Are These Common Misconceptions Getting In The Way Of Your Retirement Security?
When it comes to retirement planning there is no shortage of conventional wisdom – some of it dead wrong. Beware of formulaic rules of thumb masquerading as truth because they can still be wrong no matter how often they are repeated.
For example, it would be comforting to believe that investing in your company retirement plan is all you need to do or that Social Security will take care of your golden years, but the numbers may argue differently. Maybe you were sold a bill of goods that includes the “70% of pre-retirement spending” rule or the “save enough to cover 10-20 years” myth. Or could it be that you budgeted your retirement based on average market returns or the safety of an all bond/cash portfolio. If you are a victim to any of these myths then it is important you read what follows. Your retirement security could be at stake.
What you don’t know can really hurt you in retirement planning. Below are twelve of the most common myths in retirement planning with the facts you need to overcome them. If you are making any of these retirement planning mistakes you could convert your golden years into lead.
Retirement Planning Myth 1: I’ll Delay Saving For Retirement Until Later When It is Easier
Many people correctly determine that it will be easier to save money for retirement later in their careers rather than now so they procrastinate getting started – but that is asking the wrong question. The real question is what the easiest and the most secure path to a bountiful nest egg will be – not when is it easiest to save for it. In other words, it may be easier to save for retirement later but that is irrelevant if your true goal is to find the easiest way to a secure retirement. A secure retirement requires you to begin saving now – whether it is easy or not.
The old way of thinking was to pay off the mortgage, pay for the kid’s college, and then save for retirement. That worked fine when people didn’t live as long, but nowadays you can expect to survive 20-40 years in retirement. You may spend as many years in retirement as you did in career. The result is you need a bigger nest egg than previous generations needed to fund those extra years. A bigger nest egg requires a more aggressive approach to retirement savings while you are still working.
If you don’t start saving now you are throwing away the power of compounding returns which is one of the most powerful tools in your arsenal for achieving financial security. The sooner you begin saving, the less you must save each month to reach any given savings goal making the process easier to accomplish. The longer you wait, the more you must save each month making it harder to get started and harder to reach the goal.
“A man who makes a mistake and doesn’t correct it is making another mistake.”
You may rationalize not saving now because you have lots of time to do it later, or conversely, you don’t have enough time now to plan for later. Neither of these excuses matters because the mathematics of how wealth compounds doesn’t care about excuses – it’s inviolable. When you throw away time you throw away money. The longer you wait the harder the goal is to achieve. Procrastination is wealth suicide on the installment plan. The math of growing money doesn’t care about your rationalizations or excuses – it’s just math.
If you grow your retirement savings at 10% compounded and wait just seven years to begin, you will end up with half as much money compared to starting today. Imagine that – half the money for just seven years of procrastination. That can make the difference between spending your retirement greeting shoppers at Wal-Mart or playing golf at your local country club. Which would you prefer?
So are you going to start to build your retirement security now so you can take the easy, secure path, or are you going to wait until later when saving is easier but the goal is harder to achieve?
Retirement Planning Myth 2: My Company Or Government Will Take Care Of My Retirement
The old rule-of-thumb was retirement income came from a three-legged-stool consisting of Social Security, company pensions, and personal savings. All that is changing…
Unless you are one of the rare few with a secure pension the new rule is that savings and pensions have been blended into one category called defined contribution plans while Social Security has declined in relevance. The result is the solid three legged stool of your parent’s generation is now a wobbly two legged stool for you.
Let’s examine the demise of this three-legged-stool by first looking at the Social Security leg.
“It is error alone which needs the support of government. Truth can stand by itself.”
Social Security is actuarially unsound – it cannot work as promised. The further you are from retirement the less you should expect to receive from the system in the future. It is not politically realistic to forecast the system’s demise, but it is prudent to expect diminished payouts and means testing going forward. Depending on how conservative you want to be in your estimates, your age, and the level of lifestyle you seek, you should plan on receiving anywhere from 0-30% of your retirement income from Social Security. What that means is it makes a nice supplement but not a foundational pillar. So much for the first leg of the stool…
The second leg of the stool, defined benefit pension plans, is rapidly going the way of the dinosaur. According to the U.S. Department of Labor they have declined more than 70% to under 30,000 plans from a peak of 112,000 plans in 1985. Expect more of the same going forward. Even if you are one of the lucky few with a corporate pension it is questionable to rely on it. The reason is because a surprising number of retirees lose what they thought were secure benefits due to under-funding, corporate bankruptcy, reorganization, and other legal shenanigans that rip-off retiree’s earned benefits. The one exception is government pensions which remain reliable as of this writing despite being under-funded and at risk.
