Biggest Retirement Planning Mistake
I have been asked what is the biggest mistake that people make when planning for retirement? After completing hundreds of financial plans throughout my career, the answer is simple. Most people have no idea how much they are spending in a given year and do not account for inflation. There is an ancient wisdom that says, "Suppose one of you wants to build a tower. Won't you first sit down and estimate the cost to see if you have enough money to complete it? Suppose you start building and are not able to finish. Then everyone who sees what you have done will laugh at you."
In this scenario, the tower building is saving enough to maintain a lifestyle during retirement. While I hope that no one would laugh at you if you run into hard times during your retirement years, no one wants to be a burden to their children or family as they age.
Let us look at a potential real-world example. We will use Steve and Debbie, both age 65, with a monthly income need of $5200 a month ($62,400 annual) and assume 2.5% inflation. Given these assumptions, Steve and Debbie would need to generate over 2 million dollars in income to cover a 25-year retirement. While planning for generating over 2 million in retirement may seem like a daunting task, my experience has been that most underestimate how much they spend on a monthly/annual basis.
Many couples I have met with do some of the following mental accounting. They believe that they need the $5,200 monthly income and plan to receive $2,500 from Social Security and $1,500 from a pension leaving $1,000 a month that needs to be covered by personal savings. Steve and Debbie have been able to save $250,000 over the years in their retirement accounts, and with a 5% withdrawal rate, this would produce the $1,000 monthly need to cover their income needs.
Here is the problem. In our scenario with Steve and Debbie's actual monthly expenses are $6,000 or more. This $800 a month may not seem like a significant number, but with inflation, in year 25, it is almost $1,500 per month difference. Withdrawing the additional $800 a month from our savings would push our annual withdrawal rate over 8.5%. An 8.5% withdrawal rate is not sustainable. Unfortunately, this is also a Goldilocks scenario where everything goes just right. This example does not consider any potential issues like a market downturn, higher inflation, or unexpected health care costs.
So how do we best avoid this scenario? Like most things, the answer is easy. The execution is hard
You need to be on a tight budget and have a handle on how much you spend.
Work with a financial planner to build a plan that considers variables like inflation, market fluctuations, and many other variables.
Implement and monitor the plan.
If 2020 has taught us anything, our plans can and will change. You would not go into any other financial situation, whether at work or your personal life, that had the potential to need over two million dollars without a plan. Why would your retirement planning be any different? Work with a professional financial planner who can help you break this seemingly overwhelming task into small action steps.
No matter how complex the plan seems. Ultimately, financial planning comes down to three main variables: money in, money out, and time.