Advertisement
Financial Planning

3 Most Dangerous Myths of Retirement Planning

Rules of thumb may be a good place to start, but they shouldn't dictate all your retirement plans.

Recently I was talking to a good friend of mine, who is in his early fifties, about his retirement planning. I asked him how prepared he was. Here is what he said:

"I am all covered. I will retire at 65. I expect my retirement expenses to be 70% of my pre-retirement expenses. I will have saved up $1 million by the time I retire. I will invest this money in a portfolio of stocks and bonds with my stock allocation equaling 100 minus my age. Once I retire, I will start drawing 4% from my portfolio each year, which will comfortably cover my retirement needs."

Advertisement - Article continues below

I then asked him a follow-up question about how he plans to cover his long-term care needs. "I do not think I will require such care, but if I do—I will cross the bridge when I get to it," he said.

Lastly, he summed up his understanding of Social Security, claiming that his benefits will be tax-free.

In that one discussion, my friend helped me identify the three most dangerous myths of retirement planning. Let us discuss.

Myth 1: Retirement planning is all about following a set of magic numbers.

Let's take a look at a few:

1) the official retirement age is 65; 2) you should save $1 million in your retirement nest egg; 3) plan to withdraw about 4% a year from your retirement portfolio; 4) estimate your retirement budget as a percentage of your pre-retirement expenses; and 5) you can calculate the right asset allocation of stocks for you by subtracting your age from 100.

Advertisement
Advertisement - Article continues below

These rules are an excellent way to do a quick check on where you stand with respect to your retirement readiness. But they are no substitute for a customized plan. Here's why they may not work for you:

Advertisement - Article continues below

Rules of thumb assume retirement periods. Most rules of thumb are based on an assumption that an average retirement will last approximately 25 to 30 years. In this day and age, in which people are living much longer thanks to advances in medicine and increased awareness regarding nutrition and fitness, how real is this assumption? Do you feel secure by planning for a retirement that lasts just 25 to 30 years? Perhaps not!

Implementation of the 4% withdrawal rule is difficult. This rule suggests you take out 4% of the retirement savings in the first retirement year and adjust the withdrawal amount each subsequent year for inflation. If you do this, the rule claims, you have a high assurance that your retirement nest egg will last 30 years.

Also, to be successful, the rule expects you to stick to the plan firmly throughout its implementation. Is this practical? For example, what happens if you have a huge health-related expense or an unexpected home repair in a particular year? What happens if you wanted to make some unplanned gifts to your grandchildren in a given year? How do you manage your distributions in such situations?

Advertisement - Article continues below

In fact, it is a well-observed fact that retirement expenses in real life tend to fluctuate much differently than what the inflation adjustment dictates. Accordingly, the 4% rule is hard to implement in reality!

Advertisement
Advertisement - Article continues below

Your retirement budget is sure to be different from your pre-retirement budget. For example, expenses related to your kids, work and mortgage might decrease significantly in retirement while expenses related to healthcare, travel, leisure and entertainment might increase. In other words, planning your retirement budget as a percentage of your pre-retirement expenses is nothing more than a very general approximation.

The asset-allocation rule is outdated. It suggests that you decrease the stock allocation of your portfolio and increase your share of so-called safe investments (such as bonds or certificates of deposit) as you age. The rationale was two-fold: 1) As you age, you have less time to grow your money or to recover from a loss, and 2) the "safer" investments are safe, yet provide better returns than inflation.

Advertisement - Article continues below

However, times have changed since the rule first came into style. These days, people are living much longer, and bonds and CDs are not as rewarding as they once were. Following this rule for your retirement plan in current times could put you in the danger zone of outliving your portfolio. Not an ideal plan obviously!

Rather than blindly following these general rules of thumb, you're better off figuring out the numbers and plans that best fit your specific situation. Develop a customized retirement budget with a detailed breakdown of expected expenses. Based on that budget and your life expectancy (which you can estimate using calculators such as the livingto100 calculator), calculate what you'll realistically need for your retirement nest egg (as opposed to shooting randomly for an even $1 million). Finally, seek professional help for your retirement portfolio management and distribution needs.

Myth 2: Long-term care may not be necessary, and I will cross that bridge when I get to it.

According to a U.S. Department of Health and Human Services report, 70% of people turning age 65 can expect to use some form of long-term care during their lives. Also, the cost of a semi-private room in a U.S. nursing home average $82,125 a year, according to Genworth.

