No retiree can afford to make these financial mistakes.
In the previous article, we discussed the 13 biggest money mistakes people make in different stages of their lives. While debilitating, many people who make major money mistakes before retiring still have time to recover from it, and hopefully save up enough for a passable retirement.
However, the same cannot be said for retirees who are no longer producing income actively. One major mistake can wipe out the entire retirement fund and ruin years of savings, not to mention a terrible quality of life during your golden years.
It’s important not to mess up.
13 Biggest Money Mistakes Retirees Make
Edward Wacks, a CPA and CPF affiliated with Ameriprise Financial, said the following, “If you have children who fail a class, they can retake it. If they fail the driving test, they can still retake it. But there’s no do-over in retirement, and that’s why it’s critical to make good financial decisions.”
There’s no do-over in retirement.
Today, let us examine the biggest money mistakes one can make during retirement and how to avoid them.
Mistake 1: Falling For Fraud and Scams
For some reasons, scammers love older adults. Even though individuals aged 60 and above make up just 15% of the U.S. population, they account for 30% of financial fraud victims.
A study done by researchers at the Georgia Institute of Technology found that older adults are significantly worse than younger people at detecting whether someone who may have stolen money is telling the truth.
Be skeptical when it comes to investments and understand an investment thoroughly before you commit into it. Ask questions and research about it online.
Sniff out potential Pyramid and Ponzi schemes, and do not invest if you do not understand fully how the investment works.
Mistake 2: Cash Out Pension Too Early
A financial adviser may persuade you to cash out your pension, perhaps by suggesting that you can put your money into an investment vehicle that promises a higher return.
When given a chance, 56% of respondents choose to cash out pension as a lump sum, according to the study by Employee Benefit Research Institute.
While it may be a smart move if you have immediate financial needs such an urgent medical problem, it is generally not advisable to give up your pension for “something better”, such as a variable annuity plan.
Over the long term, you’ll have a hard time matching what a pension would pay, let alone beating it. Keep in mind that some advisers may earn a hefty commission by convincing you to convert your pension fund into an annuity plan endorsed by him/her.
Mistake 3: Not Turning Assets into Predictable Income
During your retirement, having a predictable source of income is more important than asset appreciation.
Many retirees still fixate on investment returns even during retirements. While that is not wrong, you should plan a way to cash out on the investments you have been contributing for your whole working life.
If you want to stay invested, having a 4% annual withdrawal rate is a good way to sustain your lifestyle for the entirety of your retirement. If you need $30,000 each year, aim to have a nest egg of $750,000 in investments by the time you retire.
Those looking for more security will want to keep a pension or buy a bond that provides a predictable income.
Mistake 4: Spending Too Much Too Early
Cindy Rogers, 49, a retiree from Verizon said she was told by her adviser that an annuity would provide enough income to cover her expenses, with the principal lasting her lifetime.
With Roger’s $3,700 monthly payout, she was withdrawing her savings at 8% per annum, twice the amount recommended for retiree at age 65, let alone someone who’s 49. Including fees, she was depleting her nest egg at 11% yearly.
Eventually, she lodged a complaint to Financial Industry Regulatory Authority (FINRA) for the bogus calculation.
The danger of early retirement is that it’s based on misleading calculations, so do your math before you decide when to retire, and how much to withdraw.
Mistake 5: Rolling into Self-Directed IRA Uninformed
A self-directed IRA is an individual retirement account that lets you invest in pretty much anything, including real estates, limited partnerships, and gold. Unlike traditional IRA, you are not limited to just stocks, bonds or mutual funds.
While it sounds good on paper, rolling into self-directed IRA uninformed can be dangerous. Self-directed IRAs can hold exotic assets, which IRA administrators don’t vet through. This can expose you to risky pitches and questionable investments.
In 2013, Curtis DeYoung, founder of American Pension Services, convinced multiple retirees to “take control of your own destiny” with a self-directed IRA. At end of 2013, his 5,500 strong client pool had $352 million in self-directed IRA accounts.
A lawsuit filed by Securities and Exchange Commissions (SEC) against Curtis claimed that he steered $24 million in clients’ money into worthless real estate investments, siphoned another $4.5 million to friends, and paid himself over half a million dollars salary per year.
Mistake 6: Not Being Tax Efficient During Retirement
If you have multiple retirement accounts, you need to realize that each retirement account is taxed differently.
That is to say, if you don’t strategically withdraw your expenses from each of the accounts, you may pay more in taxes than you need to.
The general consensus is to take out your least expensive assets first, namely the assets that don’t earn as much in growth and interests paid, as well as the non-taxable assets.
As this is a more complicated strategy, you may want get your trusted financial adviser to evaluate your situation and formulate an optimal withdrawal strategy.
