Believing in myths can really trip you up sometimes -- especially if you're basing your retirement-related decisions on them. Let's debunk five financial fairy tales so you can plan and prepare for as comfortable a retirement as possible.
Myth No. 1: Your spending will increase in retirement
Brian Stoffel: Many people believe their annual spending will increase -- or at least stay the same -- after they retire. On some level, it makes sense: Once they don't have a job to keep them occupied, retirees are bound to splurge, filling their time with rounds of golf, nights out on the town, and expensive vacations. And then there are the enormous healthcare costs that come with aging!
But this simply isn't true. Of course, some retirees will spend more than they used to, but they are the exception and not the rule. Morningstar's David Blanchett summarizes the reality of retiree spending well:
There is a growing body of literature exploring the spending habits and tendencies of retiree households. The majority of the studies note that consumption tends to decline at retirement. ... Overall ... the real change in annual spending through retirement is clearly negative .
There are several reasons for this. For starters, you no longer have the costs associated with working. Without a commute, you'll likely drive less, saving on gas and vehicle maintenance. Many retirees also report spending less on food because they have more time to cook and eat at home.
Myth No. 2: You'll need about 80% of your former income
Chuck Saletta: Another common myth about retirement is that you'll need to replace 80% of your pre-retirement income in order to maintain your pre-retirement lifestyle. In reality, you could probably live comfortably on less income than that, though you may want to aim for that higher target if you'd like to enjoy the finer things in life during your golden years.
A whole bunch of your expenses go away or change in retirement. For example:
- Taxes: Once you stop drawing a paycheck, Social Security payroll taxes go away, as do most Medicare taxes unless you have substantial investment income. In addition, many states levy lower taxes on retirement income than on earned income. On top of that, if your income is lower, your effective federal income tax rate will likely drop, too.
- Savings: Any income you'd been socking away for retirement is money you weren't using for living expenses. Once your retirement is funded, you no longer need to save for it.
- Mortgage: It's a common goal to get your house paid off by retirement. If you've succeeded, you can live in the same spot for far less than when you were chipping away at that debt.
- Children: If your kids are grown and independent, the costs of raising them go away. While you may still want to help them out, if they're taking care of themselves, you don't have to.
- Time-crunch costs: If you routinely did things like eat out or pay for routine upkeep and maintenance on your house because you had no time to spare while you were working, you can cut back on them. You'll have a lot more time to take care of those things yourself now.
With all those costs departing from your budget, it's likely you can live on less than 80% of your pre-retirement income.
Myth No. 3: Medicare is free
Brian Feroldi: For years, I believed that once you turned 65, all your healthcare costs would be 100% covered by Medicare. Unfortunately, that's not the case. There are plenty of costs that Medicare recipients still have to pay out of their own pockets.
To understand just how high these costs can be, you first need to understand that Medicare is split up into four parts: A, B, C, and D. Let's take a closer look at the costs of each.
Medicare Part A is used to cover inpatient visits, which usually means hospital stays. If you or your spouse has earned enough work credits to qualify, then Part A is is provided free of charge -- though there is still a $1,288 annual deductible.
Medicare Part B covers doctor visits, ambulance services, diagnostics tests, and more. Unlike Part A, Part B has a monthly premium, which varies widely from person to person based on their income. Most people pay $104.90 a month. There's also a $166 annual deductible, followed by a 20% co-pay any time the service is used.
Medicare Part C is another name for a Medicare Advantage plan, which you can sign up for instead of Parts A and B. These plans are offered by private insurers and must offer at least as much coverage as Parts A and B -- with many offering more, such as prescription drug coverage. Premiums for Part C plans vary widely, with some charging $0 in premiums. (You'll still be paying your own Part B premium, though.) Many have co-payments, too. In many cases, signing up for a Medicare Advantage plan can be a great deal.
Finally, Medicare Part D covers the cost of prescription drugs. Premiums are determined based on your income level, so the more you make, the more you'll pay. The majority of plans also have an annual deductible, capped at $360 per year, though some plans charge a flat fee to access certain drugs regardless of cost. All plans limit a patient's annual out-of-pocket costs. (That cap is $4,850 for 2016.)
Myth No. 4: Social Security will be enough
Selena Maranjian: One myth many people believe is that Social Security will provide enough income to support them in retirement. It's important to have a solid grasp of just what you can expect from Social Security so that you can save, invest, and accumulate enough to make up for the shortfall between that check from Washington and your monthly expenses.
Consider this: The average Social Security benefit was recently $1,348 per month, or about $16,000 per year. You may be expecting some pension income, significant dividend income, or a healthy inheritance that will cover the difference between what you'll need and what you'll get from Social Security. But if not, then you should be saving aggressively and investing appropriately in order to meet your needs.
If you've been an above-average earner for much of your life, then you can expect larger Social Security checks than the average American. Still, the maximum monthly benefit amount was recently $2,639 -- or about $32,000 for the whole year. That's still not sufficient income for many retirees. It's best to get a realistic idea of how much you can expect. You can do that by setting up a "my Social Security" account on the Social Security website.
If your estimated benefit turns out to be far smaller than you expected, take heart -- you can increase the size of your future monthly benefit by working longer, earning more, delaying your retirement benefits, and/or coordinating a strategy with your spouse.
Myth No. 5: Social Security is going to vanish
Dan Caplinger: As Selena notes above, many people have misconceptions about Social Security. While some mistakenly think their benefit will cover all their financial needs, others exaggerate the financial danger that the program is in. It's true that, based on recent calculations, the federal trust fund that helps support Social Security will run out of money within the next 20 years. The latest estimates predict 2034 will be the year in which the trust fund is exhausted.
However, even after that point -- which will only arrive if Congress does nothing to prevent it between now and then -- Social Security will continue to receive new funding from the payroll taxes that are withheld from workers' paychecks. Without the trust fund to supplement that ongoing revenue, Social Security won't be able to pay full benefits at its previous levels, because the nation's shifting demographics mean there will be significantly fewer working-age people contributing taxes to fund a program being used by a larger number of retirees. Current estimates suggest that the ongoing revenue will be enough to cover benefits at about 75% of current levels.
For retired Americans living on fixed incomes, the prospect of a 25% Social Security cut is no small matter. But it's far less drastic than the complete elimination of the benefit that many people mistakenly believe will happen when (or if) the program's financial crisis comes to a head.
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