7 Traps That Could Sabotage Your Retirement Plan
Not having a Plan & Not Seeking Professional Advice
Having a vision of your ideal retirement plan complete with target date is wonderful, but to what end if you haven’t taken the necessary steps of building an actual retirement plan? Making contributions to your 401(k), 403(b) or IRA is also great, but if you haven’t taken the time to determine how much you will need based on what you want to accomplish or reviewed and explored the impact the choices of today will have on your ability to meet your future goals, what is the point? Without a financial plan you are, throwing darts at a moving target in pitch black conditions.
We spend so much of our time meeting deadlines, racing to drop kids off at their extra-curricular activities, fielding phone calls, doing chores, and just trying to keep up with the daily grind. It is no wonder that most “can’t see the forest for the trees.” That is why working with a certified financial planner is crucial. They have the time and tools necessary to get a 360-degree view of your entire financial landscape. Through industry knowledge and strategic planning, they link each area of your financial life together and ensure they are working in concert for optimal results.
Your financial health is like your physical health. The human body is comprised of ten body systems that all work together to keep you healthy and alive. Each body system relies on the others to work well. For example, your respiratory system relies on your circulator system to deliver oxygen it gathers, while the muscles of your heart cannot function without the oxygen they receive from your lungs. By working together, these systems maintain internal stability and balance. Because these systems are interconnected, if something goes wrong in one system, this state of homeostasis can be disrupted and cause trouble in the other systems. The same can be said for your financial life. Tax planning, estate planning, risk management, cash flow planning, retirement planning and investment planning are all interrelated and dependent upon one another. A problem in one area can have a significant impact on another. A certified financial planner can help clients see the big picture and make choices that will position them for achieving their goals. Whether it is looking for ways to lessen a tax burden, choose the optimal Social Security claiming strategy, decide which pension payout to choose, design an investment portfolio or create a drawdown strategy for retirement, financial planners have a specific set of skills aimed at working through these issues.
Financial planners can also provide guidance on what if scenarios and contingencies. Below are a few examples of questions people have asked when working with a certified financial planner:
- How much money will I need in retirement?
- Can I buy a second home at the beach when I retire?
- If my spouse wants to go part-time now, how will this impact our retirement plans?
- What is the impact of staying in my current home or down-sizing in retirement?
- What are the tax consequences of me taking distributions now?
- How much am I giving up by taking my Social Security at age 62 versus waiting until later?
Spending Instead of Saving
Fear of missing out (FOMO) or keeping up with the Jones syndrome has become the norm for many. Unfortunately, this has created an environment where credit cards are the rule rather than the exception and being overleveraged is just our society’s way of life. Learning to temper your buying impulses is vital to your financial health and future. If you are always living beyond your means, you are in a constant state of stress and the hole you are in will get deeper and deeper until you can no longer escape without outside help. Try to avoid revolving debt as much as you can. Interest rates will eat you alive. Create a list of your monthly expenses, then categorize them into columns of needs, wants and wishes. Shoot for 50% to go towards your needs (mandatory expenses), 30% to wants and 20% to paying off debt and adding to savings. Then track your progress month to month.
Providing Financial Help to Family/Friends
You have a heart of gold but that will not help you if you’ve depleted your retirement savings to provide support to friends or family. Providing monetary support on a long-term basis to others can cause severe damage to your retirement savings. According to a report by Savings.com and Pew Research Center, half of parents with a child over 18 provide them with at least some financial support. Young adults who have recently graduated and moved home with parents spiked in 2020 reaching a historic high, and 62% of those adults do not contribute to household expenses at all, according to this report. Almost one in five adult children who receive financial support were found to be over the age of thirty. Roughly 43% of parents said they have sacrificed their own financial security for the sake of their children. Of the parents still in the workforce and providing money to their adult kids, the average person spends 23% more on their children than on their own retirement contributions. Whether this is support for education loans, housing, mandatory expenses like groceries and utilities, vacations or weddings, the result on your finances is the same. So, while your heart is in the right place, your actions could have negative repercussions.