Mistake 7: Supporting Your Adult Working Children
It is not uncommon for retired parents to continue to help their children financially, even though they are already working adults.
Many retirees make it a habit to provide money gifts to their children in the form of down-payment for a new home, or as college funds for their grandchildren.
One child may be worse off than the others, so the retired parents feel obligated to help them more. However, after some time, the parents may feel the need to give an equal amount to their other children out of fairness.
The thing is, the retirees are unable to replace their income while the working children can earn more money to cover their expenses. What the retirees can do to help is not to provide the children money gifts, but to instill proper money management mindset for the children to take care of their finances properly.
Mistake 8: Having Too Much of Your Net Worth in Your House
Many retirees have invested much of their net worth in the equity of their home, making them house-rich and cash-poor.
A house is generally an appreciating asset, but it costs the retirees too in terms of real estate taxes, utilities, services, home repairs and maintenance.
If you are in this situation, consider down-sizing since your children have most likely moved out from the residence. You can free up a significant portion of your equity and invest them into predictable income source such as bonds to supplement your retirement lifestyle.
You can also consider taking a reverse mortgage if you are unable to downsize and require some supplementary income. However, you should seek proper counseling and realize that taking up a reverse mortgage and tapping into your equity is not advisable if you plan to leave your real estate to your family member someday.
Mistake 9: Applying for Social Security Too Early
Although you are eligible to apply for Social Security starting from age 62, you will get a reduced benefit if you go for it right when you hit 62.
Compared to getting the Social Security at your full retirement age of 66, you will get 25% less if you apply for it at age 62. Conversely, if you delay it to age 70, your benefit rises another 32%.
Therefore, if you haven’t applied for your Social Security retirement benefits and you’re not in need of it urgently, you can delay your application beyond your full retirement age (66) to increase your delayed retirement credits.
Keep in mind that the benefit increase is maxed out at age 70, and will not increase further even if you continue to delay taking benefits.
Mistake 10: Withdrawing All Investments From Equity Market
Some retirees want to “safeguard” their hard-earned money and withdraw all their investments because it’s risky to leave it in the equity market.
While financial security is the top priority during retirement, getting all your investments out of the market isn’t exactly safe either.
Many retirees choose to keep their money in savings accounts, money market accounts and short term certificates of deposit (CoD) that earn a very low rate of return.
Although your money is not subjected to the irrational market swings, your buying power is slowly eroded by inflation and taxes over the years. It is always recommended to keep a portion of your fund in the equity market to take advantage of long term appreciation of the market.
Mistake 11: Overreacting to Bear Markets
Too many investors, retirees included, overreact to bear markets. After suffering huge market losses during subprime mortgage crisis in 2007-2009, many people sworn off equity market altogether.
However, in the long run, the equity market recovers and appreciates. For retirees who depend on investment returns to fund their lifestyle, it is naturally not recommended to place a significant portion of their net worth in the equity market.
The proportion of investment allocation between equity and bonds can be adjusted as we age. As a rule of thumb, having bond funds with the same percentage as your age is a standard guideline for asset allocation.
For example, a retiree at age 60 can choose to have 60% of his investment assets in bonds, and 40% in fully-diversed equity market. For more conservative investors, he can choose to have 80% in bonds and 20% in equity.
Having some investments in equity is good even during retirement to boost after-inflation returns. A mere 20% invested in equity market can boost annual returns by 50% compared to having an all-bonds portfolio.
Mistake 12: Not Diversifying Investments Properly
Some retirees may be awarded a large position in the stock of a former employer and constitute a large portion of their retirement portfolios.
Investors who have made money from a single stock or similar risky investments may be reluctant to sell, in order to avoid paying capital gain tax on their profits. Even if the investments are not performing well, many investors are unwilling to sell hoping that it will appreciate soon.
Either way, holding on to single stock, or even several stocks and depending on them to fund your retirement is a very risky maneuver. If you use your investments to fund your lifestyle, you should at least diversify your portfolio using low cost mutual funds to minimize your risk.
Mistake 13: Not Accounting For Expenses Change in Retirement
As a retiree, some of your costs go down – such as food, clothing and entertainment expenses. You have most likely paid down your mortgage too, so a lot of retirees estimate a very low month allowance during retirement.
But many people fail to account for other expenses, such as healthcare and long term care (even nursing home) for themselves and their spouse.
A recent study by Fidelity reveals an extra healthcare cost of up to $220,000 in retirement for couples retiring before age 65, while most couples near retirement estimate it to be $50,000.
If you did not account for healthcare and long-term care expenses, it’s about time you talk to your trusted financial planner to work out some realistic numbers into your retirement planning.