There are three big financial mistakes that we see a lot of retirees make. In this post, I want to share these mistakes with you. Then I’ll let you know how to avoid unnecessary worry about the success of your plan. The good news is that you can avoid these mistakes and it doesn’t have to take much extra work. Just being aware is the first step.
As you start to plan for retirement, you’re making a big transition from the saving stage to a withdrawal stage. And that alone is a big adjustment. It can be hard to get used to withdrawing money from these accounts where you had been saving for the last 30 or 40 years. With that in mind, let’s jump into the mistakes that we see when new retirees are setting up withdrawal plans.
Following Rule-of-Thumb Assumptions
The 4-Percent Rule
This can be a great way to get an idea of what’s reasonable and sustainable and how much you can withdraw. But when you get serious about planning, this is not the best way to plan your withdrawal strategy.
If you assume 4 percent is coming out, what happens if there are a few bad market years? When you retire, the amount that you were assuming you’d take out, based on 4 percent, could actually be quite a bit higher. The dollar amount stays the same, but if there’s a market dip, the withdrawal percentage is going to increase. Now, the 4-percent rule does say that it’s supposed to account for market fluctuations, but we’ve actually seen retirees who are planning on retiring based on this rule and decide to work a few extra years during a bad market because of the worry that it brought.
This is actually related to another mistake that I’m going to bring up later, so stay tuned. But those who prepare for retirement using a bucket approach, or by assigning a purpose to each account, are much more confident in their plan, even during scary markets.
The Order Of Withdrawals
The rule of thumb says to take from your non-retirement accounts first. Then start Social Security when you’re not working any more, whether you’re under your full retirement age or not. And then the assumption is, don’t spend your IRA or your 401k money until you need to. Whether that’s when you need the money or when you get to the Required Minimum Distribution age, which is 72, currently. When we run the withdrawal models for our clients, we almost always see that following this order leads to paying higher taxes over the span of the rest of their life. There are ways around paying more tax than necessary in retirement. That’s why the tax plan is such a key part when we’re planning for our clients.
Waiting Too Long To Start Withdrawals
Like I said above, it’s common for people to believe that they should use their non-retirement and Social Security before the pre-tax money like 401ks and IRAs. And I understand that if you’ve got tax-deferred money, it seems to make sense. Why not keep it in the tax-deferred account so you don’t have to pay tax on it right now?
The issue is that you could be setting yourself up for more taxes over the rest of your life. When we model this out for our clients, depending on how much they have in IRAs or pre-tax monies, many of them are actually moving to higher tax brackets in their seventies because of the Required Minimum Distribution. It doesn’t seem right. But because the RMD amounts are going up as you get older, the amount people have withdraw goes up and the amount they have to pay on taxes goes up, shooting them into higher tax brackets. It also affects Medicare premiums because how much you pay with Medicare has to do with how much taxable income you have.
What if you don’t need the money from your IRAs because expenses are low? Talk to your retirement planner about Roth conversions. That could be a good way to reduce future tax bills. There are really a lot of factors here when it comes to the retirement plan. If your advisor is only talking about investments with you, and they’re not looking at all these different scenarios and models and they don’t specialize in retirement, please reach out to me. I’d be happy to talk with you.
Not Planning For Unexpected Withdrawals
Imagine that you’re planning on using a 4 percent withdrawal rule. What happens if the unexpected comes up? The unexpected expense, or worse, a series of unexpected expenses over a couple of years, can really put a dent in your withdrawal plan. In this scenario, the advice is to think about marking a certain amount that is set aside from your withdrawal plan, kind of like a retirement income insurance plan. It’s just there; it’s conservative monies that are available. If the unexpected comes up, you’ve got the withdrawal plan working, and then you’ve got this side fund. That’s one way to think about it. One strategy that actually has this built in is the Three-Bucket Strategy, which could be helpful as you’re starting to talk with financial professionals and see if it could make sense for you. Click here to see a video that explains the Three-Bucket Strategy further.