Company offered pension plans continue to be in decline. Since the inception of 401(k) plans, the responsibility for creating retirement assets has been shifting from the company to the employee. Unfortunately, there is not enough education provided to help guide individuals who are trying to save for retirement. As a result, it is becoming normal for individual investors to work with CERTIFIED FINANCIAL PLANNERS ®. Building your wealth over time can be a daunting task, which is why we provide you with a few tips to keep in mind for your financial future.
1. Not Factoring for Longevity
Americans are living longer, healthier lives than ever before. Overall, these gains in medical care and technology have proven to have enormous benefits for American society. The bad news is that most Americans do not plan accordingly for this longevity in retirement. Nearly half of Americans greatly underestimate their longevity by five years or more 1. Consequently, many assume they have plenty of assets to retire but find themselves outliving their retirement funds and unable to meet their end-of-life needs while maintaining their current lifestyle. The chart above demonstrates the percentage of men and women who are living to the age of 90. It’s safe to have a plan that will cover your retirement needs for at least 25 years or more conservatively, 30 years.
2. Forgetting to account for inflation
Along with failing to plan for longevity, many Americans also forget to account for inflation when planning for retirement. Over the years in retirement, inflation will play a huge role in sustainability. According to the Consumer Price Index (CPI), many expenses tracked for inflation may be items that do not inflate as quickly, such as electronics or clothing. However, seniors tend not to spend their money on these items. In reality, the things that most seniors will need to purchase is food, fuel, medical care, insurance premiums, and long-term care, which will all inflate at a much higher rate. In recent history, many of these items have accelerated in cost at a 5-8% rate, as opposed to the average 2% inflation rate reported by the government for the average consumer 2. As a result, the inflation rate for seniors is predicted to be much higher than the inflation rate of the typical consumer, making it a crucial factor when planning for retirement. The chart below shows the impact of what a 3% inflation rate has on retirement. This example illustrates that the individual is short more than $650,000 and only has five years to make up the difference if he wants to sustain his lifestyle costs to the very end. Start early and plan appropriately for inflation.
3. Failure to plan for taxes
Whether people like to admit it or not, taxes tend to be our single greatest lifetime expense 3. Merely having a large amount of cash in savings will not be enough to see many individuals through retirement. For example, even if a person has saved one million dollars in a 401(k) account, a large portion of those funds will be taxed once they are withdrawn from that account. Furthermore, an individual’s tax bill will be even higher should they choose to retire earlier than expected as they may have to pay tax penalties for withdrawing their money early. Lastly, without a clear understanding of the impact of distributions, you may find that your social security is being taxed up to 85%. Therefore, individuals must plan for both the total of their assets and the cost those assets will incur in taxes once they are withdrawn from their account. Learn more about tax strategies we discuss in our year-end tax planning blog and understanding your RMD in our required minimum distribution blog.
4. lacking a holistic approach to finances
The final common mistake most people will make is not taking a holistic approach to their finances. Proper financial planning will encompass numerous aspects of a person’s finances into consideration such as taxes, estate law revisions, current market conditions, new investment options, family dynamics, and a host of possible future changes. We cover a holistic approach to investing and finances in our investing approach blog. In reality, planning for a proper retirement requires a team of specialists to provide expertise and experience that people need to reach their financial goals. As a fee-only wealth management firm, Lighthouse Financial offers a variety of services to help our clients succeed in every area of their economic life, from investment management to financial planning and tax services. Our team of professionals can take complicated situations and find simple, easy-to-understand, solutions that empower our clients to select best-fit options for their unique circumstances.