As you near retirement, it becomes clear the responsibility for most aspects of your financial life will fall squarely on your own shoulders. The paychecks you earned will now be replaced by the paychecks you create. For most, those paychecks will need to last for years and cover various expenses throughout our retirement.
Unfortunately, the mistakes you make with your retirement income can have devastating consequences for even the best laid plans.
Consider these four common mistakes to avoid:
Mistake #1: Not Having a Budget Specific to Retirement
This may seem obvious, however, it’s probably much more common than you realize. When teaching retirement courses, I ask our students how many have formalized budgets as their guide to track monthly expenses. I’m always shocked by how few actually have anything more than a budget “in their head.”
Many of those who do have something in place did not make the appropriate adjustments for retirement. Using old assumptions like “you will only need 80%” of your pre-retirement income can be dangerous, especially if you plan to be more active in those early years. Take time to understand what your fixed monthly expenses will be once you retire, along with your anticipated discretionary spending for things like travel, leisure or just spoiling the grandkids.
Without a clear budget, how will you (or your financial adviser) be able to make some of the most important retirement decisions you face, such as when to begin taking Social Security benefits, choosing the right pension elections or determining what mix of investments, insurance or banking products are appropriate for you? The answer is you CAN’T.
Mistake #2: Not Having a Written Income Plan
A written income plan is a MUST. Similar to a budget, most people never have an actual income plan during their working years because their paycheck was their income plan. Earning money and accumulating wealth is often the primary focus throughout our careers. In retirement, the responsibility now falls on you to create your own monthly paycheck from your basket of resources, including Social Security benefits, pensions, CDs, investments, annuities, etc.
A well-designed written plan should bring clarity as to when, how much and from which sources income is needed to cover fixed expenses and discretionary spending. It should also identify what percentage of your fixed monthly expenses will be covered by fixed sources of income, such as Social Security and pension, sometimes referred to as your Income Security Score. The goal should be to get this score as close to 100% as possible to avoid your monthly income being dependent on market performance.
Just like a retirement budget, a written income plan will help you make better decisions about the timing of taking retirement benefits and best combination of investments and insurance products to fill in any gaps or shortfalls.
Mistake #3: Co-Mingling Your Money
The idea of separating your money based on its purpose works in concert with creating a written income plan (see above). As your written plan begins to take form, you should be able to identify gaps, such as the amount of your monthly expenses that are not covered by fixed sources of income, such as Social Security and pensions. Combined with your other retirement needs and desires, you can now begin to allocate your resources appropriately based on purpose.
The visual of a house can demonstrate this concept:
In this example, there are three areas with different purposes, typical to many retirees.
- The foundation represents safety and would include things such as your Social Security benefits, pensions, CDs and annuities. It’s from this segment you should create your monthly income.
- The walls of the house could be dedicated to things such as health care and inflation and could include using tools like alternative investments, real estate or life insurance.
- The roof represents the growth piece of retirement and may be dedicated to market-based investments, such as stocks, mutual funds or ETFs.
REALIZE that how much is allocated to each section is completely different for everyone. For example, retirees whose benefits include multiple sources of fixed income may dedicate more of their money to risk-based solutions, compared with someone whose only source of guaranteed income may be from monthly Social Security. A lack of guaranteed* monthly income may require more to be allocated to different tools such as CDs or annuities. There is never a one-size-fits-all solution.
Mistake #4: Taking Regular Distributions from Fluctuating Accounts
This is probably the most dangerous thing a retiree can do when creating monthly income, because they are now at the mercy of the returns in the market and something called sequence of returns risk. This is all about the order in which the market returns hit your portfolio once you retire. It’s random and unpredictable and can have devasting consequences if left to chance, as this example** shows.
These two portfolios are exactly the same except the order of actual market returns was reversed in the second example. It’s here that you can see the importance of separating your money by purpose to avoid relying on recurring distributions from something so random. This is certainly one of the biggest risks many retirees will face during their retirement but often one of the areas most often left to chance.
Avoid these common mistakes to enjoy all that your retirement can offer!