While many individuals have very realistic ideas about retirement, I find that some people may be significantly overestimating their preparedness for funding their financial needs. Here are three specific mistakes which can hurt your chance of success in retirement, and a realistic solution for each issue.
Mistake #1: Thinking you can live on a small fraction of your pre-retirement income.
Occasionally, I’ll meet someone who is currently making $100,000, but who thinks that they will need to spend only $40,000 a year in retirement to maintain their current lifestyle. On a closer look, they’re saving about $15,000 today so they are really living on about $85,000 a year. This is a key problem with creating a retirement budget: when we add up projected expenditures, it is very easy to underestimate how much we need because we often forget about unplanned bills like home and auto repairs, or medical expenses. And don’t forget about taxes! Taxes do not go away in retirement, either.
Realistic Solution: Even though some expenses will be lower in retirement, most retirees find that they need 75-90% of their pre-retirement income to maintain the same lifestyle.
Mistake #2: Taking too high of a withdrawal rate.
20 years ago, William Bengen published a paper that concluded that 4%, adjusted for inflation, was a safe withdrawal rate for a retiree. While this topic has been one of the most discussed and researched areas in retirement planning, most financial planners today remain in agreement that 4%, or very close to 4%, is the safe withdrawal rate. However, many individuals who have a million dollar portfolio think that they might be able to take out $60,000, $70,000, or more a year, especially when the market is performing well.
There are two important reasons why it’s prudent to use a more conservative 4% rate. The first is market volatility. The market is unpredictable, so we have to create a withdrawal strategy which will not excessively deplete the portfolio in the event that we have large drop, or worse, a several year bear market at the beginning of a 30-year retirement. The second reason is inflation. We need to have growth in the portfolio to allow for the increased cost of living, including the likelihood of increased medical costs. At just 3% inflation, $40,000 in expenses will double to $80,000 in 24 years. And with today’s increased longevity, many couples who retire in their early 60’s will need to plan for 30 years or more of inflation in retirement.
Realistic Solution: At a 4% withdrawal rate, your retirement finish line requires having a portfolio of 25 times the amount you will need to withdraw in the first year.
Mistake #3: Assuming that you will keep working.
Some people plan to keep working into their 70’s or don’t want to retire at all. They love their work and can’t imagine that there would ever be a day when they are not going to be working. They plan to “die with their boots on”, which in their eyes, makes retirement planning irrelevant.
Unfortunately, there are a number of problems with this line of thinking. The Employee Benefits Research Institute 2014 Retirement Confidence Survey found a significant gap between when people planned to retire and when they actually did retire. Only 9% of workers surveyed plan to retire before age 60, but 35% actually retired before this age. 18% planned to retire between 60 and 64, versus 32% who actually retired in that age range. The study cites three primary reasons why so many people retire earlier than planned: health or disability, layoff or company closure, and having to care for a spouse or other family member. The study also notes that one in 10 workers plan to never retire. Even if you’re willing to keep working, the statistics are clear: most people end up retiring earlier than planned.
For a healthy 65-year old couple, there is a good chance that at least one of you will live into your 90’s. If you still think you don’t need a retirement plan because you will keep working, do it for your spouse, who might have 25-plus years in retirement if something were to happen to you. Don’t make your plan’s success dependent on your being able to keep working in your 70’s and 80’s.
Realistic Solution: Make it a goal to be financially independent by your early 60’s; then you can work because you want to and not because you have to.
A comprehensive financial plan addresses these concerns and establishes a realistic framework for funding your retirement. And whether you’re 30 or 60, it is never too early, or too late, to make sure you are on track for financial independence.