Considering a Google search for “retirement” produces 1.4 billion results, it should not be a surprise to learn that there’s an overwhelming amount of incomplete or incorrect information on the Internet purported as fact. The truth is that there’s rarely a one-size-fits-all answer to personal finance questions. Even guidance that applies to most Americans today will have several notable exceptions…all of which are almost certainly going to change, even over a few years.
While some retirement planning questions are known to be situational, there are others that are too commonly taken to be fact. Here are six such retirement planning myths that need to be debunked.
Myth #1: Before you can retire, you need to have at least $___ saved
No matter what number you fill in the blank with, it is pretty much going to be wrong. Here’s why: being able to retire isn’t about achieving some arbitrary savings goal–it’s about having saved enough to maintain your desired lifestyle in retirement. In another words, how much you need savedin order to retire is driven by how much you plan to spend during retirement, not the other way around.
If you’ve ever wondered how some people can retire in their 40s, there’s a good chance the success of their plan hinged on very low annual expenses versus a massive nest egg.
Myth #2: Retirees typically need 70% to 80% of their pre-retirement expenses
Another retirement income myth is that retirees will have lower expenses than they did during their working years or are generally willing to do without some of the creature-comforts they have grown accustomed to. While it is true that when individuals stop working they no longer have to pay payroll tax or make 401(k) contributions, there’s a misconception that those ‘savings’ won’t be absorbed by travel, leisure activities, and so on.
When planning for retirement, most individuals want to maintain their current standard of living, not do without. For affluent individuals with high incomes and comparable expenses, replacing annual earnings requires a significant and ongoing dedication to savings in order to support the same lifestyle in retirement.
Myth #3: Maxing out annual 401(k) contributions is all you need to do to save for retirement
As discussed in myths one and two, most investors want to maintain their current lifestyle into retirement. Although contributing the maximum to an employer-sponsored retirement plan like a 401(k) is a great way to build wealth and reduce your taxable income in the current year, individuals with high incomes typically cannot retire with their desired lifestyle on these savings alone. In 2019, investors under age 50 can contribute up to $19,000 and those age 50 and over can add up to $25,000 per year. Even with a long time horizon until retirement, 401(k) savings alone likely can’t replace a six-figure income.
Here’s an example: Bree is 35 and saves $19,000/year in her 401(k), increasing at 3% per year until she retires at age 65. Her account earns an average return of 6% each year. Bree expects to live until age 90 with a 20% average tax rate in retirement. Based on these figures, Bree’s 401(k) could provide just over $39,000 in annual after-tax income in retirement (in today’s dollars) which would increase 3% each year.
Investors looking to save and invest beyond their 401(k) should consider a brokerage account. In addition to boosting retirement savings, a brokerage account offers several other benefits, including flexibility and tax diversification.
Myth #4: If you haven’t saved enough, you can always work longer or get a part-time job in retirement
Although it may be possible to continue working until age 70 or beyond, there are two common external factors outside of your control that could dampen your plans. Unforeseen changes to your health (or a spouse’s) may inhibit your ability to continue working, whether in your regular occupation or in a new one. The risk is increased for individuals in occupations where there is a physical component and/or inability to work remotely (e.g. doctors or nurses, tradespeople, professor, etc.) as either an illness or physical ailment could prevent you from performing the core functions needed for your job.
Even if you are in good health, there’s always the possibility of company layoffs or downsizing. It is not uncommon for the most long-standing employees to also be the most senior, commanding some of the highest wages. If the company is experiencing financial difficulty, everyone’s job security is called into question.
Finding part-time work in retirement can also prove challenging. Retirees often find well-paying part-time jobs few and far between or more demanding than the one-day-a-week schedule they envisioned. Particularly for retirees leaving successful careers, an entry-level part-time job at the local mall just isn’t on the table.
Myth #5: You shouldn’t retire until your mortgage is paid off
Pre-retirees are often hesitant to carry debt into retirement, but the leverage can pay off if you have an attractive interest rate. Whether you’re considering downsizing and buying your new home with cash or prepaying the loan on your current home, weigh the benefits of being debt-free with the opportunity cost of not having the cash available for other purposes, such as adding to your investment portfolio. If your expectation of investment returns going forward is greater than the interest rate on your mortgage, it may be advantageous to invest the cash and obtain a loan.
Other considerations include: how long you plan to live in the home, potential tax benefits of a mortgage, any additional cash needs you foresee, and what other financial resources you may have to bridge the gap if needed. Every investor needs liquid assets, and that flexibility is worth something.
Myth #6: At retirement, your investments should become very conservative
It’s not uncommon for individuals to feel hyper-sensitive to market volatility after retiring. And it’s easy to see why: after bringing in an income for the last four or more decades, the idea of tapping your financial reserves can be unnerving. Conventional advice often says to significantly increase your exposure to bonds at retirement, but that isn’t always appropriate for every investor.
People are living longer–which usually means a retirement portfolio must last longer too. Fixed income investments (e.g. bonds) are considered safer than equity investments because they tend to be less volatile and provide retirees with guaranteed income through a coupon payment. However, with less risk comes less reward, as evidenced by the low yields over the last ten years. As new retirees look for ways to take some risk off the table, they should also consider what investment return they require to meet their income needs for the years to come.
Financial planning and investment advice must be highly personalized to each individual’s situation and goals. The availability of benefits like a pension or a windfall from an inheritance can significantly alter an individual’s finances, and with it, the recommended course of action. Before taking any broad-based retirement planning advice to heart, work to understand the underlying rationale and assumptions to help ensure it is appropriate for your circumstances. Also keep in mind that tax laws and financial strategies shift over time–even year to year. To help ensure you stay on track for retirement, you will want to periodically review your current strategy, including your spending and savings rate.
Originally seen on Forbes.com