Retirement is one of the biggest goals we need to save for, since it is not possible to borrow to pay for retirement and government pension payments have long been the subject of jokes. If you don’t want to live in deep poverty on the dole in retirement, you need to plan properly now. Here are six misconceptions about retirement that could cost you in the long run.
Medicare Covers Everything
First, Medicare is usually only available if you turn 65 and start collecting Social Security, so it isn’t an option at all if you retire early at 55. Now your retirement plan needs to cover the cost of health insurance. Second, Medicare doesn’t cover everything, though the cost of it is deducted from your Social Security check. You have to pay for hearing aids, laser eye surgery, dental work and copays. It typically won’t cover routine vision care or optional procedures like cosmetic surgery. You also won’t receive aid from the state if you want experimental treatment or top notch care when you have cancer or want private services instead of waiting for the state to provide it.
A general rule of thumb is to save at least $100,000 to cover healthcare costs alone in retirement. The cost of medical care in retirement is also why you should assume you’re going to spend as much in retirement as you do now, even if your tax rate is lower. Nor should you assume that Medicaid will cover costs like a nursing home, since the few that accept such payments have such low quality that the elderly desperately try to avoid ending up in them.
I Don’t Need to Save for My Wife’s Retirement
One too common tragedy is the man who signs up for the higher pension payout by declining the spousal benefit. The couple receives that money, and when he dies, the widow’s loss of her husband is compounded by the loss of his income. She now has to cope with impoverishment.
Another version of this are couples that save in his retirement account and never set anything aside in retirement accounts for her. By failing to put money in the wife’s retirement account like an IRA, they don’t save as much as they could in tax advantaged accounts and have less than they need at retirement. This can create major problems if a couple divorce late in life.
Sure, We Can Afford to Bail Out the Kids
Too many parents take out loans to pay for college for their children and hit retirement paying loan payments that eat into their discretionary income. In the case of federally backed student loans for parents, the debt cannot be discharged in bankruptcy and can be pursued by the IRS.
The book “The Millionaire Next Door” addressed economic outpatient care as one of the biggest impediments to building wealth. Well-meaning parents give their adult children money to live on during personal crises that never end because the adult child becomes dependent on the handouts. The parents sometimes pay for real estate that their children then live in, and while thought to improve their net worth over time, the reality is that the dependent young adults spend all of the money received and reduce their own income because they don’t have to earn as much as they spend. In short, financial gifts create dependency for young adults while preventing the parents from building up the financial nest egg they need to support themselves.
The Rules on Withdrawals Don’t Matter
Too many people fail to keep up with the rules on withdrawals from their retirement accounts. They cash out 401Ks to pay off debt while paying half in taxes or borrow against their retirement and risk paying the interest and taxes due when they lose their jobs.
Another version of this is those who don’t know the rules that let them take money out without penalty. In general, you cannot take money out of an IRA without a 10% penalty unless you follow the 72t rule. Under the 72t exception, you can take money out of the IRA in a series of equal and substantial withdrawals. Per the 72t rule, the withdrawals must be at least annual but can be more often.
Another rule states you can take money out of the IRA if you’ve become disabled before retirement age, though you must file the necessary paperwork. If filling out a form saves you 10% of anything you take out of the account, fill it out.
My Home Is My Nest Egg
One way this misconception hurts people in retirement is the assumption they can sell the home for a fortune when they retire, when the reality may be that the neighborhood has gone downhill and the property decreased in value. If you cannot sell or find you don’t want to move, the financial plan of moving to a lower cost state goes down the tubes.
Reverse mortgages promise to let you stay in the home and provide money based on the home equity, but these come with hefty fees that make it a worse financial decision than selling the house and putting the proceeds in an annuity. And this option may not be available to you if you have home equity lines of credit or an outstanding mortgage balance.
I Can Wait Until Later to Start Saving
Financial guru Dave Ramsey frequently talks about two theoretical young adults. One starts saving $3,000 per year for ten years starting at age 21 and stops at age 31, while the second starts saving $3,000 a year at age 31. Due to the compounding interest of the large nest egg, the first young adult has more money at age 65 than the one who started saving ten years later. Even if you can only save a little now toward retirement, start.
Then there’s the assumption that you’ll be able to save more later toward retirement. However, if you’re challenged to contribute 5% to retirement now, is it really likely you’ll be able to contribute 25% in catch-up contributions in middle age? Some people are afraid to start saving now in case they end up with too much money. Yet that isn’t a problem because the larger nest egg gives you the ability to spend more in retirement, give more to charity, stop saving several years before retirement, or retire earlier.
You cannot assume the state will pay for your medical costs in retirement; it won’t cover much of what you need and the quality of care will be poor. Save for your spouse’s retirement, since this ensures that your family saves as much as possible and prevents impoverishment if the main breadwinner dies. Don’t bail out your adult children, and don’t go into debt for their education. Learn the rules on retirement account withdrawals to avoid penalties and unnecessary taxes. Don’t rely on your home to fund your retirement. Start saving now, even if only a little.