While the old-style pension plan system has been decaying, defined contribution retirement plans grew from 12 million in 1974 to 64 million in 2005 (data from Employee Benefit Research Institute). Most people have effectively shifted their retirement plan from defined benefit to defined contribution which means they have similarly shifted the responsibility from the employer to themselves. It is a totally different ballgame. You are now solely responsible for funding the second leg of your stool.
This change toward defined contribution retirement plans in the second leg has subsequently affected the third leg – retirement savings. In the old pension days these two legs used to be separate, but now they get commingled in worker’s minds because defined contribution plans are a form of personal savings. Many people stop saving for retirement because they believe they are already taking care of savings through the salary reduction portion of their 401(k) at work. Where they used to have two separate and distinct legs under their stool (company pension and personal savings) they now have one (defined contribution plan), and often that leg is not strong enough to support all the weight.
This leads to the related myth where people incorrectly believe that maxing out a 401(k) is all that is necessary for retirement planning. There is a chance it might be true, but more likely it is not. Depending on your earnings level and the age you begin saving many studies show required savings levels to build a secure retirement in excess of the maximum 401(k) contribution. Because the analysis is dependent on so many personal variables including age, life expectancy and total financial picture you will need to seek individualized, professional guidance to determine the right savings level for you. The rule, however, is you can’t assume maxing out your 401(k) is sufficient because it may not be. You may have to build additional savings in that third leg of the stool to create a financially stable retirement.
And if that weren’t enough, we’re going to take all these changes that have diminished the three legs of your retirement income stool and combine them with increased longevity to create a truly stressful picture. Not only are traditional sources of retirement income drying up, but the savings pool required to fund ever longer retirements is growing to unprecedented proportions. Future retirees are being pulled from both directions – more assets required to fund longer lifespans and traditional sources of income to fund that longer lifespan drying up. The new reality is you can’t rely on the government or your employer to take care of retirement planning for you. Instead, you must do it yourself, and for a much longer lifetime. If you would like to learn more about these issues and how to solve them then I highly encourage you to get my How Much Money Do I Need To Retire ebook for the full story.
Retirement Planning Myth 3: My Inheritance Will Take Care Of My Retirement
Some people use the potential for an inheritance as an excuse to not save for retirement. This could be a major mistake unless your parents are extraordinarily rich and have health so bad you can rely on them dying soon. Otherwise, there are just too many unknowns to plan your retirement for this outcome.
“Property left to a child may soon be lost; but the inheritance of virtue… will abide forever. If those who are toiling for wealth to leave their children, would but take half the pains to secure for them virtuous habits, how much more serviceable would they be. The largest property may be wrested from a child, but virtue will stand by him to the last.”
William Graham Sumner
You don’t know if you’re going to retire and need their money before they are ready to die. You don’t know if they will outlive their money, or they could possibly spend it all at the last minute on health and nursing care. You don’t know if they might become victims of investment fraud or a stock market crash that wipes out their fortune.
Even if you avoided all these problems your parents may decide to encourage your independence and leave you nothing at all. They may go on a spending spree late in life figuring this is their last chance to live it up so they might as well make a party of it. Or maybe one parent will die and the other will remarry and leave it all to the new spouse thus cutting you out entirely. In short, you really don’t know what inheritance you can expect because the future is unpredictable. A lot of things can change.
According to a report by the Federal Reserve Board of Cleveland only 1.6% of heirs receive $100,000 or more – hardly a secure retirement. The reality is the odds are against you so it probably isn’t too smart to bet on your parent’s wealth for your retirement. The wiser move is to be self-responsible by putting away a little yourself.
Retirement Planning Myth 4: My Spouse Will Take Care Of My Retirement
It’s a good bet to rely on your spouse’s retirement – but not a sure bet. Small details like divorce and death can get in the way.
For example, did you know that when your spouse elects for a joint survivor option on his/her pension it will likely decrease the monthly payout during his or her lifetime – yet, that is the only way to protect you in the event you outlive your spouse. The alternative is a higher monthly payout today but that comes at the price of a lesser or possibly zero benefit for you should your spouse die first. Make sure to discuss the joint survivor option with your spouse so that you aren’t left out in the cold.
If you have retirement savings in a 401(k), IRA or similar make sure your spouse names you as primary beneficiary so that the money transfers to you upon death. If your children or someone else is the primary beneficiary you could end up with zippo-zilch-nada.
