Saturday, June 25, 2011

The Biggest Retirement Planning Mistakes

Talk to retirees about their financial situation and some of the worst retirement planning mistakes tend to pop up over and over again.  Here is my list of the big ones to avoid, but the biggest mistake is not to plan at all.

1. Not Planning

Retirement planning may not be fun and the initial results may be discouraging, but without a plan your odds of optimally or even adequately funding retirement are greatly reduced.  With a plan, you can make the most of your economic resources, whatever they may be, avoid pitfalls and perhaps fix some of the problems you uncover in the planning process.

Find a fee-only planner who will work with you to develop a retirement plan but won’t try to sell you financial products he or she will profit from.  If you can’t convince yourself that a planner is worth the cost, use my website to develop your own plan.  As a friend of mine likes to say, “Bad breath is better than no breath at all.”  That’s true of retirement plans, too.

2. Using Life Expectancy for Planning

Composer-pianist Eubie Blake famously said, “If I'd known I was going to live this long, I would have taken better care of myself.”  Blake was born in 1887, when life expectancy for males was about 59 years.  He lived to age 96.  If Eubie had planned to fund his retirement only until his life expectancy, he would have been broke for the last 37 years of his life.

According to the Social Security Administration’s website, the life expectancy for a room full of 100 randomly selected men born in 1940 is now about 83 years.  About 50 of them will live longer than age 83 years. Around 25 will live past age 90, and 10 or so will live past the age of 95.  

Don’t ignore longevity risk. Plan on living a long time, just in case you do.

3. Believing in Sustainable Withdrawal Rates

A widely-touted retirement funding strategy says that you can invest your retirement savings in stocks,withdraw 4.5% of your nest egg on the day you retire and withdraw that same amount every year thereafter, adjusted for inflation, and safely fund at least 30 years of retirement.  This is voodoo finance.

If you don’t want to take my word for it, ask anyone who retired using this strategy and had their standard of living cut in half by the 2007-2008 stock market crash.  Or, ask Nobel Laureate, William F. Sharpe, who debunked the strategy in his paper, “The 4% Rule—At What Price?”  

Or, you can ask retired Dallas News finance columnist, Scott Burns.  Burns, who was an avid supporter of the "SWR" strategy for years as a columnist, recently co-authored a book with Laurence J. Kotlikoff entitled Spend ‘til the End in which he now refers to the 4% Rule of Thumb as a “Rule of Dumb”.

If this is the best your financial planner can come up with, find a new planner.

4. Ignoring Inflation

Even mild inflation averaging 3% a year will more than halve your income over thirty years.  If you have a pension or annuity that has no cost of living adjustment, you need to plan for its inevitable and constant decrease in purchasing power throughout your retirement.

5. Drawing Social Security Benefits Before You Need Them

The longer you wait until age 70, the greater your social security retirement benefits will be.  If you can’t retire without them, then by all means take them when you need them.

But if you can delay your benefits by working a little longer or by paying for the early years of retirement from your savings, you may be able to improve your standard of living significantly.

6. Not Planning for Long Term Care

Medical expenses can destroy retirement savings, but the cost of long-term care, should you or your spouse need it, can be devastating.  Medical costs could easily total more than $250,000, but long-term care could cost more than half a million dollars.  Medicare helps with health care costs, but it doesn’t cover long term care.

7. Carrying Too Much Debt

Debt is a huge burden once the paychecks stop.  Try to pay off all consumer debt before you retire and consider paying down or paying off your mortgage.

8. Trusting Your Retirement Planning to a Salesman

Did you ever buy a car and drive off the lot thinking, “That nice salesman only cares about me driving away with a great car at the best possible price”?

Me, neither.

If your financial planner makes money by selling financial products, how can he or she have your best interests at heart?  If he sells stocks, for example, you can bet stocks will be a big part of the “right plan” for you – maybe even too big a part. 

As the saying goes, when you have a hammer everything looks like a nail.  Find a fee-only planner with an entire box full of tools and no incentive to pick the wrong one.

9. Saving Too Little (Or Too Much) for Retirement

Ideally, we would like to maintain about the same standard of living after retiring that we enjoyed before. We don’t want to scrimp through our careers in order to live a lavish retirement, or live beyond our means and then retire as paupers.

Consumption-smoothing software like can help determine the amount of pre-retirement saving that is required to achieve a similar standard of living after we retire.

10. Establishing the Wrong Priorities

Saving for retirement is important, but it isn’t always the top priority.  People with a lot of expensive consumer debt would be better off retiring that debt before retiring themselves.

Retirement savings may well be more important, however, than paying for your kid’s college.  Your children have a lot more time to repay college loans than you have to save for retirement.  Besides, what kid wants you to pay for their college tuition if it means having to move in with them when you’re 80?

Young people right out of college would be better off maintaining a decent standard of living, avoiding consumer debt and building an emergency fund than saving for retirement.

Not everyone has the same priorities, but understanding yours and putting them in perspective is critical to a successful financial plan.

This is by no means an exhaustive list of mistakes people – even professional financial planners – make when planning retirement.  Use it as a checklist when reviewing your retirement plan to make sure you have covered the obvious. 


Flying said...
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Flying said...

Great chapter Dirk. Perfect amount of data, easy to read/understand and extremely worthwhile information.