5 Retirement Mistakes to Avoid
Planning for retirement requires many decisions about your future which can be overwhelming. There are so many things to do that it’s easy to overlook the simple things. My goal in this blog is to inform you of five common retirement mistakes that you should be sure to avoid. This is important because the only people make these mistakes is because they were not aware of them until it was too late. Therefore, you are in the right place as I will provide you with the information you need to avoid these pitfalls and improve your retirement planning process.
Key Takeaways:
Are you paying too much in taxes?
How soon is too soon to collect Social Security?
Do you have an investment policy statement?
How much money do you need to retire well?
Don’t get ripped off by people or products
Are you paying too much in taxes?
The first mistake that I see people make is that they pay too much in taxes. I have seen several examples of this both pre and post-retirement, and the long-term effects can be significant. A lot of these mistakes are basic such as missing opportunities for deductions. Therefore, I will review a few of the common deductions that you should not miss.
The first deduction that you should target comes from contributing to a retirement plan through your employer. If they offer a retirement plan such as a 401(k) or 403(b) with employer match, then you take advantage of it. If possible, you should at least contribute the percentage that your employer is willing to match. If your employer offers a 4% match, then you are going to contribute 4% for a total of 8% towards your retirement account. This amount will not only be deducted from your taxable income, but the money will grow tax-deferred until withdrawn.
The next deduction comes from contributing to a Health Savings Account (HSA) which is only available to individuals on a high-deductible health plan. As an individual, you can contribute up to $3,650 in 2022 with an additional $1,000 catch-up contribution for individuals aged 55 and older. These HSA contributions can continue until you enroll in Medicare which is typically age 65. Therefore, you should take advantage of the HSA account while possible because you can invest the money that you don’t plan to use in the short term. A benefit of an HSA account is that you can withdraw this money tax-free if it’s used for qualifying health related expenses.
If you are married or have a dependent, then you can contribute even more and receive a larger deduction. For those individuals, the deduction increases to $7,300 with a $1,000 catch up clause for each of you if you’re 55 or older. This is one of the great opportunities that I see many couples fail to take advantage of. This is an issue because they could have received a large deduction, invested the money within the account so it would grow, and could one day pull out for qualified health-related expenses tax-free. Therefore, if you qualify for an HSA account then I strongly suggest you open the account and begin to contribute.
If you have more money that you want to save (invest) on a pre-tax basis, then you can contribute up to the limit in your retirement plan such as a 401(k) or 403(b). The limit for individuals in 2022 is $20,500 and $27,000 for those over the age of 50. This would make sense for those who find themselves in the higher tax brackets. The reasoning is that you can invest pre-tax money into the account, take the deduction, and then pay lower taxes in retirement. Of course, this strategy assumes that you will be in a lower tax bracket in retirement since you are no longer working.
If you believe that you will be in the same tax bracket, if not higher in retirement, then I would suggest a different strategy. In that case, you should contribute the maximum to a Roth IRA or Roth 401(k). Unfortunately, the Roth IRA is a newer investment that individuals between the ages of 50 and 70 have not utilized as they hold most of their money in their retirement plans. This is a problem because once the Required Minimum Distributions (RMDs) start at age 72, they could push you into a higher tax bracket when combined with Social Security and pensions. Whereas they would have had more control over these distributions if they had contributed to a Roth IRA instead. Therefore, having a mixture of pre and post-tax retirement accounts can grant you the opportunity to take strategic distributions in the future with the goal of limiting your total taxes in retirement.
Imagine a couple that is filing jointly in 2022. Their first $20,500 of taxable income would put them in the 10% federal bracket and the next $63,000 would push them into the 12% bracket. Any additional taxable income would push them into the 22% bracket. However, this is where the impact of deductions can be seen. Most married couples in Connecticut receive the standard deduction of $25,900 with an additional $1,300 for those over age 65. Therefore, a married couple filing jointly could have a taxable income up to $112,000 before entering the 22% federal tax bracket.
For those with under $112,000 of taxable income and money in a retirement plan(s), I would suggest that you take a distribution now. I have discussed the reasoning above, but this way you can better control the amount of taxes you pay in the future. It gives you an opportunity to pay 12% tax on the distribution rather than waiting for your RMDs to start and potentially having to pay 22% in the future. Another option would be to take the distribution from your retirement plan and transfer it into a Roth IRA. This way the money can be withdrawn tax-free in the future, and you do not have to worry about RMDs.
How soon is too soon to collect Social Security?
The second mistake that I see people make is that they collect Social Security too early. Over the past 20 years that I have worked with clients, I have watched an abundance of information come out about the benefits of delaying Social Security. There was so much that Congress had to change the rules on how people can collect their benefit.
The rule of thumb is that individuals should wait until their full-retirement age, if not until age 70 to collect. This is especially true for couples where one spouse has a higher Social Security benefit than the other. In this scenario, the higher earning spouse should delay their benefit at least until full-retirement age which spans from age 66 to 67 depending on your birth year. Although those that can delay their benefit until age 70 will be better off.
In many of these relationships, the spouse with the higher benefit is the male. Statistically, males tend to have shorter life expectancies than females. Therefore, the higher-earning male must ensure that their spouse is provided for once they have passed. One of the best ways to do this is for the male to delay their benefit at least until full retirement age, but ideally until age 70 to receive their maximum benefit. This way the surviving spouse can collect the decreased spouses’ benefit once they have passed.
Unfortunately, many individuals struggle to delay their benefit because they do not know what the future brings. There is always the chance of passing away at a young age which causes individuals to panic as they want to collect from the source they contributed to throughout their lives. I cannot blame anyone for feeling that way, but statistically you are much better off if you delay your benefit. It doesn’t work out for everyone, but I would suggest using your retirement accounts for short-term funds while you delay your Social Security at least until full-retirement age.
