How to Avoid Ruining Retirement
by Emma Snow
Copyright 2006 Emma Snow
Wealth seems to be everyone's dream; the ability to relax a
little more, to not stress so much about finances and to enjoy
the "good life." So often it is believed that wealth is only
attainable by those with large incomes. Those with smaller
incomes may not put anything aside, assuming such small savings
won't make enough of a difference in the long run. In my
experience in the financial services industry, there were
several times when I would help an elementary school teacher or
janitor with their sizeable 403(b) account. Obviously for them,
small savings over time made a big difference. In the same
category are those who have large incomes and assume they always
will. They constantly spend to the top of their income level and
set little or nothing aside for the future. Yes, I also remember
helping doctors or attorneys take loans out of their 401(k)
accounts. I found that it wasn't so much what you made but
everyday decisions that determined long-term success.
When I once asked a janitor of an elementary school how he had
accumulated his 1.7 million dollar 403(b) he said, "I just
started putting money into it when I first came to work here, a
little bit each paycheck." Now, 40 years later as he approached
retirement with a steady pension and a large 403(b) account he
was financially wealthy. Avoiding financial mistakes is the key
for anyone to retire well. This article lists some of those
mistakes and ways to steer clear of them.
Waiting Until You're 55
Not starting to save soon enough is number one on our list.
Beginning early to save for retirement can make a huge
difference in the long run. To illustrate this, let's assume we
have two people saving for retirement, we'll give them simple
names that correspond with the age they started saving, Mr. 25
and Mr. 45. Mr. 25 puts $3,000 into an IRA each year until he
retires at age 65. Assuming he gets an 8% growth rate on
average, he amasses $839,343 or almost a million dollars by age
65. If Mr. 45 were to put the same amount aside but start at age
45 instead of 25, he would only have $148,269 saved, definitely
not enough to start retirement with. For Mr. 45 to end up with
the same amount as Mr. 25 he would have to save almost $17,000
per year until age 65. $17,000 per year for 20 years equals
$340,000 cash out of pocket, whereas $3,000 per year for 40
years is only $120,000. Mr. 25 only had to save about one third
the amount Mr. 45 did all because he started early. Letting
compounding do the work for you allows you more money for other
things you want.
1% Is Enough, Right?
Putting aside too small a percentage of income is another
mistake people make. It may be difficult when just starting out
and times are lean, but you will thank yourself in the long run
if you make this a priority. Going back to Mr. 25 again from
above, if he would have only put away $1,000 each year, his
ending balance would have only been $279,781 in 40 years, again
assuming the 8% growth rate. We know how much $3,000 per year
would have saved him, but what about $6,000 per year? He would
have $1,678,686. Doubling his savings doubles his end result.
I'm a Millionaire!
Not realizing just how much needs to be saved in order to retire
is our next mistake. While the 1.6 million in the above example
may seem like a lot of money, it won't pay the bills in 40
years. Assuming prices go up by 3% each year, 1.6 million will
only have the buying power of a half a million dollars in 40
years when Mr. 25 wants to retire. Assuming Mr. 25 lives to the
ripe old age of 90, a 1.6 million dollar account will give him
about $2,300 dollars of income each month in real terms. This
assumes that he earns 6% on his money after he retires. Does it
seem odd that our 1.6 million dollars is now only worth $2,300
dollars per month? Inflation is the culprit. In actuality Mr. 25
will be getting about $9,800 dollars out of his account each
month in retirement, but because prices for everything will be
so much higher in 40 years it will only be able to buy the same
amount that $2,300 dollars buys today. This is what "real terms"
means. Mr. 25 will have to determine if $2,300 per month will be
enough to live off of in retirement. Most likely it will not be
enough unless he really likes ramen noodles.
Do I Get a Checkbook with my 401(k)?
Using Retirement Accounts as income before retirement is
becoming a mistake that more and more people are making. This is
especially true for those who have employers contribute to their
retirement accounts. While it is tempting to assume this is just
extra money you can spend, it has terrible long-term effects.
Taking as little as $5,000 out of your retirement account at age
30, is like taking out $35,000 in 35 years. If it would have
been allowed to stay in the account and grow over 35 years, it
would have accumulated to almost $35,000. The other problem is
that you will most likely have to pay taxes and a 10% penalty on
the money because it is being taken out before age 59 1/2. Now
to get $5,000 after the taxes and penalty, you have to take out
over $8,000, which would equal over $55,000 lost in 35 years.
I'm Sure my Basket Can Hold All of This
Not diversifying or putting all your eggs in one basket is
another financial blunder. I was a retirement specialist working
with 401(k) and 403(b) account owners when the market crashed in
1999 and 2000. How vividly I remember talking with people in
their fifties and sixties who in February of 2000 (right before
the NASDAQ started falling) wanted to put their entire
retirement account into technology. I discussed with them the
advantages of diversification especially in such a volatile
market. Some listened, but most didn't. The comment I remember
the most is, "I don't have enough money to retire so I need it
to grow really fast." The result was buying in at an all time
high and then either jumping out along the way down or riding
the market to the bottom. Those who stayed in for even a year
lost more than half of their retirement in a technology fund.
Compare that to those who were diversified across several
markets, domestic and international, and several types of
investments, equity, fixed-income and short-term. Someone in
their fifties, planning on retiring in 10 years would be
diversifying if they had about 60% in stocks and the rest in
bonds and money markets. This type of portfolio still lost money
during that volatile time, but not nearly as much as a
technology fund did. Those with a diversified portfolio lost
about 5-15% in that same time period that the technology sector
lost 50-65%. Trying to earn money for retirement by putting all
your eggs in one basket, especially when you are close to
retirement, is almost as risky as using the slot machines in Las
Vegas. If you are behind in your savings, your best bet is to
start contributing the maximum allowed and push back retirement
for a few more years.
Won't Uncle Sam Take Care of Me?
Relying solely on Social Security will leave you with little
income in retirement. In a message to the public issued by the
Social Security and Medicare Board of Trustees in 2005 they
stated, "We do not believe the currently projected long run
growth rates of Social Security and Medicare are sustainable
under current financing." They went on to say that without major
changes to Social Security, it will begin to fall short in 2017
and will only be able to fund 74% of benefits by 2041. The
suggested solution is to either increase taxes 15% or decrease
benefits 13%, neither of which are good for retirement. To
continue to live the same lifestyle that you are accustomed to,
saving for retirement is essential.
Another Trip to the Doctor?
Not preparing for healthcare in retirement is something that we
have recently had to think about. There is a good possibility of
Medicare not being able to meet our needs in the future or we
may need our own health insurance to carry us until Medicare
kicks in. Being prepared to pay for premiums or medical expenses
in retirement is becoming a necessity. A 2004 study found that
an average retiree spent 22% of their income on healthcare
costs. For someone on a $50,000 a year retirement income, this
equates to $11,000 per year. Take that over a 25 year retirement
and you are up to $275,000 for healthcare costs alone. Long-term
care such as nursing homes or in home assistance is another cost
that should be prepared for. With less and less employers
covering healthcare in retirement, this is another area that is
often overlooked when planning for the future.
Avoiding these financial mistakes will determine your quality of
life in retirement. The next step is to get started. There are
many brokerage firms that will educate you about your options at
no cost. They can help you open a retirement account or
determine if you are contributing enough to your current
retirement account. The can also help you decide on what types
of investments are appropriate given your age, timeframe and
risk tolerance. The most important thing to remember is that it
is never too late to start saving and even a little money set
aside makes a big difference in the long run.
About the author:
Emma Snow is a writer who specializes in financial planning. She
has worked in the financial industry for over eight years.