Understanding common retirement planning mistakes is crucial because retirement planning itself is a complex process, requiring us to make numerous assumptions about the future. Whether you’re creating your own plan using software or working with a financial professional, it’s vital to question the assumptions behind your strategy and recognize potential pitfalls.
Overlooking certain risks or making unrealistic assumptions can lead to a retirement plan that looks solid on paper but falls short in reality.
In this text, let’s share ten common retirement planning mistakes people often make. These insights will help you build a more resilient, realistic plan that can withstand the uncertainties of life. Let’s dive in!
1. Underestimating how long you might live (longevity risk)
One of the biggest retirement planning mistakes is misjudging your lifespan. This is known as longevity risk. Many people simply use average life expectancy figures or add a few extra years as a buffer. But the truth is, you might live much longer than you expect, and failing to plan for this can jeopardize your financial security.
According to data from Capital Group and other studies, the probabilities of living beyond common retirement ages are surprisingly high:
- A 65-year-old man in good health and a nonsmoker has a 50% chance of living beyond age 88 and a 25% chance of living beyond 94.
- Women tend to live longer, with a 50% chance of living to 90 and a 25% chance of reaching 96.
- For couples, there’s a 25% chance that one spouse will live beyond 98.
These numbers might surprise you, but they highlight the need to prepare for a potentially long retirement.
To incorporate this into your retirement plan, you can create alternative scenarios that extend your life expectancy assumptions. For example, if you initially plan for yourself to live to 95 and your spouse to 98, consider a scenario where both live to 100.
Using retirement planning software like Boldin, you can adjust these assumptions and see how your chance of success changes. In one example, increasing life expectancy reduced the plan’s success rate from 90% to 82%. This doesn’t mean your plan is doomed, but it underscores the importance of planning for longevity risk.
2. Not planning for the possibility of retiring earlier than expected
While most people plan to retire at a certain age—say 62, 65, or even 70—life often has other plans. Health issues, layoffs, or other unexpected events can force you to retire earlier than anticipated. This risk is often underestimated in retirement planning.
A 2024 study comparing workers’ planned retirement ages to actual retirement ages revealed significant disparities. For example, 15% of workers said they planned to work until at least 70, but only 6% of retirees actually did so. This gap shows that early retirement is a common occurrence.
Retiring earlier means:
- You save less because your working years are shortened.
- You begin drawing down your retirement savings sooner.
- You may have to claim Social Security earlier, resulting in lower monthly benefits.
- Your retirement horizon lengthens, increasing the risk of outliving your money.
Using retirement software, you can model scenarios where retirement begins earlier than planned. This will help you understand the impact on your savings and income and adjust your strategy accordingly. It’s a vital step to avoid unpleasant surprises.
3. Using unrealistic rates of return assumptions: A big retirement planning mistake
Investment returns are a key assumption in retirement planning, but they must be realistic and aligned with your actual investment strategy.
Match rates of return to your asset allocation
Many investors make the mistake of assuming high rates of return without considering their portfolio’s composition. For example, if you hold a portfolio entirely in Treasury bills, expecting returns similar to a 60/40 stock/bond mix is unrealistic.
Historical data from Vanguard, covering 1926 to 2022, shows average returns vary widely based on asset allocation:
- 100% bonds yield significantly less than portfolios with a mix of stocks.
- Portfolios with 60-70% stocks generally produce higher average returns but come with more volatility.
Your retirement plan’s expected rate of return should reflect the asset allocation you intend to maintain. Adjusting assumptions downward to account for future uncertainty is prudent.
Be realistic about your own behavior
Another retirement planning mistake is overlooking the investor behavior. Market volatility can tempt investors to sell assets at the worst possible times, reducing overall returns. If you know you might struggle to stick to your investment plan through downturns, it’s wise to lower your assumed rates of return in your planning.
Being honest about both market risks and your reactions to them can make your retirement plan much more reliable.
4. Ignoring investment fees
Investment fees can significantly erode your retirement savings over time. Whether you pay a financial advisor’s fee or invest in mutual funds with high expense ratios, these costs must be factored into your plan.
Using the Financial Independence Calculator (FICOC), we can see the impact of fees on a $1 million portfolio with a 30-year retirement and a 4.5% initial withdrawal rate:
- With no fees, the plan’s chance of success might be around 93%.
- Adding a 1% advisor fee drops the success rate to 78%.
- Including an additional 0.75% in mutual fund fees further reduces success to 70%.
This dramatic decline underscores how fees are one of the largest, often hidden, expenses in retirement. If you’re working with an advisor, ask how fees are incorporated into your plan. If you’re managing your own investments, seek low-cost funds to minimize the drag on your portfolio.
5. Overlooking home equity as a retirement resource
Home equity is often ignored in retirement planning because it’s not a liquid asset. However, it can be a valuable resource to fund expenses, especially later in retirement.
Options to tap home equity include:
- Reverse mortgages, which allow you to convert home equity into cash without selling immediately.
- Downsizing to a less expensive home and using the proceeds to supplement retirement income.
- Relocating to a state with lower housing costs or taxes.
