Planning for retirement is important, and below are 8 critical retirement planning mistakes to avoid.
- Not having a cash flow plan: Retirement is all about cash flow not your net worth. Without cash flow you do not have a retirement. Your income will determine your lifestyle in retirement. Now that you are retiring, what you have accumulated needs to provide for your income needs for the remainder of your life. Spending too much in the early years or experiencing significant losses in the early years could result in you running out of money before you run out of time.
- Not having a budget. Many high net worth/high income earners have never lived on a budget. Because their wages are high, they have just lived comfortably and been able to save along the way. When you retire you no longer have earned income. Now what you have saved needs to provide for you. To create a good cash flow plan in retirement you need to have a good handle on how much money you spend every month and year. Underestimating your budget could throw off all of the calculations you make when creating a retirement plan. The more accurate your budget, then the better your cash flow plan. I’ve used and recommend mint.com as a tool to help you know where your money is going. When it comes to living on your budget, I prefer the old fashioned envelope system. Benjamin Franklin once wrote, “A small leak will sink a great ship.” Create a budget before your retire and practice sticking to it.
- Not maximizing Social Security. For many people Social Security retirement income will represent 40% or more of their guaranteed retirement income. Social Security is tax-advantaged income, inflation adjusted and has spousal and survivor benefits that need to be considered. A poor choice when starting social security could result in $100,000 or more of lost benefits and could be the difference between having enough money to last the rest of your life or running out of money too soon.
- Having debt: To quote the Bible, “The borrower is slave to the lender.” If you envision retirement as a time of freedom, travel, spending time with loved ones and service to others, then having debt may hinder your dreams and your sense of confidence. I’ve found the most successful retirees pay cash when buying used cars; pay off credit cards every month and only justifing using them at all as a means of accumulating travel rewards; and, in the best case situations, have paid off their mortgage.
- Assuming unrealistic stock market rates of return: Since 1926 the stock market, as measured by the S&P 500, has averaged annualized returns a little more than 10%. The key to these returns is time. Over shorter periods of time, the stock market can trade sideways or negative. Assuming constant rates of returns of 7-10% may make your retirement numbers look good, but may not be realistic given your retirement time horizon. If you are thinking of buying stocks today, then you should take to into consideration that the S&P 500 looks expensive relative to history when using price-to-earnings on a cyclically adjusted basis. Robert Shiller is a Nobel prize-winning economist who is well known for the CAPE ratio. This fundamental, inflation adjusted means of valuing the stock market has the S&P 500 with a CAPE higher than 27 where the median over the past 130 years has been closer 16. There have only been 3 times in the last 130 years where stocks have been more expensive. With yields on 10 year treasuries yielding less than 2%, I’d say bonds are also looking expensive on a historical basis. When making assumptions about future rates of return, I like to say, “Let’s hope for the best, but plan for the worst.” To be safe, I’d recommend only assuming a 4% rate of return on your at risk assets when constructing your retirement plan.
- Not planning for long-term health care costs: Most people will be eligible for Medicare when they turn 65 and many will choose to purchase a supplemental policy to cover the 20% of health care costs that Medicare does not cover. However according to Steve Brown, a local long-term care insurance agent, less than 9% of people in the United States have insurance for long-term care health costs that are not covered by Medicare or supplemental plans. These are the types of health care events that don’t kill you but require you to need some assistance for an extended period of time. They can be brought on by stroke, heart attack, cancer, dementia, Alzheimer’s, Parkinson’s, MS and the list goes on. According to Genworth’s website, a recent study shows that 70% of people over 65 will need some type of support over their lifetime. In Washington State, the average monthly cost for a private nursing home room was $8,500 per month. Many people I’ve met with don’t want to believe that any of these things could ever happen to them. They point to their good eating habits, healthy lifestyle choices, family history and argue that they will never end up needing assistance. While no one wants to think about how our health could change possibly losing our independence, not planning for this type of health care expense could significantly strain, if not completely wipe out, a retirement plan. Worse it may lead to adult children having to consider becoming care givers. There is an old saying that says, “One mamma can take care of eight babies, but eight babies can’t take care of one mamma.”
- Not planning for inflation: Ask anyone who retired with a fixed pension 20 years ago about inflation, and you will get an earful. During the last 100 years, inflation has averaged 3.3% as measured by CPI and during the past 10 years has averaged 2.3%. The Federal Reserve has an inflation target of 2% over the medium term. When planning for your future income needs, be sure you are taking into consideration the fact that your dollars will purchase less in the future than they do today. Create a plan that assumes you will need more dollars to maintain your lifestyle needs in future years.
- Not having a plan for when one spouse dies: Oftentimes with married couples one person manages the household and one person manages the finances. Unfortunately when the one spouse who manages the finances passes away or experiences a significant health event, the well spouse can be left in a fog of uncertainty about what they should do, where things are and what should happen next. Not only do you need to make sure the surviving spouse will have enough income to maintain their lifestyle, but also the surviving spouse needs to be able to have the confidence to be able to continue to carry on the plan that was originally created.
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Featured in the Kitsap Peninsula Business Journal March 2015 issue.