5 Mistakes Investors Make When Planning for Retirement

May 31, 2024
Estimated Reading Time: 8 Minutes

Retirement planning is a crucial aspect of financial management that promises peace of mind and security in your golden years. Yet, despite its importance, many people find themselves unprepared and stressed as they approach retirement age. According to the National Institute on Retirement Security, 55% of working age Americans are concerned that they cannot achieve financial security in retirement. And over 20% of US adults say that their biggest financial regret is not saving for retirement early enough.

In this article, we'll explore 5 common mistakes when planning for retirement and provide practical advice on how to avoid them. By understanding these pitfalls, you can take proactive steps to ensure a financially stable and fulfilling retirement.

5 Mistakes When Planning for Retirement

Mistake #1: Underestimating Expenses & Not Saving Enough

Many people underestimate the amount of money they will need when planning for retirement, even if they started saving early. They do not save enough or fail to invest their savings wisely -- for example, they may rely on low-interest savings accounts instead of diversified investment portfolios for their retirement savings, which can lead to insufficient growth of retirement funds. They also might not regularly review and adjust their retirement plans based on changes in economic conditions or personal goals, and many people fail to account for the long-term effects of inflation, which can significantly erode purchasing power over time.

Additionally, many individuals have an optimistic bias when planning for retirement, believing that they will need less money than they actually will. They might assume they will always be healthy, that unforeseen expenses will not arise, or that their expenses will drastically decrease in retirement. However, while some costs like commuting may reduce, others such as travel, hobbies, and leisure activities can increase, which could make maintaining their lifestyle more expensive than they anticipated.

Underestimating expenses and not saving enough can lead to financial stress and the need to make difficult lifestyle adjustments. Retirees may have to cut back on activities, travel, or other aspects of their desired lifestyle, which could reduce their overall quality of life. Without adequate planning, retirees might deplete their savings too quickly, leaving them vulnerable in their later years.

To avoid making this mistake, it's essential to plan thoroughly and consider all potential expenses, including taxes and the impact of inflation. Consider seeking professional advice on realistic projections and strategies to ensure adequate retirement savings and to regularly review and adjust your plan.

Mistake #2: Making Poor Investment Choices & Failing to Diversify

Investment choices and failing to diversify can also have an impact on an individual's retirement plan. Making overly conservative or overly aggressive choices can jeopardize retirement savings, and putting all retirement savings into one type of investment or asset class can be risky.

This mistake could be due to a variety of factors. Investors could be engaging in emotion decision-making or overestimating their investment knowledge and ability, which could lead them to take on too much risk or to make speculative investments without adequate research. Or they could be influenced by the media and investing trends. The media often highlights trending investments, such as an exciting over-leveraged hedge fund, which can cause people to invest in these popular stocks or sectors without fully understanding the underlying fundamentals or looking for other opportunities. Poor investment choices could also be a function of chasing past performance or only concentrating on familiar investments. Investors often chase past performance, assuming that a previously successful investment will continue to perform well. This could lead to buying into overvalued assets, missing out on opportunities in undervalued ones, or concentrated risk.

Along with increased risk, poor investment choices and failing to diversify could lead to lower overall returns, which could jeopardize retirement goals. Poorly performing investments may also cause financial stress and anxiety, and a lack of diversification may necessitate significant lifestyle adjustments in retirement due to insufficient funds.

To avoid these pitfalls, consider consulting with a financial advisor to help you develop and stick to a long-term investment plan that includes regular rebalancing and avoids emotional decision-making. They can also help you diversify your portfolio across different asset classes and conduct regular reviews to adjust your portfolio so that it aligns with your risk tolerance, goals, and changing market conditions.

Mistake #3: Not Having a Withdrawal Plan & Ignoring Tax Implications

Having a withdrawal plan helps ensure that an investor's savings and investments last throughout their retirement years while also minimizing the amount of taxes paid over time. However, many retirees are unaware of Required Minimum Distributions (RMDs) for tax-deferred accounts like traditional IRAs and 401(k)s, leading to unplanned and potentially substantial tax consequences. The rules surrounding RMDs are complex, and retirees may not know when they must start taking RMDs or how to calculate them.

This mistake can lead to monetary consequences in the form of penalties and tax inefficiencies. Without a structured plan, retirees may withdraw from accounts in a tax-inefficient manner, leading to a higher overall tax liability. Withdrawals before age 59 ½ from some accounts, such as a traditional IRA or traditional 401(k), typically incur a 10% penalty plus ordinary income tax, with some exceptions. Additionally, for traditional IRAs and 401(k)s, investors must start taking RMDs based on the year in which they were born. Failing to take RMDs can result in significant penalties, creating unforeseen expenses in retirement. This mistake could also result in the rapid depletion of retirement savings, inconsistent income, or missed opportunities for strategic moves, such as Roth conversions or tax-loss harvesting, that can optimize retirement finances.