Finally, Social Security also has a complex set of rules regarding treatment of spouses that varies based on work history, etc. Contact the Social Security Administration for more details on exactly how it might affect your personal situation.
In short, just because your spouse’s retirement was adequate while he/she was alive does not necessarily mean you will be financially secure in the event of death or divorce. Before you bet your retirement security on your spouse’s retirement make sure you understand all the details.
Retirement Planning Myth 5: My Company And Medicare Will Take Care Of My Health Insurance Needs During Retirement
According to an October 31, 2005 Time magazine article the percentage of employers with 200 or more workers offering retiree health insurance dropped from 66% in 1988 to 36% in 2004. Employee Benefit Research Institute shows only 13% of all private sector employers offering retiree medical benefits. Are you one of the lucky few? If you are then consider a survey by Wyatt Co. showing 38% of corporations with retiree health benefits planning to reduce those benefits in the near future. Can you really rely on being the freak exception to a clearly developed trend? Retiree health benefits are diminishing.
Businesses are having a hard time coping with increasing health insurance premiums and are aggressively reducing retiree health coverage. Depending on when you plan to retire and who you work for you will probably be on your own for health insurance.
“A government that robs Peter to pay Paul can always depend on the support of Paul.”
George Bernard Shaw
No problem, you say, that is why we have Medicare. Unfortunately, most studies show Medicare usually covers less than half a retiree’s medical bills. A study by Hewitt Associates shows health care expenses can cost retirees 20% of their annual income. Expect this situation to worsen over time as Medicare’s fiscal problems continue to deteriorate.
What this means is you will need to consider supplemental medical insurance and possibly even long term care insurance as potential additional costs for your retirement budget. Once again, you are on your own and need to be self-responsible.
Retirement Planning Myth 6: I Will Only Need 70% – 80% Of My Pre-Retirement Income During Retirement
If only life were so simple…
The truth is estimating the amount you will spend during retirement is complex and unique to each individual. Oversimplified rules-of-thumb like 70%-80% of pre-retirement spending deceive more than they illuminate.
According to the Employee Benefit Research Institute 52% of retirees surveyed spent 95% or more of their pre-retirement income during retirement. That makes sense given that many retirees replace their work lifestyle with expensive, active lifestyles.
You can expect spending during retirement to decrease over time as your age increases because of diminished activity and consumption levels with aging. However, you can also expect spending to increase as you age due to inflation and rising health care costs. How these contradictory influences play out to effect total spending is impossible to predict since nobody knows what future inflation will be or what health care issues you will face.
“If you know how to spend less than you get, you have the philosopher’s stone.”
If that weren’t enough to confuse you then also realize your spending will vary depending on what age you choose to retire at, what your interests are, where you live, and other lifestyle issues. A fortune to one person’s retirement plan could mean poverty to someone else.
Using a rule-of-thumb like “70% of pre-retirement income” as a retirement budget hardly even qualifies as a ballpark estimate. The smarter alternative is to put together a budget based on your personal situation and goals for retirement then stress test those figures with various inflation assumptions and potential costs for health crises. This guesstimate will be better than the alternative but will likely be a far cry from what you actually end up spending during retirement because ultimately the future is unpredictable.
In short, your spending during retirement is unknowable and can only be guessed at with serious potential inaccuracy. Relying on any budget over a potential retirement time horizon of 30 years is more fiction than fact. If you aren’t totally clear on this then just look back 30 years ago in your life and honestly assess if you could have even remotely guessed what you would be spending today. It wasn’t likely then, and it isn’t likely now.
If you would like solutions to budgeting for retirement I recommend the How Much Money Do I Need To Retire ebook.
Retirement Planning Myth 7: Invest In “Super Safe” Bonds and CDs To Lower Risk and Preserve Capital
A retirement portfolio built on bonds and CDs made sense for earlier generations when life expectancies were short and inflation was tame, but that isn’t the situation facing today’s retirees.
“Observance of customs and laws can very easily be a cloak for a lie so subtle that our fellow human beings are unable to detect it. It may help us to escape all criticism; we may even be able to deceive ourselves in the belief of our obvious righteousness. But deep down, below the surface of the average man’s conscience, he hears a voice whispering, “There is something not right,” no matter how much his rightness is supported by public opinion or by the moral code.”
