When Fidelity Investments held its first-ever Retirement IQ Survey earlier this year, the results were dismaying. It appears that most Americans are clueless about some basic retirement finance subjects. And if you don't understand these fundamental aspects of pre- and post-retirement finance, how can you possibly come up with a retirement plan that works?
Here are some topics you should study up on if you want a financially stress-free retirement.
The stock market's historical returns
When the market crash at the start of the Great Recession trashed everyone's retirement savings portfolios, many workers reacted by pulling out of the stock market and putting all their money into "safer" investments such as bonds. By selling out after the crash, they turned those paper losses into real, and devastating, losses -- and then they missed the huge market rebound that followed.
Even today, many people refuse to buy stocks because they believe they're sure to lose money. In reality, the stock market has enjoyed a positive return in 30 out of the last 35 years -- a fact that only 8% of Fidelity's survey-takers were aware of -- even though that time period has included multiple market crashes. And while stocks are unquestionably riskier than bonds, they also produce far higher long-term returns. Given that many Americans aren't able to save as much for retirement as they should, getting the highest possible returns on those investments is crucial.
Length of retirement
When asked how long their retirement savings would need to last if they retired at age 65, 38% of Fidelity's survey respondents gave an answer of 12 to 17 years. In reality, if you're turning 65 today, your expected lifespan is about 22 years. That means you have a 50% chance of living more than 22 years and a 50% chance of living less than 22 years. So if you were to retire around age 65, you'd need to have enough money saved up to last you at least 30 years in order to have a reasonable chance of not outliving your money. If you underestimate how long your retirement is likely to last, as many survey respondents did, you're setting yourself up for financial disaster.
Retirement account distributions
Once you retire, hopefully with fat balances in your retirement savings accounts, how much money can you safely take from those accounts each year without running them dry? There's no hard-and-fast answer to this question, but many respondents to the Fidelity survey believed they could safely take as much as 10% to 12% each year from their retirement savings accounts -- and that answer is dangerously wrong.
If you're in your 60s and you take more than 3-1/2% of your total account balance per year, you're edging into dangerous territory (though you can increase the percentage you take as you age). An annual withdrawal rate of 4% or even 5% may be safe -- if your portfolio produces excellent returns during those years. Taking more than that during the first few years of retirement sets you up for income shortages a few years down the line.
Fidelity's most recent Retiree Healthcare Cost Estimate survey found that a 65-year-old couple retiring in 2016 could expect to pay $260,000 in healthcare expenses during retirement. The majority of respondents underestimated their likely healthcare expenses -- some by as much as $200,000.
Because healthcare is one of the few expenses that are likely to go up during retirement rather than down, budgeting for healthcare is a crucial part of retirement planning. Medicare is less comprehensive (and more expensive) than many Americans believe, and the remainder of healthcare expenses fall straight on the retiree's shoulders. And that $260,000 figure doesn't include long-term care expenses, which Fidelity estimated would average an additional $130,000 for that 65-year-old couple.
Realistic retirement planning
Acquainting yourself with the realities of retirement expenses, investment returns, and other financial basics will allow you to set up a retirement savings plan that will actually work for you when you hit retirement. Starting early makes saving easier, but if you've dawdled, that doesn't mean you're doomed to a retirement spent dining on cat food. It just means you'll need to work a little harder to save and possibly delay your retirement by few years. So take a look at your retirement plan and see if any of these errors are built into it. If they are, now is a good time to fix that.