a discounted rate) or as late as age 70 (for which the benefit increases due to delayed benefit credits).
Early Retirement
• The Social Security benefit is reduced by 0.555% for each month before the Full (Normal) Retirement Age, up to 36 months.
• If Social Security benefits are collected more than 36 months before the Full (Normal)
Retirement Age, then the benefit is reduced 0.416% for each month beyond 36 months.
• Example:
• A retiree has a Full (Normal) Retirement Age of 67 years, at which point she will collect $2,000 per month. The retiree, however, chooses to file for early benefits at age 62, thus 5 years or 60 months before her Full (Normal) Retirement Age.
• The first 36 months are discounted at 0.555% per month x 36 months = 20% reduction.
• The next 24 months are discounted at 0.416% per month x 24 months = 10% reduction.
• In return for collecting Social Security benefits 5 years before the Normal Retirement Age, the retiree’s benefit will be permanently reduced by 30% in this example. In other words, the $2,000 monthly benefit at the Full Retirement Age is now reduced to $1,400 per month.
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| Considerations:
• Evaluate your projected sources of retirement income to determine any additional income need (via Social Security) and the corresponding age at which taking Social Security makes the most sense.
• Realize that taking an early benefit (as early as age 62) will result in your Social Security benefits being permanently reduced by as much as 30%. While the monthly difference might sound small, compounding the difference over an extended period of time (perhaps as much as 30+ years) can have a profound impact on your retirement.
• If you choose to collect early Social Security benefits before your Full Retirement Age and you have earned income above the Social Security earnings limit ($15,720 for 2015), your benefits will be reduced by $1 for each $2 above the earnings limit (for each year before your FRA). In the year you reach the FRA, your benefit will be reduced by $1 for each $3 above the earnings limit. Given this additional reduction in benefits, it generally does not make sense to apply for early Social Security benefits while you are still working and have earned income that will exceed the Social Security earnings limit.
• Lastly, remember that your monthly Social Security benefit can be increased if you choose to delay your benefits past your FRA, up to age 70. The delayed retirement credit varies by year of birth; for those born 1943 or later, the additional credit is 0.667% for each month benefits are delayed (thus an additional credit of 8.0% for each year that benefits are delayed).
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The professionals in The Wealth Office™ at DiMeo Schneider & Associates, L.L.C. are prepared to evaluate any of these items in greater detail. For further information and assistance, please contact any of the professionals at DiMeo Schneider & Associates, L.L.C.
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| Helpful Resources
• Social Security Administration – ssa.gov
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