There are plenty of headlines about how you should prepare for retirement -- but what about the things you definitely don't want to do? When it comes to retirement planning, knowing what mistakes to avoid can be even more important than saving wisely. With that in mind, here are five retirement mistakes we'd advise Foolish readers to steer clear of.
With newfound time on their hands and a sizable nest egg to play with, retirees may be tempted to pick up day trading as a way to generate extra income from their portfolio. That's especially true if they've been watching late-night TV programs pitching some "can't miss" strategy to earn money from the stock market by simply buying or selling stocks rapidly in order to take advantage of daily price swings.
If this sounds like a good idea to you, I'd strongly recommend that you reconsider your game plan. Why? Simply put, the odds are overwhelmingly against you.
In 1999 the North American Securities Administrators Association hired a group of consultants to gather and analyze data from a sampling of customers who had account activity that could be classified as day trading. Their report concluded that "70% of public traders will not only lose, but will almost certainly lose everything they invest."
Not only that, but even those day traders who managed to make a small profit from their activities still ended losing in the end because of the double hit of commissions and taxes. In fact, only 11.5% of the accounts in the study had managed to turn a profit at all from day trading.
Does gambling your retirement on a roughly one-in-10 chance of success sound like a risk worth taking?
So what should retirees do instead? I'd suggest sticking with the tried-and-true plan of investing in high-quality stocks or simply sticking with a plain vanilla S&P 500 index fund. While both of those methods won't get your heart racing, they certainly have a much better chance of being profitable in the long run and will keep you from making a huge retirement mistake.
A big mistake to avoid in retirement -- and the years leading up to it -- is underestimating the cost of healthcare. This can be especially easy to do if you have a great health insurance plan now and you're not used to paying much to doctors and other healthcare providers. It can also be easy if you're very healthy and rarely enter the healthcare world except for occasional checkups.
The folks at Fidelity offer some eye-opening statistics on this matter. For example, every year they estimate what a 65-year-old couple would face in total out-of-pocket healthcare expenses throughout retirement. The most recent estimate is a whopping $245,000, up considerably from last year's $220,000. Worse still is a finding from the Fidelity 2015 Couples Retirement Study: Only 22% of couples surveyed had factored healthcare costs into their retirement planning. Additionally: 74% cited as their top concern the worry that they might not be able to afford unexpected healthcare costs in retirement.
Medicare is, of course, a great boon for Americans aged 65 and older -- but it likely won't be enough. So what can you do? Well, learn more and develop a strategy. Long-term care insurance is one option, though it's imperfect, getting quite costly itself the older you are when you sign up for it. You might just plan to save more aggressively and aim for a bigger nest egg. Or delay starting to collect Social Security in order to end up with fatter benefit checks. Other possible options for some include reverse mortgages or tapping life insurance policies for extra income, though that comes at the expense of heirs.
One retirement mistake that seniors often recognize far too late is that maintaining a budget is still important.
When you retire, your monthly income is more than likely going to drop off from your wages earned when you were working. Social Security is only designed to replace about 40% of your working wage, with your other channels of income, such as IRAs, 401(k)s, pensions, and investment accounts expected to make up some of the difference. However, some seniors fail to take this income decline into account and are somewhat surprised to discover how reliant they are on their nest egg come retirement. If seniors become too reliant on their nest egg on a monthly basis to cover their expenses, they could actually run the risk of burning through their money too quickly and outliving their nest egg.
There are two solutions to avoiding this problem that are best off implemented together. First, formulating a working budget is a must. Budgeting allows you to fully understand your cash flow and optimize your spending, saving, and investing. It'll also help keep your spending habits in check. Best of all, there are countless software programs that can help you create a budget these days in 30 minutes or less.
Secondly, consider adjusting to your post-retirement income for months or years in advance. No one enjoys the sudden jolt of say a 20% reduction in their monthly income. However, if seniors are prepared for that haircut and progressively adjust their budget and lifestyle habits to match their monthly retirement income well in advance, it should be an easy transition when you do finally hang up those work boots for good.
One retirement mistake to avoid is getting out of stocks completely. Too many retirees and pre-retirees incorrectly perceive stocks as "too risky" and put their entire nest egg in fixed-income investments, or worse, into savings accounts and CDs.
The problem is inflation. Let's say that you have a $1 million nest egg and you put it all in bonds with an average yield of 5%, so your annual income is $50,000. And, maybe this sounds like enough to live on. However, $50,000 today won't be worth $50,000 in 20 years. In fact, based on the historical average inflation rate (around 3%), your bonds' $50,000 in annual income will only have about $27,000 in purchasing power in 20 years.
In short, stocks can provide income and growth that can help you keep up with inflation and then some.
While it's true that many stocks are risky, and even the safest stocks are likely to experience a lot more ups and downs than say, Treasuries, that doesn't mean they should be avoided. As long as the stocks you own pay a decent dividend and have a history of increasing their payout every year, fluctuations in market price are nothing to worry about. Here's an article with a few examples of great retirement stocks to get you started.
You'd think that taxes wouldn't be as big a deal after you retire, since your income from a job disappears. But the interplay among tax-favored retirement accounts, investment income, Social Security, and other sources of income can create even more tax complications than you faced during your career.
For instance, withdrawals from traditional IRAs and 401(k) accounts add to your taxable income, and so the more you take out, the greater your potential tax liability can be. Because a portion of your Social Security benefits can get taxed if your income exceeds certain thresholds, those retirement-account decisions can also indirectly increase your tax bill by boosting the amount of your benefits that gets included in your taxable income. Similarly, the tax treatment of private pensions will affect the rest of your finances, and the timing of stock sales in your regular investment portfolio is important in minimizing tax liability.
Fortunately, you can create a strategy that will help you control taxes but still let you meet your financial needs. Ideas like balancing income from different sources can reduce the impact that one particular source of income can have on your tax situation, making your year-to-year tax situation more stable. All it takes is good planning, and the first step is being aware that a potential problem exists.