Lastly, if you look at the United States’ current inflation rate it currently stands at 7.7% (as of October 2022). One of the best features of Social Security is that it provides a cost of living adjustment (COLA) each year. The previous COLA was the highest in almost 40 years which helped Social Security benefits keep pace with inflation. Therefore, if we continue to experience high inflation, then delaying your benefit becomes even more important. Delaying your benefit past full-retirement age increases your benefit by 8% per year until age 70. The COLA increases your benefit on a dollar basis, so larger benefits will receive larger COLA increases.
Do you have an investment policy statement?
The third retirement mistake that I see people make is that they fail to have an Investment Policy Statement (IPS). Let me make this clear, every investor should have an investment policy statement. An IPS establishes the framework for your portfolio including your investment goals, restrictions, tolerances, and preferences that an investment manager must follow. One of the main details found in the investment policy statement is your asset allocation which is the proportion of stocks, bonds, and cash in your investment portfolio.
An investment policy statement provides a concrete plan that you plan to follow to achieve your long-term goals. Without one, you are essentially winging it which could result in having a collection of investments. To further illustrate my point, imagine a “hot stock pick” that you received from a friend, a promising mutual fund that you purchased last year, and your company’s target date retirement fund that you invest in on a bi-weekly basis. You now have a “collection” of assets that you accumulated over time, but no direction. These investments do not collectively create a diversified portfolio and unfortunately, many investors will continue to purchase these investments when the market goes up and sell when the market goes down. This is not a successful investment strategy and will only hinder your success in the long term. Therefore, I strongly suggest that you create an IPS and trade with a strategy rather than with emotions.
How much money do you need to retire well?
The fourth mistake that I have observed is that people do not know where they stand financially. Would you plan a trip somewhere without knowing your starting point? You wouldn’t even be able to begin to know where you would fly, drive, or walk. You wouldn’t know how much the trip would cost or how long it would last. Unfortunately, this is the way many of us approach our financial planning.
Transamerica Center for Retirement Studies asked more than 6,300 US workers to estimate the money they would need for retirement and nearly half of the participants supplied a dollar amount by guessing alone. Only 7% opted to use a retirement calculator which displays the unwillingness or inability for individuals to conduct their own financial planning. Many people just assume an amount they need and work towards saving that amount. However, under this strategy it is impossible to know where you stand and what you need to save until retirement.
Therefore, let’s cover a few resources that you can use to gauge your position. The first resource I would suggest are any free tools provided within your retirement plans (401(k), 403(b), etc.). These have become increasingly popular and can provide useful metrics such as projected monthly income from your portfolio in retirement. Another resource would be to consult with your local Financial Planner. A financial planner, such as myself, specializes in this type of retirement planning. Using a financial planner will result in more specific figures and recommendations which can improve your retirement planning process. Not only will you better understand the process, but you will have a resource that you can consult whenever you run into an issue.
Don’t get ripped off by people or products
The last mistake that I see people make in retirement is they make poor choices when it comes to either financial advisors or products. There are a lot of people out there marketing themselves as financial advisors when they should not. I’ve touched on this in past podcast episodes, but our regulatory bodies should be to create a distinction between a financial advisor with a fiduciary responsibility versus a broker who makes money through commissions. The difference is that advisors with a fiduciary responsibility to clients do not sell commission based products which removes a significant conflict of interest from the equation.
Unfortunately, it is hard for the consumer to understand the difference between the two. Therefore, before you contract with any advisor make sure to do your research to understand if they are a fiduciary. I have seen advisors claim to be fiduciaries because they are registered as investment advisors while they hold a broker-dealer or life insurance license. I would consider those advisors to be part-time fiduciaries, which is a problem because as a consumer, you won’t be sure which hat they will be wearing that day. It causes you to think, are they recommending this product because it would benefit me or because they will make a commission?
One way to avoid this confusion is to find a fee-only financial planner. These advisors are paid either through a flat fee or on an hourly basis. If the fee-only advisor manages your portfolio, then they will be paid based on the percentage of assets they manage for you. These annual fees are typically around 1%, so an individual with a $500,000 portfolio will pay about $5,000 in fees per year. Therefore, the benefits of using a fee-only advisor are the transparency, zero conflicts of interest, and of course, their specialization in the field.
I will cover a few resources that you can use to determine whether your advisor or potential advisor is a fiduciary. There is a website called BrokerCheck by FINRA where you can search for advisors. If their profile comes up, that means the advisor holds their broker’s license, so they are not a fiduciary. To contrast, if you search for the advisor and find their profile on advisorinfo.sec.gov, then they are indeed working on a fee-only basis as a fiduciary.
The last thing I will cover are a few strategies that you can use to avoid being scammed by your advisor. The first tip is to never write a check to your advisor unless it’s for a fee. Any checks to be invested should be written out to a third party. For example, I use TD Ameritrade as my custodian, so all my clients make their checks out to TD. Bernie Madoff was able to pull off his scheme because all his client’s funds were held within his company account rather than a third party.
Another tip would be to target advisors with the Certified Financial Planner (CFP) designation. The process to earn the CFP requires a lot of time, effort, and money which means the people that do have the CFP are serious about their career. Additionally, to hold the designation, you must make a commitment to high ethical and professional standards laid out by the CFP. Therefore, when it comes to Financial Planners, the CFP is the highest standard which should provide peace of mind to the client.
For anyone in the search for a financial planner, my name is Ryan Morrissey. I hold the CFP and have been in business for over 20 years. If you follow the link, it will take you to a page where you can set up a free consultation with me. Throughout the introductory call, I can cover any questions you have and together we can determine if I would be a good fit for your needs. Remember, you can’t start retirement planning too soon so there’s no reason to wait!
