Post #19 – The 2 Biggest Retirement Planning Mistakes Made by People over 50
There are many investment/retirement mistakes people over 50 make in planning for their retirement. In my experience there are 2 retirement planning mistakes and 2 investment planning mistakes that are the most common. In this post I will discuss the retirement planning mistakes.
In my opinion the two biggest retirement planning mistakes made by people over 50 are:
1. Assuming you can work as long as you want,
2. Counting on the equity in your home to fund retirement.
For many people working past the age of 65 may be the only option they have to build up the retirement assets necessary to retire anywhere near the way they live while working. And I do recommend that everyone work as long as they are able to if they enjoy the work they are doing. But I see a lot of people in their 50s that are planning to work longer to fund their current lifestyle and, at the same time, saving in the hope that they can maintain their current lifestyle after they retire. In my opinion this is not a good plan of action and, for many people, will result in a disappointing retirement.
Assuming you can work as long as you want (or need to) would be fine if jobs were guaranteed. But jobs are not guaranteed especially for people over 50. A couple years ago I read an AARP survey about people who retired before age 65. One of the report survey questions was did the person retire voluntarily or not. The survey reported that about 40% of the people who retired before age 65 did not do so voluntarily. They were forced to retire earlier than they wanted. There were several reasons why, but the two biggest reasons were employer “reductions in force” and health reasons. Read this article on taking social security early. Several of the people profiled intended to work longer but experienced an unanticipated job loss.
When it comes to your retirement planning, I think the prudent thing for people over 50 or for that matter people at any age to do, is to assume you will not be able work beyond the age of 60 to 65. If you were planning to retire later than 65, what this implies is you must increase your current rate of savings to allow for the shorter time frame to save. This invariably means you need to reduce spending on your current lifestyle. I know that this is not something that people will want to do, but I believe it is a matter of “it is better to be safe than sorry” in the event the job market deals you an unexpected blow in the years just before retirement. If, when 65 rolls around, you are able to continue working, by all means, take advantage of it and keep working; just don’t plan on being able to do so beforehand.
The second biggest retirement planning mistake people over 50 make is counting on using some or all of their home equity to make up for their retirement savings shortfall. After the recent housing bust, this thinking is likely less prevalent than before. In any event, this is not a good plan. The recent housing bust is one good illustration why. Because housing has traditionally increased in value over time, many people view their home as an investment. Your home is not an investment. It is an asset, but it is an asset dedicated to maintaining your lifestyle just like your car. I know of many people who are planning to sell their house when they retire and use the proceeds to fund their retirement.
If selling your home to fund your retirement is your plan, the question you must ask yourself is how will I pay for a place to live? One response may be that some people plan to move in with their children when they retire. If this is your plan, I would be sure to ask my children how they feel about this, and be aware that they could change their minds down the road. A more likely response is I will rent a place and use my previous home’s equity to fund my retirement.
In most parts of the country renting a home is definitely cheaper than owning the same home when it comes to out of pocket expenses. But, when it comes to the retirement phase, renting is not necessarily a cheaper option. Let’s look at a simple example to illustrate why. Let’s say you sell your mortgage-free home and net $300,000 from the sale. You want to rent a similar home in the neighborhood and the rent is $1,250 per month or $15,000 per year.
So you now have $300,000 to use toward your retirement spending that you did not have before, but you also have another $15,000 per year expense that you did not have before. Using the 4% rule (i.e., you can only live off 4% of your assets per year to be sure you do not run out of money), the $15,000 per year rental expense translates into needing an additional $375,000 ($15,000 divided by 4%) set aside in assets to pay for the rental expense. As you can see this is more than the $300,000 you netted from the sale of your home. When renting, you also do not have to pay for property taxes, insurance, or maintenance so this is an expense you avoid when renting. But the point in this example is when you rent, due to market uncertainty, you must set aside $375,000 in assets to support the annual rental fee versus the $300,000 you will have available from the sale of your home. So, if you sell your house, you do not necessarily have more assets to fund other non-housing retirement expenses. Also by setting aside another $375,000 to fund your rental expense, you have increased the amount of money you have to manage throughout retirement. This increases the impact of market risk on your living expenses.
When people retire and sell their house, they generally move to a lower cost area and/or buy a much less expensive home such as a townhouse or condo to be able to come out ahead financially from selling their home they had while working.
The retirement planning message here is, if you are over 50 and you think you are going to use some of your home equity to fund some of your retirement expenses, the best planning move is to sell your home now and move into a smaller less expensive home. This does two things for you. First, you lower your current housing expenses allowing to save more now. Second, you will know the exact amount of money you will net from your home sale to invest toward your retirement. This approach will not leave you with any nasty surprises about how much you thought you would net from the sale of your current home when you are ready to retire.
In the next post, I will discuss the 2 biggest investment planning mistakes people over 50 make.
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