To have a successful and secure retirement, you’ll want to avoid these eight retirement planning mistakes:
1. Underestimating your needs. The average person will need to replace 80% to 90% of their preretirement income in retirement.
2. Overestimating your ability to continue working. People frequently retire early, often for good reasons. Unfortunately, there are also negative reasons (such as having to leave the workforce due to health reasons, loss of job or having to take full-time care of a spouse or elderly parent). A good retirement plan considers contingencies, including the need for disability insurance.
3. Becoming too conservative with your investments. Unfortunately, too much of a “safe” thing may not be safe because of the risk of inflation, especially for those with pensions without inflation adjustments. While the return on bonds can be eroded by inflation, stocks provide better long-term protection against the risk of unexpected inflation.
4. Underestimating your tax rate. People often assume that their tax rate in retirement will be lower than actually proves to be the case.
5. Failing to provide for a spouse. Couples should take into account that upon the first death, Social Security benefits will be reduced. While living expenses may be reduced, the reduction in income should also be considered. And employees working for companies with traditional pension plans often fail to consider the surviving spouse when deciding on pension payout options. If you are married and have a financial adviser, talk with him or her about this.
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6. Taking retirement withdrawals from the wrong locations. The rule-of-thumb approach for the most efficient order of withdrawals from retirement savings is to first draw down the taxable accounts, then the tax-deferred accounts —such as a traditional individual retirement account and 401(k) — and finally the nontaxable accounts (Roth IRAs). As with any rule-of-thumb, this may not be applicable to your specific circumstances. Talk to your tax professional about this.
7. Underestimating the importance and need for diversification. When approaching or entering retirement, we often make the mistake of believing that our horizons are too short to diversify our stock holdings to such asset class as small-company stocks, international stocks and emerging market stocks. However, diversification across non-highly correlating asset classes is the winning strategy no matter what the investment horizon. Diversification across equity (stocks) asset classes is actually more important as the investment horizon shortens. This is because any asset class can underperform by a very large amount over even fairly long horizons, let alone over relatively short ones. Diversification reduces the risk of any single asset dragging down the portfolio.
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8. Underestimating the risks of inflation. The impact of inflation can be devastating. Historically, the rate of increases in wages has exceeded the inflation rate. So, while employed, the risk of rising inflation is not that great. However, once we enter retirement, the risks of inflation increase. One reason is that Social Security benefits are indexed to inflation, not to the cost of living of retirees, which tends to increase faster. For example, historically, the cost of medical care has historically risen at a faster rate than overall inflation.