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Nearly half of Americans who retire by age 65 are at risk of running out of money, according to Morningstar.
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Single women have a 55% chance of running out of money, a higher rate than single men and couples.
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Experts advise better tax planning and diversified investments to mitigate retirement risks.
If your goal is to retire at the standard age of 65, buckle up because you’ll want to hear this.
According to a simulated model that takes into account factors such as health changes, nursing home costs and demographics, about 45% of Americans who leave the workforce at age 65 are likely to run out of money in retirement.
The model, conducted by Morningstar’s Center for Retirement and Policy Studies, showed the risk is highest for single women, who have a 55 percent chance of running out of money, compared with 40 percent for single men and 41 percent for couples.
According to Spencer Look, associate director of the center, the group most likely to end up in this situation are those who have not saved for a retirement plan. But retirement advisers say that even those who think they are prepared are not.
It’s a big problem, says JoePat Roop, president of Belmont Capital Advisors, who has been helping clients set up income streams for their retirement years. What may surprise many is that one of the biggest mistakes people make has less to do with how much they save and more to do with how they plan their savings.
To be more specific, Roop says what takes retirees by surprise is Taxes and the lack of planning around themMany people assume they will be in a lower tax bracket once they stop receiving a paycheck. But in their experience, retirees often stay in the same tax bracket or may even end up in a higher one.
“It’s a mistake in many ways,” Roop said. After retirement, most people’s spending habits stay the same or increase. When more free time is available, more money is spent on leisure and travel, especially in the early years of retirement. The result is a higher withdrawal rate, which can push a person into a higher tax bracket, he said.
People spend their working lives investing in a 401(k) or an individual retirement account (IRA) because they allow contributions to be made before taxes are paid. It seems like a great advantage to be able to reduce taxes and defer them. The downside is that withdrawals will be subject to taxes.
His solution is to add a Roth IRA, an after-tax account that allows earnings to grow tax-free. That way, during a year when he needs to withdraw a larger amount, he can tap into that account, he said.
Another big mistake people make is moving money inefficiently This leads them to pay more taxes than they should or to lose out on future earnings. This may include the decision to withdraw a large amount of money from an investment account to pay a mortgage or buy a house.
“There are rules that the IRS has set for us and they are there to pay the government, not you,” Roop said.
A clear example of a major 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 prompted him to withdraw 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 where there wouldn’t have been any taxes, 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 paid him a 10% bonus, or $15,000. The mistake could cost Bob between $45,000 and $55,000, between the taxes owed and the uncollected bonus.
The lesson: don’t be Bob.
The next big mistake is sequence riskwhich is when you withdraw money from your portfolio when the stock market goes down.
“The S&P 500 has had an average return of about 10% over the last 50 years,” Roop said. “So it’s a safe guess that over the next 50 years it’s probably going to return 9 to 11%. But when people retire, we don’t know the sequence of returns.”
Simply put, if you retire next year with a $1 million investment portfolio and the market drops 15% that year, you now have $850,000. If you need to withdraw money during that time, it will be very difficult to break even, Roop said.
This means that owning stocks and bonds isn’t 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 time in the market.
Gil Baumgarten, founder and CEO of Segment Wealth Management, says another big reason he sees people running out of money is the Lack of adequate risk taking that they make during their income-generating years.
A low-risk approach is to earn interest on cash, a terrible form of compounding because it is taxed more than ordinary income and generates less of a return, he noted. Stocks, meanwhile, could generate higher returns and pay no taxes until sold — or no taxes at all if you opt for a Roth IRA.
“People don’t take into account how expensive things become over time, not realizing that they can live another 40 years in retirement. You can’t get rich by investing money at 5%,” Baumgarten said.
As for those who do take risks, it’s often the wrong kind. They chase the hype and gamble on highly speculative investments. They end up losing money and assume that risk is bad, Baumgarten said. The right kind of risk is greater exposure to stocks through mutual funds or index funds and even buying blue-chip stocks, he said.
Read the original article on Business Insider