To avoid these consequences, consider having a withdrawal plan in place. Understand the difference between taxable, tax-deferred, and tax-free retirement accounts, and map out which of these you're going to make withdrawals from at different points in your retirement. Make sure that your plan includes RMDs and implements tax-efficient strategies (such as Roth conversions, asset allocation, and Qualified Charitable Distributions) to help reduce your overall tax liability.

Mistake #4: Overlooking Long-Term Care Needs & Not Accounting for Healthcare Costs

Healthcare costs in retirement are a significant concern for many individuals as they plan for their post-working years. These costs can be substantial and may increase over time due to inflation and increasing medical needs as people age. According to Fidelity Investments' 2023 Retiree Health Care Cost Estimate, a 65-year-old who retired in 2023 could expect to spend an average of $157,500 in healthcare and medical expenses throughout retirement, assuming the retiree is enrolled in traditional Medicare.

A Brief Overview of Medicare

  • Eligibility: Most Americans become eligible for Medicare at age 65.

  • Coverage Parts:
    • Part A: Hospital insurance, usually premium-free if you have paid Medicare taxes for a certain period.
    • Part B: Medical insurance, covering doctors' visits, outpatient care, and preventative services, with a monthly premium.
    • Part C (Medicare Advantage): Optional plans offered by private companies that combine Parts A and B and often include additional benefits.
    • Part D: Prescription Drug Coverage, requiring a separate premium.

  • Supplemental Insurance (Medigap): Additional insurance to cover costs not included in Original Medicare (Parts A and B), like copayments, coinsurance, and deductibles.

Long-term care (LTC) needs are another consideration for older adults and their families. A 65-year-old has an almost 70% chance of needing some type of LTC services and support in their remaining years.

Although these are two important factors to consider when planning for retirement, they are often overlooked due to:

  • Misunderstanding Medicare and Medicaid: Many people mistakenly believe that Medicare will cover most or all of long-term care expenses. In reality, Medicare provides limited coverage for long-term care, typically only for short-term skilled nursing care following a hospital stay. Medicaid does cover long-term care, but only for individuals with very low income and assets.
  • Underestimating Costs: Premium payments for Medicare Parts B, C, D, and Medigap, deductibles and copayments, and coinsurance are all out-of-pocket costs that some people underestimate when planning for retirement. On average, retirees might spend around $4,500-$6,000 per year on these costs. Additionally, people often underestimate the high costs of LTC services, which can vary widely based on the type of care, location, and level of service required.
  • Optimism Bias: Many people are overly optimistic about their future health and underestimate the likelihood of needing long-term care. This optimism bias leads to a tendency to believe that they will remain healthy and independent throughout their retirement years.

To avoid making this mistake, it's important to plan ahead. Start saving early and consider health savings accounts (HSAs) if eligible, which offer tax advantages for medical expenses, or use tax-advantaged retirement accounts to save for future healthcare expenses. Additionally, strengthen your understanding of Medicare. Research and choose the right Medicare plans that fit your healthcare needs and budget, and consider Medigap or Medicare Advantage plans for additional coverage. Lastly, consider purchasing long-term care insurance. Although this type of insurance can be expensive, it is designed to help cover costs of nursing homes, assisted living, and in-home care, which can reduce the financial burden of LTC.

Mistake #5: Lacking an Estate Plan

Estate planning involves more than just drafting a will; it includes setting up trusts, designating beneficiaries (such as a spouse, children, or charitable organization), and planning for incapacity through powers of attorney and healthcare directives. While saving for retirement is critical, focusing solely on accumulating assets without considering how they will be distributed or managed after death through an estate plan can undo decades of careful planning.

Insufficient estate planning can lead to intestate succession -- if an individual dies without a will, their assets will be distributed according to state intestate laws, which may not align with their wishes. This could lead to public family disputes, unintended beneficiaries and years of legal fees. Lack of estate planning could also result in higher estate taxes and probate fees, as well as mismanagement of assets. Without a clear estate plan, the probate process can be lengthy and complicated, delaying beneficiaries' access to funds and assets.

A comprehensive financial plan can help evaluate these potential risks. Investors who want to address these risks should seek out professionals whom, as part of their planning, routinely include outside professionals such as estate attorneys to create a comprehensive retirement plan. Utilize wills, trusts, powers of attorney, healthcare directives, and beneficiary designations to clearly outline your wishes, minimize estate taxes and probate fees, and provide for your loved ones. As these values evolve, your plan should as well.

Consider revisiting your retirement plan.

A well-thought-out retirement plan is essential for ensuring financial security and peace of mind later in life. By avoiding common mistakes such as underestimating expenses, neglecting healthcare costs, and failing to diversify investments, you can set yourself up for a more comfortable and worry-free retirement. A financial advisor can help you regularly review and adjust your plan to accommodate changes in your financial situation and goals.

If you'd like to learn more about the retirement planning services we provide for our clients, you can contact one of our advisors here.

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