Advertisement - Article continues below
Advertisement
Advertisement - Article continues below

Based on this data, a couple planning for retirement, and assuming three years of long-term care for each, should plan to set aside close to $500,000 just to cover their long-term care needs.

That is a lot of money. If you are at all serious about having a secure retirement, procrastinating on the long-term care decision is a bad idea!

In order to help you make the decision, here are a couple of options you could consider:

  • Plan to self-fund long-term care expenses, and save additional money in your nest egg.
  • Consider purchasing a long-term care policy. Depending on your tax situation, the premium towards the policy could offer you a limited tax break.

Myth 3: My Social Security benefits are always tax-free

If you are in the camp that thinks Social Security benefits are never taxed, wake up. This is, in fact, a myth.

Up to 85% of your benefits could be taxed, based on your other retirement income. In other words, you could get away with paying no taxes at all if your non-Social Security income is low enough. For example, if you are married and filing jointly, and your adjusted gross income plus your tax-exempt interest income plus half of your Social Security benefits equals less than $32,000, then you owe no tax. On the other hand, if your income is above this threshold, the tax you owe is based on a complex calculation found in the worksheets of this IRS publication 915.

That said, here is some good news: No matter what your income is, the maximum you will be taxed is 85% of your benefits. The other 15% is tax-free. To that extent, Social Security is tax-advantaged, but not tax-free.

So, what do you think? I hope this gives you enough food for thought and helps you to become more serious about your retirement planning.

Vid Ponnapalli is the founder & president of Unique Financial Advisors. He provides customized financial planning and investment management solutions for young families with children and for professionals who are approaching retirement. Ponnapalli is a Certified Financial Planner™ with an M.S. in Personal Financial Planning.

Advertisement

About the Author

Vid Ponnapalli, CFP™, MS, EA

Founder & President, Unique Financial Advisors

Vid Ponnapalli is the founder and president of Unique Financial Advisors. He provides customized financial planning and investment management services for Generation X professionals. Ponnapalli is a Certified Financial Planner™ with an M.S. in Personal Financial Planning. He is an Enrolled Agent (EA), licensed to prepare tax returns and represent taxpayers before the Internal Revenue Service. Ponnapalli is a current active member of the National Association of Personal Financial Advisors (NAPFA), the Financial Planning Association (FPA), XYPN (a financial planners network focused on Generation X and Generation Y clients) and National Association of Enrolled Agents (NAEA).
Advertisement

Most Popular

What Trump's Payroll Tax Cut Will Mean for You
Tax Breaks

What Trump's Payroll Tax Cut Will Mean for You

President Trump issued an executive order to suspend the collection of Social Security payroll taxes. How much will it save you?
August 10, 2020
7 Surprisingly Valuable Assets for a Happy Retirement
happy retirement

7 Surprisingly Valuable Assets for a Happy Retirement

If you want a long and fulfilling retirement, you need more than money. Here are the most valuable retirement assets to have (besides money), and how …
August 3, 2020
How a Second Stimulus Check Could Differ from Your First One
Tax Breaks

How a Second Stimulus Check Could Differ from Your First One

The HEROES Act, which the House passed in May, would authorize another round of stimulus checks. While the new payments would be similar to the first …
August 11, 2020

Recommended

Drawing Down Retirement Savings in a Pandemic
Coronavirus and Your Money

Drawing Down Retirement Savings in a Pandemic

Tapping the right accounts at the right time matters. Knowing how much a retiree can spend each year without running out of savings in old age is even…
August 7, 2020
20 Dividend Stocks to Fund 20 Years of Retirement
dividend stocks

20 Dividend Stocks to Fund 20 Years of Retirement

Each of these high-quality dividend stocks yields roughly 4%, and you can expect them to grow their payouts even more. That's a powerful 1-2 combo for…
August 5, 2020
Calculating Taxes on Social Security Benefits
social security

Calculating Taxes on Social Security Benefits

Uncle Sam can tax up to 85% of your Social Security benefits if you have other sources of income, such as earnings from work or withdrawals from tax-d…
August 4, 2020
The Joys of Being Retired
Empty Nesters

The Joys of Being Retired

More freedom, being able to give back, and time to deepen relationships are common themes in your e-mails.
July 30, 2020