Retirement planning software like New Retirement lets you model these scenarios. You can simulate moving to a different state, downsizing, or using a reverse mortgage to see how these decisions affect your overall plan.
6. Failing to account for assisted living and long-term care costs
Assisted living and long-term care costs are a major expense many retirees overlook. These costs can be substantial and vary widely depending on location.
According to 2024 data, average assisted living costs by state can reach tens of thousands of dollars per year. The National Center for Assisted Living reports that the average length of stay in assisted living is about 22 months, which can mean an expense of around $120,000 or more.
Planning for these costs is essential. Tools, like Boldin, allow you to factor in long-term care expenses, either by planning to use savings or by tapping home equity specifically for these costs.
Ignoring these expenses can severely disrupt your retirement budget and jeopardize your financial security.
7. Unseen saboteur: healthcare costs in retirement
A critical retirement planning mistake involves not accurately forecasting and preparing for healthcare expenditures. While many diligently save and invest for their post-work years, the sheer magnitude of potential medical costs can catch even savvy planners off guard.
It’s a common misconception that government programs like Medicare will cover all health-related expenses. In reality, these programs have limitations, leaving significant out-of-pocket responsibilities for retirees.
Overlooking these potential costs can severely impact your financial stability and quality of life during retirement, turning what should be golden years into a period of financial stress. Therefore, a proactive and realistic approach to healthcare cost planning is not just advisable, but essential.
Strategizing for out-of-pocket medical and long-term care expenses
To effectively integrate healthcare into your retirement planning, you must look beyond basic Medicare coverage. Consider the costs associated with deductibles, copayments, coinsurance for doctor visits and hospital stays, and particularly prescription drug expenses.
These can be substantial even with Medicare Part D. Many retirees opt for Medicare Supplement Insurance (Medigap) or Medicare Advantage (Part C) plans to help manage these unpredictable out-of-pocket costs. However, these come with their own monthly premiums that need to be budgeted.
Furthermore, a significant potential expense is long-term care, which includes services like home health aides, assisted living facilities, or nursing home care. Standard health insurance and Medicare typically do not cover most long-term care services.
This means you’ll need a separate strategy, which might involve purchasing long-term care insurance, earmarking specific assets, or considering how home equity could be utilized. Tools like Health Savings Accounts (HSAs), if funded during your working years, can also offer a tax-advantaged way to pay for qualified medical expenses in retirement.
Failing to plan for these distinct healthcare and long-term care costs can lead to rapid depletion of retirement savings when health issues inevitably arise.
8. Not preparing for the possibility of passing away early
Many couples plan their retirement assuming both spouses will live to an advanced age, such as 95. However, it is a huge retirement planning mistake to ignore the impact if one spouse passes away earlier than expected.
Early loss affects several aspects of your retirement plan:
- Taxes: You may move from married filing jointly to single filing status, affecting tax rates.
- Expenses: Some costs may decrease (e.g., insurance, daily living expenses), but others like housing may not.
- Income: Social Security income typically reduces to a survivor benefit, which is often less than the combined benefit of two checks. Pensions and annuities may also adjust based on survivor benefits.
Modeling a scenario where one spouse passes away early is easy with retirement software. It helps you understand the financial impact and prepare accordingly.
9. Ignoring the potential role of annuities
Annuities often get a bad rap, but they can be a useful tool in retirement planning when used appropriately. Annuities provide guaranteed income, which can cover essential expenses and reduce longevity risk.
A common rule of thumb is to have at least 50% of your necessary retirement spending covered by guaranteed income sources like Social Security, pensions, and annuities. Some retirees prefer a higher percentage to increase financial security.
Single premium immediate annuities, for example, can convert a lump sum of savings into a steady income stream for life. You don’t have to annuitize your entire portfolio, but even a portion can improve your plan’s reliability.
Retirement planning software often allows you to model annuities and compare scenarios with and without them, giving you a clearer picture of their potential benefits.
10. Failing to stress test your retirement plan
One of the most critical steps in retirement planning is stress testing your plan against various “what if” scenarios. Life is unpredictable, and your plan needs to be robust enough to handle multiple risks simultaneously.
Examples of stress tests include:
- Living longer than expected (e.g., to age 100 instead of 95).
- Retiring earlier than planned.
- Higher than expected expenses, such as $1,000 more per month.
- Lower than expected investment returns or prolonged market downturns.
- Higher inflation rates.
By combining these factors, you get a realistic sense of how sensitive your plan is to different risks and which factors have the biggest impact. For instance, you might find that living longer doesn’t affect your plan as much as retiring early or facing higher expenses.
Tools like Boldin enable you to create and compare multiple scenarios side-by-side, helping you identify vulnerabilities and make informed adjustments.
Conclusion: Building a realistic and resilient retirement plan
Retirement planning is full of uncertainties, but by avoiding these ten common mistakes, you can create a plan that truly prepares you for the future.
By thoughtfully addressing these areas, you’ll be better equipped to enjoy your retirement with confidence and financial freedom. Remember, the best thing money can buy is financial freedom, and a strong retirement plan is your roadmap to that freedom.
If you want to dive deeper, consider using robust retirement planning tools, or consult a knowledgeable financial planner who can help you model these scenarios and build a personalized plan.
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