Planning for retirement is fun. You are about to go through one of the most significant transitions of your life and you get to decide how.
Retirement planning is also a fun topic for an academic who studies and researches it. It’s very rewarding as a practitioner who helps others with it. I get it… not everyone enjoys it as I do.
I’ve been studying and practicing retirement for over a decade — I have a Ph.D. and am a CFP practitioner — and in that time I’ve learned that most people really just want to live their lives. Retirement planning helps them do that.
So what are some of the key things to consider when planning for retirement to make sure you can get the most out of it? In this article, I point out six mistakes that I see people make. Often, people simply don’t know they need to think about these issues.
1. Not Planning For Taxes
Saving for retirement is good, but it’s also important to think about where you save. Money withdrawn from IRAs, 401ks, Roth, and taxable accounts will impact your tax bill differently both when you put it in and when you take it out. You need to deliberately consider how to structure your savings so that your taxes are as efficient as they can be in retirement.
A common mistake retirement savers often make is to only consider the immediate effect of saving in a certain type of account. Don’t get hung up on thinking about taxes in single-year terms. Planning for taxes over multiple years will lead to better results. For example, money that you have saved in tax-deferred accounts will come out. When it does, you’ll owe taxes on it. Plan for that by estimating your marginal tax through time and moving your tax liabilities to years you expect to be in lower brackets. This might mean withdrawing money in tax-deferred accounts or converting it to a Roth IRA when you expect to be in a relatively low-tax year.
When you are doing proactive tax planning, I recommend working with a tax professional to file taxes. Take note that I said “file taxes.” That means gathering your information, filling out forms, and submitting your return to the IRS. That’s different from tax planning. Even if you are working with a financial planner or doing your own tax planning, I still think it’s a good idea to work with a dedicated tax preparer to complete your documentation. Improper filing can ruin a good tax plan, so I’m not a fan of risking it. I’m an Enrolled Agent and I still pay a dedicated tax preparer to file my return every year.
Pro Tip: You need to be planning long before the filing deadline, which is generally April 15 of the following year.
2. Not Maximizing Social Security Benefits
There’s more to think about than simply deciding at which age you want to file. Timing your benefits with other sources of income as part of a complete income strategy can help you make the best use of your benefits.
As an example, social security planning can be an excellent way to help take care of a lower-earning spouse if the higher-earning spouse passes away. When a couple is both alive, they can both draw from their own earnings record (or the lower-earning spouse can draw a spousal benefit based on the higher-earning spouse’s record). That’s simple enough, right?
When one spouse passes, the surviving spouse generally has the option to continue taking their own benefit or the benefit that the higher-earning spouse was receiving. That’s great right? Of course it is. Said another way — the surviving spouse is going to lose one monthly social security check. This reality is often reason enough alone to delay the higher-earning spouse’s benefit for as long as possible to take advantage of delayed credits.
Don’t wait until you are 65 to start tracking this either. Go to MySSA and create your account so that you can see your earnings record and social security benefit estimates.
3. Forgetting Your Friend IRMAA
To forget something, you need to know about it first. Well, if you didn’t already know, I have two pieces of unexciting news for you (sorry):
- Medicare isn’t free.
- The amount you pay is based on your income.
Now, let me explain. Medicare is the primary federal health insurance program for people 65 and older. It consists of two basic parts — A and B. These parts are known as “Original Medicare” and provide coverage for hospital and medical expenses. Some people will also get an additional Part D for drug coverage.
What about C? Good question. Medicare Part C is a type of private insurance that combines parts A, B, and D along with some additional coverages.
So, what does it cost? For most people, there is no premium for Part A because you paid for it through payroll deductions while you were working. There are separate monthly premiums for both Parts B and D, however.
For 2022, the standard Part B premium is $170.10 and the standard premium for part D is dependent on the particular plan you choose.
So what is IRMAA? IRMAA is the income-related monthly adjustment amount. As its name suggests, IRMAA is an additional amount that is added to your premium as your income increases. This is important to know so that you don’t forget to include it in your budget if it applies to you. Also, it’s good to know because you can possibly reduce or eliminate it if you plan. Remember what I said about tax planning? Here is where you can see a big impact. If you take steps now to reduce your taxable income later, you may not have to pay as much for your Medicare coverage.
4. Not Having A Withdrawal Plan
You’ve saved for retirement over the entire course of your career. You were careful to get every employer matching dollar you could. You’ve done well and now you feel like it’s time to hang it up, travel, play with the grandkids, climb Mt. Everest… just kidding.
So, how will you spend your savings to be able to live in retirement, while at the same time not running the risk that you run out of money too soon? There are a lot of good ways to handle this. The point is to make sure that you think this through so that you aren’t just winging it. Spend some time researching different withdrawal methods to understand the pros and cons of each so that you can figure out which you prefer and will work best for your situation.
- Maybe you want to have a few years’ worth of cash on hand so that you don’t have to worry about short-term market performance. That does protect you from short-term volatility. However, the more cash you hold, the lower your long-term expected return will be.
- You might follow a withdrawal rule of thumb like the 4 percent rule. This can be incredibly helpful, but does introduce some uncertainty and likely needs to be tailored to better fit you.
- Even still, you might want to create a bond ladder so that you know you’ll have a set amount maturing each year that you can spend. A strategy like this can reduce market uncertainty, but you have to carefully consider the effect of inflation over time.
There are many different ways to take withdrawals from your savings. I’m in no way suggesting these are the best or even that one of these is right for you because I don’t know you or your situation. These are just a few examples to help get your wheels turning.
5. Chasing Investment Returns
There’s a difference between saving for retirement when you are trying to accumulate a balance and living in retirement when your investments are supporting spending. Your investment plan should match that reality.
Even after you retire, your savings will still need to generate returns to support your retirement. However, you don’t need to go chasing investments solely for their potential to grow. That’s because there is a tradeoff between investment returns and risk. If you invest too aggressively, you may find that you are forced to sell investments at a loss in a bad year so that you can pay for food, utilities, and whatever else you need.
You can’t completely risk, but you need to consider risk in your investment plan. Sometimes it makes sense to dedicate a portion of your savings to investments that can provide a stable base to withdraw from (like the bond ladder I mentioned) while allowing your other investments to grow.
6. Not Knowing How Much To Save
The first step is simply knowing how much you need to save because it provides you with a target. A simple strategy for figuring this out is to work backward.
First, estimate how much you’ll need to spend each year. It won’t be exact, but think about how much you spend now, what you spend money on, and how you think that may change once you retire.
You can then figure out how much you’ll need to save so that you’ll be able to spend the amount you’ve planned for. Don’t forget to account for any spending that will be covered by Social Security or pensions.
I’ve spelled it out step-by-step in this article, as well as illustrated it with an example if you’d like further guidance.
Don’t get distracted by popular folk wisdom here either. “You need $2,000,000 to retire” or “You need 25 times your salary” are all just rough estimations that don’t at all take into account the many variables that differ from person to person.
You can find calculators online to help you such as this one from AARP.
Moving Forward, Think About Retirement
This is just a basic overview of some items that often catch people off-guard. While I call them “mistakes,” the reality is that a lot of people make them, so you are in good company. A lot of times, people simply don’t know these issues are present.
Regardless of your age or stage in life, when you first learn about them, you can start to correct any of these mistakes now and have a better plan going forward.
For more information on retirement, check out these articles: