Retirement planning, and financial planning in general, involves a lot of moving parts. You are already well-acquainted with many of them - income, expenses, and taxes are the most obvious - but once you start moving into the retirement phase, or at least planning for it, you have to be a bit more careful and diligent about what you think might happen going forward. When you are still working, if things don't go as planned, you have options: work longer, possibly get a promotion/raise or make bonuses to bring in more income, or even cut expenses and save more. Once you retire,
you have fewer options to produce income (in general) and once money is spent it can be much harder to replace.
The following are some of the most common retirement planning oversights to be aware of, and to avoid:
• Not having a retirement account because your company doesn’t offer one.
If your job doesn’t offer benefits - one in three Americans are gig workers without benefits - you can still open
and fund retirement accounts on your own by using a solo 401(k) plan through your bank, a traditional or Roth IRA,
or a SEP (Simplified Employee Pension) IRA.
Even if you have a 401k, you should be aware of other options that may benefit you in the long run. A 401(k) isn’t always the most tax-efficient since it is subject to taxes when the money is withdrawn (usually in retirement),
you have less control over how your money is invested, and you will be be penalized if you need to withdraw any money before age 59 1/2. You should certainly have a 401(k) if your employer offers it, at a minimum to take advantage of any company match policies, but, if possible, you should also utilize other types of accounts, like a Roth IRA and a
Health Savings Account (HSA).
Contributions to a Roth IRA are made with after-tax money, so withdrawals are tax-free (not just the principle, but any gains as well), and you have control over the investment options. HSA's also offer tax-free withdrawals at any time for health/medical needs, balances over $1,000 can usually be invested, and anyone can contribute to your HSA (maybe family would like to help out?). You do need a high-deductible health care plan to be eligible, but if you can, this is a highly advantageous option for retirement savings. You will always have medical expenses, but you don't want to have to pay taxes on withdrawals to pay them!
• Contributing less to your 401(k) than your company matches.
Always contribute at least as much as your company match. Don't give up free money!
• Many people don't realize that at least part of Social Security income can be taxable.
Up to 85% of your Social Security benefit can be taxed, depending on the total of all other income together with 50% of your Social Security benefit. Those taxes need to be taken into account. There are also 9 States that tax Social Security benefits. To optimize the value of your benefit, it is important to know the expected amount that you will receive at different claiming ages, how taxes may affect that, and the net amount that you will receive after Medicare payments are deducted from your monthly benefit check (it is common to have Medicare payments taken directly out of your Social Security check). After potential taxes and Medicare expenses are deducted, the spendable amount of a
$2,000/month check could easily become $1,500. Don't count on being able to spend the entire amount of your estimated benefit.
• Don't rely on Social Security as your entire retirement plan.
Social Security benefits are much more modest than many people realize, with the current average monthly benefit being ~$1,976. Be aware of how much it currently costs for you to live comfortably (needs and wants), and plan to save the difference between that and your expected Social Security benefit. Don't forget to inflation adjust your expenses. Social Security will likely have an annual Cost Of Living Increase (COLA), but it won't keep up with actual inflation and increasing Medicare expenses. Unless you have exceptionally low expenses, you will need some other type of
income/savings, in addition to Social Security, to be able to comfortably pay your bills.
• Health Care is one of the largest expenses in retirement.
Everyone's needs will be unique, but a common recommendation is to plan for $150,000 to $175,000 of medical related care expenses, per person, during the course of retirement. It would be a mistake not to plan for that, as best you can.
• It is estimated that more than 70% of Americans will need long-term care at some point.
This could be for a retirement/nursing home, a memory-care facility, long-term hospital care, or an in-home nurse.
This is separate from general medical care expenses above, so you may want to consider some level of long-term
care insurance. The best time to purchase this type of insurance is in your 50's as it gets much more expensive
in your 60's, and later.
Because long-term care is often necessary due to a catastrophic illness or injury, it’s very difficult to predict who will need it, for how long and how much it will cost. The average monthly cost for an assisted care facility is ~$5,500 per month, and ~$6,000 per month for in-home care. The amounts can vary greatly from State to State but you want to be sure that any insurance limits will be enough to protect you.
• Picking a plan/investment strategy that doesn’t match your personal risk tolerance.
Retirement accounts enable you to invest in the stock market. Investing is inherently risky, and people have different levels of risk tolerance, based on their personalities, life situations, planned career trajectory, family situation, assets and other factors. For instance, someone with a large family and little savings may want to invest their retirement funds in a low-risk account, whereas someone who has plenty of income and no dependents may be enticed to take more investment risk.
Age is also a factor. It’s not uncommon for younger people to have a larger percentage of their retirement savings in higher-risk investments (they have more time to weather the ups and downs of the markets) and then gradually transition to lower-risk choices as they get closer to retirement age. Always carefully assess what risk level you are comfortable with, and make your investing decisions accordingly. Tailor your investment decisions to your own comfort level, not the latest trend or "hot idea". You make money by being consistent over time.
• Inflation will have a tremendous effect on your expenses over time.
While inflation in general is a constant, fluctuating from year to year, it will cause your expenses to continually increase even through retirement. You have to plan for this. Using historical averages, your current annual expenses (if nothing changed) could easily double over the course of 25 years (a common retirement period). For example, if your expenses at age 65 will be $50k/year, that could become $100k/year by age 90. Over that 25 year period your expenses would average out to ~$75k/year. That means that over 25 years, you may need a total of $1.875M to fund retirement.
Don't panic! If you have $2k/month for an expected Social Security benefit (for example), subtract $600k ($24k/year x 25 years = $600k) from the $1.875M goal. You will end up with a little more than $600k because of the annual Social Security COLA, but let's be conservative. Then subtract what you have already saved for retirement (let's say $400k). $1.875M - $600k - $400k = $875k. If you are age 50 and have 15 years until retirement, you would need to save ~$1,100/month to reach that goal. $400k in current savings + $13k/year additional savings, earning 5% (fairly conservative) = $875k after 15 years.
If that's not realistic right now, save as much of that as you can, and increase it as your income increases each year. Being diligent about saving a little more each year, not just saving large amounts to start with, is how most people are able to save and reach their goals. This is fairly simplistic, so creating a detailed financial plan will be much more accurate as it will account for many more variables, but this is a good starting point.
Think ahead, plan ahead, be prepared!