Carl G. Jung
The old standard for retirement investing was to preserve capital so it could be spent over a 10-15 year period. Losses could not be risked because there wasn’t enough time to recover from them. But today’s retirees are facing 30+ year time horizons with inflation eating at their purchasing power making a no-risk portfolio potentially the most risky portfolio of all.
An inflation rate of just 4% will cut your purchasing power in half every 18 years meaning you have to double your money just to break even. If you don’t double your money it means your nest egg is worth effectively half as much. Imagine living long enough to have that happen twice during your retirement. It is equivalent to living on one fourth the portfolio you began with. The rule is clear: today’s retirees must not only preserve capital, but they must grow it as well to preserve purchasing power.
The result is many financial advisors now encourage stock investing to add a growth component to your portfolio to offset inflation. This introduces a great deal of potential risk so they’ve also developed elaborate Monte Carlo simulations based on historical data to give you comfort. For many retirees the market is simply too risky so people seek other alternatives including income producing real estate as a way to fight inflation with greater safety.
The truth is no simple answer exists to structuring a retirement portfolio to guard against the ravages of inflation while protecting capital to an acceptable risk level. Greater longevity combined with government indebtedness has magnified the risk of inflation to equal or exceed the risk of losing principle from fluctuating, growth oriented investments. Most retirees have no choice but to embrace this new reality with a less traditional portfolio allocation or face the potential risk of outliving their assets.
Retirement Planning Myth 8: Retirement Means Not Working
The traditional retirement converted full time work into full time leisure, but all that is changing. Many people are choosing phased retirement, second careers, and stint work as an alternative to full-time leisure. The reason for the change relates to issues of fulfillment and the other bugaboo facing new retirees – increased longevity.
“Musicians don’t retire; they stop when there’s no more music in them.”
Today’s retirees face as much time in retirement as they did in career. Many are realizing 30+ years of full time leisure is not necessarily a recipe for happiness and fulfillment. Instead of taking a binary approach to life by working like crazy so they can retire and do nothing constructive at all, they are using these extra years to introduce a third phase to life that balances work and leisure. In other words, rather than retiring from life they are building a satisfying life that they never want to retire from.
Besides finding greater fulfillment and connection in work another motivator for the change is the sheer magnitude of the nest egg required to fund a 30+ year retirement without earning additional income. Many are realizing their savings have fallen short of perpetual financial security. By adding part-time work, phased retirement, and second careers new retirees are earning just enough income to afford retirement now so that they can lead a more balanced life today rather than being stuck in an unsatisfying career just to build a bigger savings account for tomorrow.
Retirement Planning Myth 9: Retire At Age 65
What’s the magic of age 65?
This myth began because traditional pensions and Social Security were paying full benefits at age 65. When people became eligible for full benefits it created a disincentive to work so most people naturally chose retirement as a response. Since everyone else retired at that time it became an expected standard. But those times they are a changin’.
“Retirement at sixty-five is ridiculous. When I was sixty-five I still had pimples.”
Pensions are going the way of the dinosaur and Social Security is hardly significant enough to be a decision breaker in your retirement plans. The truth is retirement begins in an ideal world when you are ready and can afford it. In a less than ideal world it begins when your health fails so you can no longer work or your employer forces it on you through a layoff or downsizing.
Some people “retire” in their 30’s (this author included) and some people never retire. The magical age of 65 as a secession point for career and the beginning of life on the pro-leisure circuit is a myth. You are free to choose to retire – or not – at any age. The earlier you begin retirement planning and the more aggressively you build wealth the more flexible and free you will be to make the right choice that is most fulfilling for you.
Retirement Planning Myth 10: My Expected Lifespan Is 75-85 Years
This fact is a statistical truth and a retirement myth simultaneously.
If you look at an actuarial table used by the IRS or an insurance company you will see the statistical facts are true: the average life expectancy is in this range. However, this fact is totally irrelevant to any one person – including you. Half the people will live longer than the median and you will do everything in your power to be part of that group. The chances of you dying promptly at an average age are close to zip so it makes no sense to build a financial plan based on it.
For example, if you make it to age 65 you are expected to live much longer than average because the averages include the 21% of the population who died before age 65. How would you feel if you budgeted to run out of money after 15 years only to live for 30 instead? This outcome is all the more likely given that average life expectancies are trending higher and will likely imply greater longevity than today by the time you die and become part of the statistics. In fact, life expectancy has increased 100 days per year for the last century. That is a lot.
“Life can only be understood backwards; but it must be lived forwards.”
