About 45% of Americans will run out of money in retirement, including those who have invested and diversified. These are the 4 biggest mistakes that are made.
Some wealthier millennials and Gen Zers are saving too much for retirement.Getty Images
Nearly half of Americans who retire at age 65 are at risk of running out of money, Morningstar finds.
Single women have a 55% chance of running out of money, more than single men and couples.
Experts recommend better tax planning and diversified investments to limit retirement risks.
If you’re planning to retire at the standard age of 65, buckle up, because you’re definitely going to want to hear this one.
According to a simulated model that takes into account things like changes in health, nursing home costs and demographics, about 45% of Americans who leave the workforce at age 65 are likely to run out of money during retirement.
The model, created by Morningstar’s Center for Retirement and Policy Studies, showed that the risk is higher for single women, who had a 55% chance of running out of money, versus 40% for single men and 41% for couples .
The group most susceptible to ending up in this situation are those who haven’t saved for a retirement plan, said Spencer Look, the center’s deputy director. Yet retirement advisors say even those who think they are prepared are not.
It’s a big deal, says JoePat Roop, the president of Belmont Capital Advisors, which helps clients set up income streams for their retirement years. What may surprise many is that one of the biggest mistakes people make isn’t so much about how much they save, but about the way they plan around what they save.
To be more specific, Roop says what catches retirees off guard taxes and the lack of planning around them. Many assume that they will fall into a lower tax bracket once they stop receiving a salary. But his experience shows that retirees often remain in the same tax bracket or can even end up in a higher tax bracket.
“It’s wrong in so many ways,” Roop said. After retirement, most people’s spending habits stay the same or increase. When you have more free time, more money goes toward entertainment and travel, especially in the first few years after retirement. The result is a higher withdrawal rate, which can put you in a higher tax bracket, he noted.
People spend their careers investing in a 401(k) or an IRA because they allow pre-tax contributions. It sounds like a great benefit if you can reduce and defer your taxes. The downside is that withdrawals will be taxed.
His solution is to add a Roth IRA, an after-tax account that allows profits to grow tax-free. This way, during a year when you need to withdraw a higher amount, you can resort to that account, he noted.
Another big mistake people make is… Pumping money around in an inefficient way causing them to pay more taxes than they should, or lose out on future returns. This could include the choice to withdraw a large amount from an investment account to pay off a mortgage or buy a house.
“There are rules that the IRS has put in place for us, and they are there to pay for the government, not you,” Roop said.
A good example of a big tax mistake that one of Roop’s clients (let’s call him Bob) recently made was liquidating part of an IRA to buy a house.
Bob is a man of modest means who is retiring this year, Roop said. But a sudden breakup with his girlfriend led him to cash out part of his IRA to buy a house. He decided to withhold the tax, which could have been between $30,000 and $40,000.
“When he told us this, my jaw dropped,” Roop said. “I said, Bob, you had the money for the down payment in another account that wouldn’t have been taxed, and we were going to roll over your IRA and put it in a tax-deferred account.”
In this case, Roop planned to transfer money from Bob’s IRA into an annuity that would have given him a 10% or $15,000 bonus. The mistake could cost Bob between $45,000 and $55,000, between the taxes owed and the missed bonus.
The lesson: don’t be Bob.
The next big mistake is sequence riskthat is when you withdraw from your portfolio when the stock market falls.
“The S&P 500 has averaged almost 10% over the past fifty years,” Roop said. “And so it is a correct assumption that this will probably be between nine and eleven percent over the next fifty years. But as people retire, we don’t know the sequence of returns.”
Simply put, if you retire next year with an investment portfolio worth $1 million and the market falls 15% that year, you now have $850,000. If you have to pull back during that time, it will be very difficult to get back to breakeven, Roop said.
It means that owning stocks and bonds does not provide enough diversification. He noted that you should also have something that is principal protected, such as a CD, fixed annuities or government bonds. This way you can avoid touching your portfolio during a bad market period.
Gil Baumgarten, founder and CEO of Segment Wealth Management, says another big reason he sees people running out of money is the lack of appropriate risk taking they earn during their earning years.
A low-risk approach is to earn interest on cash, a terrible form of compounding because it is taxed higher than regular income with a lower return, he noted. Meanwhile, stocks can earn higher returns and aren’t taxed until they’re sold, or aren’t taxed at all if you choose a Roth IRA.
“People don’t take into account how expensive things become over time, and don’t realize that they can live another 40 years in retirement. You can’t get rich if you invest your money at 5%,” Baumgarten said.
As for those who do take risks, it’s often the wrong kind of risk. They chase hype and bet on highly speculative investments. They end up losing money and assume the risk is bad, Baumgarten said. The right kind of risk is higher exposure to equities through mutual funds or index funds and even buying blue chip stocks, he noted.
