Financial Pitfalls to Avoid for Retirement
LeConte Wealth Management Offers Answers to Questions about Retirement
Alcoa, Tenn. – It soon will be two years since the primary trauma of the current recession took hold, and many retirees – as well as those who have not yet retired but are of retirement age – are still reeling from the damage inflicted to their nest eggs.
Alcoa-based LeConte Wealth Management conducted a survey of East Tennesseans in February of last year, just as the reality of the recession’s long-term economic impact was sinking in for consumers.
When asked about their confidence in meeting or maintaining their retirement goals, 49 percent of East Tennesseans ages 35 and up indicated decreased confidence, with 41 percent of retirees citing decreased confidence.
At the national level, the nonprofit, Washington, DC-based Employee Benefit Research Institute released its 20th annual Retirement Confidence Study for 2010 in March, citing that while “Americans’ confidence in their ability to retire appears to be stabilizing . . . their self-described preparations for retirement continue to erode.”
The report found that a growing number of U.S. workers report that they have “virtually no savings and investments,” with more than half of workers (54 percent) reporting that “the total value of their household’s savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000.”
The study also reported that one-quarter of workers indicated plans to postpone their planned retirement age, and among the reasons, “the poor economy,” “a change in their employment,” “inadequate finances,” and “the need to make up losses in the stock market.”
As recovery from the recession continues to plod along with very modest, incremental gains, LeConte Wealth Management responds to several retirement-focused questions that the firm is routinely asked by clients and other East Tennesseans:
Q: What are the top three financial mistakes retirees make?
1. Spending too much and depleting savings early — The biggest question on the minds of our retired clients when we first meet is, “Do I have enough to last?” In the absence of a formal retirement distribution plan, a simple rule of thumb is to access no more than 4 percent per year from investments to make sure the goal of outliving savings is achieved. For example, if a retired couple has $3,000 in monthly Social Security, and an $800,000 nest egg, they should likely withdraw no more than $2,600 per month from savings. That would give them a total of $5,600 in monthly income.
2. Overlooking health care costs – The healthcare landscape may be changing in America, but it is unlikely to become any less expensive. Pre-retirees tend to underestimate how much they are likely to have to spend on healthcare in retirement. Several examples are retiring early without a plan to bridge the gap until Medicare eligibility at 65, not accounting for supplemental insurance needs beyond Medicare coverage and the likelihood of requiring eventual nursing care. Accounting for these costs should be part of every pre-retiree’s target budget.
3. Investing too aggressively — When a person goes from building savings to accessing income in retirement, their portfolio should become fairly conservative. That is because a severe market decline, like 2008, can permanently compromise a retiree financially. Take the above example of a couple who rely on the portfolio to generate $2,600 per month. If their investments lose 20 percent of their value that could translate to more than $500 in potentially lost monthly income.
Q: Why do you think some people do not plan or plan inadequately for retirement? What are the most common reasons you see?
LWM: In short, it’s often fear of the unknown. When people are afraid of the answer to a question, they may not ask the question. Many people don’t know what their retirement will look like, and they are afraid they will not have enough money to support their retirement. They also may be afraid that if they seek advice from a professional, they will be sold a financial product they do not understand or will not help them reach their retirement goal.
Q: What should a basic retirement plan include? What questions should it answer?
1. Projections – How much income can I reasonably expect from my investments? Retirement projections are number-crunching exercises that allow a person to see the effects of longevity, inflation, taxes and investment performance on retirement income with the objective of determining how much income one can count on from a portfolio. Be aware of assumptions that seem overly optimistic, like aggressive investment returns or unrealistic inflation and tax rates.
2. Investment Allocation – How should I be investing across all of my accounts? At LeConte, we spend a lot of time talking about the difference between a “collection of securities” and a “purpose-built portfolio.” Where the “purpose” is retirement, the investments should be allocated to take as little risk as necessary to ensure not just that it meets your income needs now, but that it will continue to do so for the rest of your life.
