A Morningstar study showed that 45% of Americans leaving the workforce at age 65 are likely to run out of money. If you are a single female that number is 55%!
One half of new retirees will run out of money? How can that be?
1. Well, the obvious answer is they didn’t save enough! Now, while that is a major contributory factor, there are other factors. Even those that save enough, run a risk of living longer than their money. For many people, it is not about how much you save, but how you plan to use the money saved.
2. One of the biggest risks to retirement money is Sequence of Returns risk, which is when you withdraw money from your investments during a market downturn. If you experience a large downturn just before retirement or in the first couple of years after, it could be difficult to recover. However, by working with your financial advisor to coordinate the timeline of income and cash needs in your financial plan with your investment allocation, you can help mitigate much of this type of risk.
3. Many people underestimate the amount of taxes they will pay in retirement. For 50 years, the mantra has been put pretax money away now when you are in a high tax bracket so that you can take it out later when you are in a low tax bracket! My experience has been that people end up in the same or higher tax brackets in retirement, plus that taxable income versus tax free money from a Roth or HSA causes then to pay additional capital gains tax, social security tax and higher Medicare premiums.
If you are eligible for HSA, put the maximum in and pay your deductibles and copays out of pocket, letting the money grow tax free, and then reimbursing yourself for past expenses in retirement.
Utilize a Roth IRA or Roth 401K instead of a pretax contribution, so you grow your money tax free.
The farmer would gladly give up the tax deduction on his seed, to get the much higher harvest tax free.
Most people accumulate the same amount of money using a Roth as they doing a pretax account and they don’t have to share 15-34%, or more, with the IRS. The calculators assume you will invest the tax savings, people just don’t do that.
In addition, you can control when you take your money out as there are no RMDs and no impact on IRMAA (Medicare Part B) surcharges or impact on taxability of your Social Security.
4. I also find clients wanting to use their IRA money to pay their mortgage off or on other large expenses or purchases. This can cost a lot of extra taxes or acceleration in taxes and a loss of future tax deferred growth on the IRA or 401K.
5. One final note, many people don’t take enough investment risk while they are working. Either keeping their money in low return accounts or using a balanced approach with bonds and cash to limit short term volatility. When doing this it won’t grow enough to offset inflation. Historically, the long term return on a diversified portfolio of stocks have been very predictable and have done better than other asset classes that do not beat inflation. But the price we pay for that long term performance is short term volatility. Understanding that down years are normal and staying the course is important, investors have experienced returns that have beaten inflation.
I tell my clients, that 401K and IRA’s are long term investments and until you are about 10 years out from expected withdrawals, invest in stocks, stock mutual funds or stock ETF’s. At the 10 year mark, begin reallocating to match the future withdrawals needed based on your financial plan.
Retirement money is not an emergency/contingency fund and it is not for shorter term goals. Make sure you have money in shorter term allocations, such as cash, money market, CDs and bonds to meet these goals and needs.
So, make sure you are saving enough for future needs and goals, think about taxes and invest based on your financial plan.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. A Roth IRA offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal or earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes. The return and principal value of stocks fluctuate with changes in market conditions. Shares when sold may be worth more or less than their original cost. The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value. Bank certificate of deposits are insured by an agency of the Federal government and offer a fixed rate of return whereas both the principal and yield of investment securities will fluctuate with changes in market conditions. All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. Investors should consider the investment objectives, risks and charges and expenses of the fund carefully before investing. The prospectus contains this and other information about the funds. Contact the issuing firm to obtain a prospectus which should be read carefully before investing or sending money.