Time and again, we see clients face various problems with their retirement planning. Some of them approach us early enough for us to develop a comprehensive plan so they can avoid potential problems, while others end up learning these planning lessons the hard way.
From our experience in building over one hundred retirement plans for clients, we’ve identified the 3 most common mistakes that can potentially hinder your retirement goals. In this blog, we’ll dive into those mistakes and discuss simple strategies to avoid them so that you can achieve your ideal retirement.
Furthermore, we’ll highlight the tremendous value that lies in working with a ‘retirement-focused’ advisor like us – and how we help our clients navigate through their retirement journey.
Read on to learn how you can prevent the 3 biggest planning mistakes going into your retirement!
1. Not Separating Your Key Retirement Decisions
There are numerous factors that you should consider before rushing into any major retirement decision. It’s extremely important to analyze every aspect of your retirement individually before you integrate them into your overall plan.
This involves 2 key steps:
a) Separating retirement decisions between you and your spouse
Every commercial you see shows two people sailing on a boat or walking down the beach together. This creates a belief that you and your spouse must retire together to enjoy your life to the fullest. That’s not true!
You don’t necessarily need to follow the exact same retirement plan as your partner. In fact, we suggest doing just the opposite. By adopting varying strategies, it’s possible to maximize your combined retirement benefits.
For instance, let’s say you and your partner plan to retire together at age 65. Is it really a good idea for both of you to opt for Social Security at the same time? Probably not. If one of you takes Social Security at age 62, and the other takes it at age 68, you’ll likely be far better off.
The person with the lower benefit can take it three years early, resulting in an initial pay cut, and the person with the higher benefit delaying it by three years boosts their Social Security. In a way, one person going three years early and the other going three years later kind of just averages out to what you would have done, but here’s the catch: boosting the higher Social Security in the long run can be extremely helpful to the surviving spouse down the line.
b) Separating Social Security and pension decisions from your retirement decision
Most people say, “I retire today, so I should take my Social Security and pension today.”
Over the years, many people have learned how to time their Social Security right in order to maximize the benefits. However, they still end up making mistakes when it comes to pensions.
Pensions are designed to begin payments at the “normal retirement age.” Believe it or not, virtually zero people we talk to, advisors included, understand that you can likely take your pension at a different time than right after you retire, sometimes even if it’s past your “normal retirement age.”
We work with several publicly traded companies – such as AT&T, WE Energies, and Harley-Davidson – that offer various pension plans. Let’s assume that they set the normal retirement age at 65. If you retire early, you’re allowed to take your pension early. However, there’s a pay cut, which is usually 5% per year. This means that if you take your pension at 55, your pension amount is cut in half! If you do the math, then by allowing it to double by age 65, you’re essentially seeing a growth of 7% per year.
Every time we meet someone, we look at all their options to determine if it’s possible to take the pension early or even past the normal retirement age. To get a better perspective on this, let’s look at a real life example.
We recently worked with 2 employees from WE Energies. One of them had their pension maxed out at 65, while another employee still had room for massive growth, potentially 16% per year, by waiting for a few years.
If employees within the same company can have completely different pension plans, then how can you generalize that it’s best to take it immediately after you retire? That’s why it’s critical to separate your pension and Social Security decisions from your retirement date decision, and it’s so important to run the numbers instead of following the advice of coworkers.
2. Following the Crowd Instead of the Math
The best way to know whether a particular decision is right for you is to run the numbers. Always follow the math, not the crowd.
One of the most common trends we see is people choosing the lump sum payment from their pension instead of monthly payments, sometimes because everyone else is doing so. Sometimes, that might be right, but even then, you might be able to improve that lump sum payment by nearly thousands of dollars by simply waiting for a few months instead of taking it the day you retire..
In order to stop following the crowd and make better decisions, you need to understand and overcome the following:
a) It’s hard to turn down a huge amount of money
Given the option, whether you would like $2,500 monthly or $500,000 today, which one will you choose? Most likely the second one, right? However, that’s not really a fair comparison. It’s like comparing a ‘dollar’ amount with a foreign currency. You must translate it!
In order to make an accurate trade-off between the available options, you must convert the monthly payments to make it comparable with the lump sum amount. We often help our clients compute the ‘present value’ of all future monthly payments, and guess what? It often turns out to be significantly higher than the lump sum - we’ve even seen up to a 50% difference in some cases!
b) The fear of missing out
Many people have a fear that if something happens to them and their spouse, they’ll lose out on all future benefits. Having this fear is completely natural, but it can cause you to make some poor decisions with your money.
Many pensions have a rule that enables your beneficiary to collect the outstanding benefits if and when the need arises. For example, the public employee Wisconsin Retirement System provides a 15-year guarantee to government workers to ensure their benefits are not lost, but are transferred to their beneficiaries.
Even if your pension plan doesn’t involve any such guarantee, there’s a simple alternative – insurance. We recently helped a client hedge against such risk through term insurance at a cost of a few thousand dollars. This, in turn, helped them realize and feel confident in taking the benefit that was about $100,000 better!
c) If the advisor says so, it must be right
Have you ever wondered why most advisors usually insist on taking out the lump sum amount? There might be a hidden incentive for them!
If you take out the lump sum, then your advisor will get to invest that money on your behalf and earn commission payments. This might not be possible if you opt for the monthly payment instead.
We’re not suggesting that taking the lump sum is always wrong or that every advisor out there is unscrupulous. We only ask one thing from you – always run the numbers and make informed decisions based on what the math dictates instead of what the crowd is doing.
3. Ignoring Taxes
Ignoring the tax implications of your retirement decisions is a huge mistake.
There’s a lot of math that comes along with taxes. Your taxes could be wildly different based on whether you take out your money from IRAs and 401(k)s in December versus January. Additionally, depending on when you take Social Security, your taxes could range from being almost zero to nearly double your ‘tax bracket number!’
When you plan well ahead of time, there’s a lot that you can do to optimize your tax situation. From your Medicare premium costs to your required minimum distributions, you can minimize your effective tax rate in every area by having an efficient tax plan in place. For example, we have helped a lot of our clients save money in taxes through an effective charitable giving plan.
To dive into more details and gain a much deeper understanding about how your taxes work, check out our Blog: 5 Ways to Improve Your Tax Picture in Retirement.
The Value in Working With a Retirement-Focused Advisor
Recently, someone called us and said, “I want to work with you, but honestly, I’ve done it my whole life and I’m struggling to understand what the value of having an advisor is.” During that call, we were able to determine that there was a potential for saving at least $600 in yearly taxes by only asking a few basic questions!
For anyone wondering about what the value is in working with a retirement-focused advisor, allow us to do one of the following for you:
a) We can look at your tax return, conduct a tax analysis, and see if there's any way you can plan out your taxes better. We'll do it for free! We just want to make sure that you're aware of your opportunities.
b) If you’re struggling with a major pension decision, we can help you do a thorough evaluation by translating the monthly payment amount. This will help you make a fair comparison between the available options and make the right decision.
After that, you can decide if working with a retirement-focused advisor is valuable. If you choose to work with us further, we would love to explore other areas of your retirement to help you reach your ideal retirement.
If you’ve any questions on how to put your retirement puzzle together, feel free to contact us!