Last Updated: April 6, 2009
There are plenty of ways to wreck your retirement. But knowing the top 10 might give you a fighting chance of at least avoiding the big ones. Of course, as with many things in financial planning, much is subject to debate. Indeed, there are plenty of times when it's difficult to make blanket statements. Here's what one researcher and one financial planner had to say about the subject.
- Don't Make Saving a Habit. "Young workers may think they have plenty of time to save later, but setting aside a little bit of money on a regular basis throughout one's working years produces a greater nest egg than setting aside a large amount later on," wrote Pamela Villarreal, whose "Ten Ways to Wreck Your Retirement" report was recently published by National Center for Policy Analysis. For his part, FPA member, Michael A. Branham, CFP®, a financial planner with Cornerstone Wealth Advisors, Inc., said much should be done to make saving a habit early on
long before entering the workforce.
- Leave Matching Funds on the Table. "Not taking advantage of an employer's matching contributions to a 401(k) account is like turning down a raise," wrote Villarreal. "An employee who turns down a dollar-for-dollar 401(k) account match of up to 5 percent of his salary is passing up a 5 percent bonus paid with untaxed dollars." Said Branham: "It would be interesting to know how many people in America don't realize that they are giving up free money by not contributing to their 401(k). Staying in the habit of saving is important, especially when you can buy equities as such depressed prices."
- Borrow against 401(k) Savings. "This is a surefire way to set back one's retirement plan by thousands of dollars through lost compound interest," wrote Villarreal. "A $25,000 loan today can cost more than $175,000 in lost retirement interest income over 30 years." For his part, Branham said there's a certain amount of debate about this subject. "In general I would tell you to avoid this, but there do seem to be some instances where this strategy can be responsibly utilized, particularly if other options are limited," he said. "The biggest examples are in buying a first home or providing resources you may need to bridge some living expenses between jobs when things are really tight. There are, of course, risks in both cases, but this one seems a bit less
damaging than some of the others."
- Cash Out 401(k) Savings. "Cashing out a 401(k) account when changing jobs means that more than one-third of the balance can be eaten up in taxes and penalties," wrote Villarreal. For his part, Branham agrees rolling a 401(k) over to an IRA is simply a better option than cashing it out. However, there's always the exception. "The obvious exception is when losing a job, and the resulting income, results in real financial hardship," he said. "For some, there are just very few good alternatives."
- Jump In and Out of the Market. "In 2008, 401(k) plans lost an estimated $2 trillion in value," Villarreal wrote. "But this 'loss' would have been on paper only, were it not for the fact that many workers essentially locked in their losses by selling their equity funds during the recent downturn." Planners don't disagree. "This is a conversation being had with every client these days," said Branham. "This isn't simply limited to 401(k) plans, either. Trying to time a market is a sucker's bet. You may make the right call on the exit, and even if you don't the most important decision you then have to make is when to get back in."
- Rely on Home Equity. "Purchasing a home and selling it years down the road does not always produce a significant profit on which to retire," Villarreal wrote. "Even before the housing bubble burst, the average home was a mediocre investment. One dollar invested in stocks in 1963 would have grown to $12.36 by 2006, while the same dollar invested in a house would have grown to only $1.79." Branham, for his part, generally agrees with the principal of not relying on your home equity to provide your retirement income, but he also said there is more gray area here than in some others. "While I am not an advocate of using your home as the sole vehicle for retirement savings, there are cases (maybe more frequently than some may realize) where home equity can play an important role in the retirement income for you," he said. "This is particularly true in cases where people simply haven't saved enough to provide for their income needs. We are not big advocates of reverse mortgages, but there are other ways to unlock home equity, if necessary."
- Do Not Diversify Savings. "Relying on one type of investment is a recipe for disaster," wrote Villarreal. "It is important to consider diversifying among asset types (stocks, bonds, money market funds), as well as diversifying within each type of asset (rather than holding one stock or bond)." Said Branham: "The downfall is a year like 2008 when diversification helped very little. Still, broad diversification between equity categories, commodities, and fixed-income assets has been a proven method of smoothing out some of the bumps over long periods of time."
- Underestimate Longevity. "More people are living longer," wrote Villarreal. "This means that retirees should have strategies to ensure they don't outlive their money, including working past retirement age, annuitizing retirement account money, and staying at least partially invested in stocks." According to Branham, this is actually a mistake made by many people. "There is a reason planners plan to age 100 these days," he said. "With medical advances and new medical treatments people are living longer. The need to provide income in your retirement for 30-40 years is not all that uncommon these days, and not planning accordingly could really jeopardize your ability to provide the necessary income you will need for your entire life." In fact, he noted that many financial planning clients, prior to engaging a planner, seriously underestimate their potential life expectancy. "I have yet to meet a client that would rather run out of money late in life than die with more money than they needed to live," he said.
- Ignore Inflation. "When a household's income, combined with half of their annual Social Security benefits, exceeds a certain threshold, a portion of their Social Security benefits are subject to federal income taxes," wrote Villarreal. "The thresholds are not indexed. Over time, inflation pushes more and more retirees into the income range where they must add 50 cents of benefits to their taxable income for every dollar their income exceeds the threshold. This means their marginal tax rate will be 50 percent higher." This, like the longevity issue, is one of those issues that people are aware of but may not fully comprehend, said Branham. "Taking the potential impact of inflation into account can mean the difference between having the income you
need for life and running out of money before you are ready to," he said. This is also an important topic when discussing realistic income targets as you approach retirement and consider withdrawal rates.
- Stay in Debt. "Entering retirement debt-free is essential to being able to maintain a comfortable standard of living," Villarreal wrote. Again, Branham said staying in debt generally wrecked retirements, but that notion is now being viewed by some in the financial planning community as one of the "old ways" of looking at things. "If you have sufficiently saved to fund your retirement there seems to be little wrong with paying for an asset over the period you intend to use it," he said. "Paying off your home prior to retirement could limit the amount of potential savings in the preceding years. If you are 60 years old and have sufficient pension and/or financial assets to provide an ongoing standard of living you want, does it really matter that part of your cost of living is a mortgage payment for a house they will spend the rest of their lives in?"