There is a lot of talk of “fake news” these days and the same could apply to retirement planning. I often hear several recurring myths that could affect people’s ability to properly plan for their retirement. Here are ten of the most common that I come across:
1. It is too early to start saving for retirement. This is particularly regrettable for several reasons. First, with the demise of traditional pension plans and the looming insolvency of government programs like Social Security and Medicare, young people will likely have to save even more than previous generations. Second, they have the most to gain from being able to invest more aggressively and enjoy the magic of compounding for longer. Finally, the financial habits that people develop early in their careers can follow them throughout their lives.
If you are just starting your career, try to contribute at least enough to get your employer’s 401 (k) match so you don’t leave that free money on the table (even if that means having to share living expenses with a roommate). for a little longer). You can then start slowly increasing your contributions over time as your income increases. Your pension plan may even have a contribution rate escalator that will do this automatically for you.
2. You will need about 80% of your current income in retirement. This may be true for many people, but retirement needs can vary widely depending on your particular situation. You may need less than this if you are saving a lot for retirement, have your mortgage paid off, or are planning to downsize or move to a lower cost area. On the other hand, you might need more than 80% if you want to spend more time traveling or engaging in other expensive activities.
One expense that people often underestimate or neglect to consider is the cost of health care. This is especially true if you plan to retire before you qualify for Medicare at age 65 and will not be covered by your spouse’s plan. You will most likely then have to purchase insurance on your own, which can be very expensive. Even once you reach the age of 65, a recent study estimated that a typical 65-year-old couple without other health insurance would need around $ 295,000 to cover medical costs over their lifetime, regardless of long-term care or Medicare cuts the government might do to stay solvent.
3. You won’t see a Social Security dime. This myth stems from the fact that the social security trust fund was projected run out in 2037. The good news is that doesn’t mean there won’t be any money in the program at all. After all, millions of people will continue to pay taxes into the system.
However, it is expected that there will only be enough money to pay about 76% of the promised benefits. This means that you might want to take your estimated profit and reduce it by about 25%. While it seems safer to assume that you won’t get anything at all, the amount you would have to save in this unlikely scenario can be overwhelming.
4. Your tax rate will be the same in retirement, so you will not benefit from the tax deferral. While it’s true that many people will be in the same tax bracket in retirement, that doesn’t mean you won’t benefit from the tax deferral. First, you will still benefit from any additional income on the money that would have been paid in taxes each year.
Second, you can be in the same bracket but pay a lower effective rate upon retirement. For example, let’s say you’re in the 28% bracket now and after you retire. When you contribute to a pre-tax 401 (k), you are contributing money that would otherwise be taxed at 28%. But when you take that money out in retirement, some of that money is likely to be taxed in the lower brackets, allowing for a lower average rate.
5. If you contribute to a pension plan, your money will be fully locked in. This myth is often linked to the former, as young people usually also save for emergencies, buying a house and possibly going back to school. One of the best solutions for someone in this situation is a Roth IRA since the sum of the contributions can be withdrawn at any time and for any reason without taxes or penalties. Anything you don’t need to withdraw will increase and become tax-free after age 59 1/2 (as long as the account has been open for at least 5 years).
You can also access some of the money in your retirement account without taxes or penalties by taking out a loan. Unlike credit cards and home equity loans, there is no credit check and the interest is accrued to your own account. As a last resort, you can also request a withdrawal of subjection. Just be aware that these are limited to certain circumstances, are subject to taxes and early withdrawal penalties, and cannot be refunded. While it’s best not to touch your retirement money at all, knowing that these options are available can help you feel more comfortable contributing to these accounts.
6. You can be well diversified by simply distributing money among all of the investment options in your retirement plan. Depending on how that money is allocated, you may not be as diverse as you think. For example, let’s say your plan has 5 options: a corporate equity fund, 3 other equity funds, and a bond fund. If you spread your money evenly, you would have 20% in bonds and 80% in stocks, with 20% in company stocks. It’s a pretty aggressive mix and it’s generally a good idea not to have more than 10-15% in a stock, especially if it’s your employer’s stock since your work is already tied to your company’s fortunes. .
You can actually be well diversified with just one fund by choosing a one-stop-shop asset allocation fund like a target date retirement fund. These funds divide your money into many different investments depending on how long you have left until retirement. You can also create a custom portfolio based on your risk tolerance and time frame using a spreadsheet like this.
7. You should invest your retirement account in the best performing funds. Choosing the best performing funds may seem intuitive, but it turns out that not only past performance is a poor indicator of future performance, it can in fact be an indicator of poor performance in the future. Standard and Poor’s is conducting an ongoing study in which they take a look at the top 25% of mutual funds in various categories and see how they performed 5 years later. Their last report shows that these top performers are in fact less likely than average to continue to be top performers and that the most common outcome for them was actually sell-off or style change.
Instead of looking at past performance, look at the costs when comparing funds of a similar type. Many studies have shown a fairly good correlation between low costs and superior investment results. Morningstar Mutual Fund Rating Service
8. You cannot contribute to an IRA because you have a working retirement plan. This myth stems from the fact that if you are covered by a workplace pension plan, there is income limits to be able to deduct traditional IRA contributions. However, even if you don’t qualify for the deduction, you can still make non-deductible (but still tax-deferred) contributions and possibly Roth IRAs.
9. Your income is too high to invest in a Roth IRA. You can earn too much contribute to a Roth IRA, but there is a way to get money into a Roth IRA through the backdoor. Since there is no income limit on Roth IRA conversions, you can contribute to a non-deductible IRA and then convert it to a Roth. The only catch is that if you have other pre-tax IRAs, you will have to pay tax on the converted amount of the pro-rated IRA. However, you can avoid this by transferring the pre-tax IRAs to your employer’s retirement account.
10. You should automatically transfer your employer retirement plans to an IRA when you leave. Many financial advisors like to give this impression because most of them make money by managing IRAs or selling the investments they contain, but there are several reasons why this is not always a good idea. idea. First, if you have a 457 plan or if you retire during or after the year you turn 55, you could make penalty-free withdrawals from that employer’s pension plan immediately, when you had to wait until 59 1/2 years old with an IRA. Second, if you have company shares in your pension plan, you can benefit from advantageous tax treatment by transferring the stock to a brokerage account rather than transferring it to an IRA. Finally, you can have access to investments and advisory services at a lower cost than with an IRA.
Don’t believe everything you hear, especially about something as important as your retirement. If you are unsure of what to do, consult a qualified and impartial financial professional. Your employer may even give you one for free as part of a workplace financial wellness program.