The truth is the fastest growing population age group is 85+ and living to age 100 may become relatively common with all the developments in biotechnology, nanotechnology, and health care. Equally possible is that you could die tomorrow – but you can’t build your retirement plan around that outcome because you would have a financial disaster if you were wrong.
The key principle here is your retirement plan must provide income to support your life until you die – no matter when that occurs. It could be much longer than average or it could be less. Here’s the rub though. If you die early and leave money behind it is doubtful you will regret the extra cash; however, if you live longer than average and don’t plan for it you are guaranteed to deeply regret running out of money.
You simply have no real choice but to manage for that risk by assuming you will live for 90-100 years unless genetics or current health argues otherwise. The risk of the alternative is simply too great to accept. Financial planning based on average life expectancy is a dangerous myth.
Retirement Planning Myth 11: I Can Plan The Growth Of My Savings Based On Long-Term Historical Average Returns
Most computer models for retirement planning assume long-term historical average returns to determine the expected asset growth in a portfolio going forward. It would be nice if the process was that simple, but it’s not. The past is not the future. Average returns deceive just like average life-spans deceive.
The only average return you care about is the one that happens to your money once it’s invested – not what happened in some historical past that extends beyond your grandparents birth. The future is unknown and unpredictable. The required disclosure for financial documents is true and should be respected: “past results may not be indicative of future results.” Take this warning to heart.
High tech financial planners attempt to improve on blind historical models by applying Monte Carlo simulations that randomize historical returns to give computer generated confidence intervals – but it is still historical returns no matter how you slice them up, and you can still end up running out of money even if the historical odds are low.
“I feel like a fugitive from the law of averages.”
William H. Mauldin
The computer may claim a 90% confidence interval but it doesn’t mean you won’t live through the 1 out of 10 chance that results in failure, and it doesn’t say anything about how the future could be totally different from the past invalidating the premise of the model altogether. Either of those scenarios could equal “broke” for you even if the odds were low based on historical extrapolation.
For example, the historical returns from stocks may average anywhere from 7% to 11% over the very long-term depending on assumptions and time period analyzed but interspersed within those long-term averages are 15 year periods with negative real returns after adjusting for inflation. If you just happened to retire in the middle 1960’s the odds based on history were low that your portfolio would do so poorly, but it would have done poorly nonetheless.
Similarly, the odds generated by Monte Carlo models are based on a time period when the United States was the dominant global economic force with an increasing number of workers as a percentage of population adding to GNP growth. All of these facts are changing in the future which casts any historical extrapolation into doubt.
In other words, the investment returns during your retirement may be way above average or way below average – nobody knows because the future is unknowable. What we do know, however, is if your retirement budget is based on average expectations and you get less than average results you could be in for a real problem.
You need a better plan.
Retirement Planning Myth 12: I Will Be In A Lower Tax Bracket When Retired
As you already learned from Myth #6 you may need as much income during retirement as you did before retirement. If your income isn’t going to drop then there’s not much credibility to the idea your taxes are going down. Similarly, top tax rates have been cut by more than half in recent decades and the country has a serious debt and spending problem so the odds are just as good that tax brackets will be rising instead of falling.
If that wasn’t enough then consider how all the tax deductible money you socked away in 401(k) contributions during your working years will become fully taxable at ordinary income rates during retirement.
Rather than hoping to be so impoverished in retirement that your tax bracket drops it would be far wiser to build a retirement plan that is so successful you actually increase your tax burden.
Retirement Planning Myth Bonus: Retirement Planning Is All About Money
“Twenty years from now, you will be more disappointed by the things you didn’t do than the ones you did do. So throw off the bowlines. Sail away from the safe harbor. Catch the trade winds in your sails. Explore. Dream. Discover.”
Money is an important and essential element of retirement planning and that is why most information about retirement focuses on it – but it is not the ultimate goal. It is a means to an end, but not the end in itself.
Retirement is a lifestyle choice with the objective of creating a more fulfilling, satisfying and happy life. The money is just a means to support the lifestyle. Numerous studies show that unless you are facing abject poverty your happiness during retirement will result more from your relationships with friends, family and a sense of connection and purpose in life than how much money you have. Money is just a tool for living that fulfilling life, but it won’t create it for you.
When planning your retirement make sure to plan a fulfilling lifestyle for yourself. Spend as much time developing your life plan as you do your financial plan. Putting the two together is what makes the golden years truly golden, and Financial Mentor is here to help you achieve that goal.
Finally, most of the issues raised in this article are fully answered in the ebook How Much Money Do I Need To Retire.
Make sure to pick up a copy, and let us know how we can support you.