Most people dream of a retirement spent pursuing all the activities they couldn't do while working, not one spent wrestling with money problems. Yet if you're not careful, you could make expensive money mistakes that will end up tainting the rest of your retirement -- and in the worst-case scenario could even run you out of money. Below you'll find some regrettably common retiree money mistakes; hopefully these grim examples will ensure that you'll never fall into these traps yourself.
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1. Retiring too early
Picking the wrong retirement date can cause irrevocable harm to your finances. In most cases, the mistake is retiring too early -- if you quit working before you have enough savings and other sources of income to keep you going for the rest of your life, you'll either end up scraping and pinching to get by or you'll simply run out of money.
More retirees choose to claim their Social Security benefits at age 62 than any other age. 62 is the earliest that you can start getting Social Security benefits, but claiming your benefits this early comes at a price -- your Social Security checks will be permanently reduced by an early retirement penalty of as much as 30%. In fact, according to the 2017 Annual Statistical Supplement of the Social Security Administration, the average 62-year-old receiving Social Security benefits gets $1,076.70 per month; the average 70-year-old gets $1,482.40. That means that retiring early is a double financial whammy: not only do you stop saving and start spending your retirement money earlier than most, but you also end up with a smaller Social Security benefit.
For some retirees, it makes a lot of sense to retire that early. If you've been diligent about saving and have plenty tucked away by age 62, or if health reasons force you to retire at that point, then clearly retiring early is the best choice. But for most retirees, it's best to wait at least until full retirement age before walking away from your job forever.
2. Spending too much of your savings too quickly
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When you first retire and start drawing from your retirement savings, the balances in those accounts may look enormous. Sadly, it's way too easy to drain down those high balances to the point where they can no longer support you. Take too much out of your retirement savings, especially in the first few years of retirement, and you'll end up with serious cash shortages later on.
For example, let's say that you have $300,000 in your retirement accounts on the day you retire. You decide to take $30,000 per year (which equals $2,500 per month) from your accounts, combining this money with your Social Security benefits to give yourself a comfortable income. Assuming that your retirement investments produce a 6% annual return during this time, you'll run out of money during your 16th year of retirement. If you plan to live for more than 16 years, this is pretty terrible news.
In order to make your retirement savings last, you need to preserve your capital. That means you need to take less money from your investments than they gained over the course of the year. If your investments grew by 6%, you have to take less than 6% of your account balances out that year to keep your savings from shrinking. Indeed, the safest approach is to plan to take no more than 4% of your total account balances out of your retirement accounts each year -- and in a bad year, you may need to take less. Keeping your account withdrawals low is especially important early on in retirement; as you get older and your life expectancy gets shorter, you can get a little freer with your withdrawals. For example, once you hit 70 you might hike your planned account withdrawals up to 5% or even 6% of your total account balances, and at 80 you might go as high as 8%.
3. Choosing the wrong investments
Once you retire, your investment priority changes from growing your money to preserving your money. That's because during retirement you're living on the income from those investments and can't afford to take the kind of risks that will generate the highest possible returns.
Retirement is a time to shift your investment focus away from stocks and toward bonds. However, you can't dump your entire stock portfolio and just own bonds; the return on bonds is so low these days that you almost certainly won't be able to generate enough money to live on. And while interest rates are likely to increase in the future, they rarely go high enough to make an all-bond portfolio livable; the average annual long-term return on bonds is around 5% to 6%, whereas the average annual long-term return on stocks is about 10%.
The easy way to figure out how you should balance your portfolio is to subtract your age from 110 and put that percentage of your investment money in stocks, with the remainder in bonds. Thus, a 70-year-old would have 40% stocks and 60% bonds in his retirement savings accounts. Such a distribution would result in roughly a 7.3% average annual return over the long haul. Of course, that's only an average; in any given year you could make substantially higher or lower returns than this. That's why it's important to save enough so that you can get by with a low withdrawal rate, as explained in the previous section.
Fixing these money mistakes
So what do you do if you've already made one of these mistakes? If you retired too early, picking up a part-time job can provide you with some extra income and preserve the money in your retirement savings accounts. Finding additional sources of income can also help if you've taken too much money out of your retirement savings; in a best-case scenario, you may even be able to put some money back into those accounts. Rebalancing a portfolio that's too heavy in either stocks or bonds is a fairly simple proposition -- just sell some of the excessive investments and use this money to buy the other type. And now that you know how serious these issues can be, you'll be able to avoid falling into these money traps in the future -- and you can enjoy the rest of your retirement without financial woes.
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