The earlier you start making contributions to your retirement accounts, the better your chances of reaching your retirement goals. This is a function of compounding, which is when an investment earns a return and the gains on the initial investment are reinvested and begin to earn their own returns. Two individuals could add the same amount to their retirement plan accounts for the same number of years, but the individual who started contributing at an earlier age will end up having more by retirement. For example, at age 25, Andrew started contributing $1,000/month in an investment account where it accrued at a rate of 7%. Becky started contributing the same amount at age 35 where it accrued at the same rate. They both saved for ten years. Both saved the same amount of $120,000 over the same period of ten years, but the ending balance was dramatically different. Andrew ended with $1,444,969 and Becky ended with $734,549. That is the power of compounding! So, start early and increase your contribution rate every year if you can. At the very least, contribute enough to take advantage of any employer matching opportunity. For example, if your employer matches 100% of your contribution, up to 5% of your salary, then you should contribute at least 5%, thereby making your total contribution rate 10%. Why wouldn’t you take advantage of free money?
Withdrawing Money Early
Withdrawing money from retirement accounts prior to age 59 ½ has severe consequences, unless you fall into one of the exceptions (first time home buyers, qualifying education expenses or qualifying medical expenses exceeding a certain percentage of your adjusted gross income). There are some additional rules that, at times, allow for penalty-free hardship withdrawals such as being laid off or fired from a job. For everyone outside of these exceptions, if you choose to withdraw money early, the IRS typically slaps a 10% penalty on you when you file your tax return. That could mean handing the government 10% of the withdrawal amount in addition to paying ordinary income tax on that money. If the withdrawal increases your income to the point that you are in a higher tax bracket, your tax rate could increase, and you may have fewer deductions and credits you can claim. You are also missing out on the investment returns you could have earned if you had left the money in the account.
Being Too Conservative
When planning for long-term goals such as retirement, a certain degree of risk is required. If you are not earning at least the inflation rate annually, you are losing purchasing power over time, which can erode your assets. Sequence of return risk is also a concern, which is when you withdraw too much from a portfolio when the market is trending down. This hurts the future potential growth of the assets. Stock funds will fluctuate more in the short-term than bond funds, but they are more likely to deliver higher returns over time. The average return on the S&P 500 has been about 10% going all the way back to 1926. There are various options available to investors ranging from conservative to aggressive. Working with a financial advisor can help you determine the right mix of investments and proper allocation for you based upon your risk tolerance, time horizon and goals. As you age, these investment tools and your overall allocation will change to reflect your current situation.
Relying Too Heavily on Social Security
Most retirees will need anywhere from 70% to 80% of their former income to maintain their standard of living. If you are an average earner, your benefits may take the place of about 40% of your former wages. For higher earners, Social Security will replace even less of your income, creating a substantial shortfall. Another matter to keep in mind is that while the chances of Social Security going away is extremely slim, benefit cuts are a real possibility due to the baby boomers leaving the workforce in droves in coming years. The cost-of-living-adjustment (COLA) has been generous as of late, but that is in large part due to high inflation. This won’t last forever. Relying on Social Security for some of your income is fine but relying on it as the primary source of income will get you into trouble. Educate yourself on Social Security.
Retirement is supposed to be a time of enjoyment; one you have worked a long time to secure. Don’t let these seven traps sabotage it.
CNBC. (April 2022). Half of parents till financially support their adult children, study shows
Money.U.S.News.com. (September 2019). 5 Consequences of an Early 401(k) Withdrawal
Marketwatch.com. (July 2022). Scared of stocks?
The Motley Fool. (February 2022). 3 Reasons You Can’t Rely Too Heavily on Social Security
Main Street Advisors, LLC. November 2022. Main Street Advisors, Inc. is a Registered Investment Advisor. The articles and opinions expressed in this material were gathered from a variety of sources, but are reviewed by Main Street Advisors, LLC, prior to its dissemination. All sources are believed to be reliable but do not constitute specific investment advice. The views expressed are those of the firm as of November 2022 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice. Any advice given is general in nature and investors must consider their own individual situation. Always contact your financial/investment professional before making any financial decisions. Main Street Advisors, LLC is not responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.