3. Distribution Plan – How do I access my investments for income? This final piece involves the logistics of creating your retirement paycheck. It determines when and from which accounts to take money and should address any tax ramifications.
Successful retirement income strategies have four ongoing objectives:
1. Provide the cash flow necessary to maintain your lifestyle.
2. Maintain an appropriate investment allocation to optimize risk-adjusted return.
3. Minimize tax liability.
4. Ensure the sustainability of your retirement income through your lifetime.
Q: What are some common regrets that you see retirees having?
LWM: It all funnels back to a lack of competent advice and guidance. Common regrets include: “If I had known what a difference in income it could have meant, I would probably have worked for one or two more years”; “I lost so much money in 2008; I didn’t realize how much risk I was taking with my portfolio”; and “I bought an investment without understanding all of the details, and now I am having trouble getting anyone to explain it to me.”
Q: When should people start planning for retirement?
LWM: The short answer is if you plan to retire, you should be planning for retirement now.
Q: How important is it for couples to agree on a retirement plan?
LWM: It is very important and often overlooked by financial advisers as a necessary first step in retirement planning. Many pre-retired couples are surprised to find that their conceptions of retirement differ dramatically. We encourage clients to take a step back and think more conceptually about how they envision their retirement, rather than beginning with number crunching, investment allocation or distribution rates. Consider the following fundamental questions:
• Where do we want to live?
• How will we spend our time?
• What continuing family obligations, either to children or parents, will we have?
• Are there special things like travel or hobbies that you’ll want to pursue immediately, but probably not for the duration of your retirement?
Q: What are common sources of income during retirement?
LWM: Social Security, pension and savings are common retirement income sources.
Retirees can be divided into two main groups, those with and those without pensions. For those with pensions, the security of their retirement income is provided by that pension benefit from their employer. Fewer companies provide pension benefits, and thus, a greater number of retirees will be responsible for creating their own retirement security.
For those without pensions, they must rely on their savings to provide income beyond Social Security. This makes it imperative to have a well-developed plan in place to avoid overspending or taking too much investment risk, which can lead to running out of money.
Q: Are there any common scams (current or past) that retirees should be aware of to avoid, based on your knowledge?
LWM: Any financial strategy should have a clear connection to maintaining retirement security and avoiding unnecessary risk. For example, although a reverse mortgage might be suitable for an elderly person desperately in need of supplemental income, taking out a mortgage to invest its proceeds is virtually never an advisable practice. An investment product or strategy may very well be a scam if there is obscurity in how it works or how the person selling it to you is compensated.
Q: Would you suggest that retirees downsize liabilities/cut expenses after retirement?
LWM: We suggest that no one should retire before securing conservative projections of how much they should be spending in retirement. Then, it’s critical not to overspend.
One emerging trend that may spell trouble for pre-retirees is their continued reliance on home equity to finance more than their home. The genesis of the 30-year mortgage decades ago was predicated on the assumption that homeowners would pay off debt on their homes before they retired. The aftermath of our recent credit binge has unfortunately left many homeowners carrying staggering amounts of mortgage debt into retirement.
As debt relates to retirement planning, one should consider the effects of continued mortgage payments in retirement on reduced levels of income. Conventional advice suggests that any major debt like auto loans, home mortgages or even large credit card balances be paid off before retiring.
Q: What are your thoughts on retirees working part-time?
LWM: Just as working for the same company for 30 years has become an antiquated notion, so has the “clocking out, forever-and-always” retirement. We have found that some clients make a healthier transition to retirement (financially, emotionally and lifestyle-wise) by gradually reducing their work schedule and responsibilities. One client affectionately called it his “full time, part time, no time” transition.
And while more common among small business owners or solo practitioner professionals, it also has become the reality for those who may have lost their jobs in the past two years. For those not quite ready to retire, working part-time, contracting with a previous employer or doing some freelance work may provide the extra time their portfolio needs to grow or bridge the gap until Social Security eligibility.