45% Americans Could Run Out Of Money In Retirement Despite Financial Planning: 4 Mistakes To Avoid

A Morningstar Center for Retirement & Policy Studies research leveraged a new simulation tool to find that 45% of Americans retiring at 65 face risks of running out of money in retirement as people live longer and share greater responsibility for their retirement savings. The simulation considered attributes like health conditions, nursing home expenses, and demographics, among others, to reveal that single women have a 55% chance of running out of money in retirement, followed by couples at 41% and single men at a 40% risk. Furthermore, the timing of leaving the workforce also influences financial risks in retirement, as almost 54% of US households retiring at 62 could go broke compared to 28% of retirees leaving the workforce at 70. Collecting Social Security at 62 also locks you into reduced pay for life. The Social Security Administration revealed that the average monthly check for those retiring at 70 is $4,873 compared to $2,710 at 62.

While delaying retirement is one way to increase your Social Security checks and add more money to retirement accounts, a Northwestern Mutual survey found that most people want to retire at 65. Many of those who retire earlier cite reasons like layoffs or health challenges. Morningstar's associate director Spencer Look opined that these estimates could become realities for those not contributing to a retirement plan. While the retirement landscape isn't an immediate national crisis, the future of 69 million workers or over 50% of the US workforce, hangs in the balance as they lack access to retirement plans like 401(k)s from their employers, per the Economic Innovation Group. Morningstar research found that people who contributed to their 401(k) lifelong remain at risk of running short in retirement, possibly because they cashed out during a job change or have depleted their accounts severely through premature withdrawals. Some retirement experts also believe that many who feel prepared for retirement have a good chance of facing shortfalls in their golden years because of inadequate tax planning and knowing how to use their banking and investment accounts wisely.

Lack Of Tax Planning

Although Americans contributing their pre-tax income to traditional 401(k)s or IRAs can defer taxes on the capital gains, a lack of planning around what they have saved catches many retirees off guard. Belmont Capital Advisors president JoePat Roop old Business Insider retirees are surprised at their tax liabilities in retirement because many assume they will fall in a lower tax bracket when the paycheck from work stops coming. He has witnessed many retirees remain in the same tax bracket or move to a higher one. Post-retirement spending habits stay the same or become more extravagant, especially in the first few retirement years when you suddenly have more leisure time, which many spend on travel and entertainment. This situation leads to a higher withdrawal rate, placing you in a higher tax bracket. Since withdrawals from traditional 401(k) and IRAs are taxed like regular income, Roop suggests workers add a Roth IRA in the mix, which grows your post-tax contributions for tax-free withdrawals in retirement. The financial expert recommended using a Roth IRA when you have to withdraw higher amounts to save significantly on taxes. You can open a Roth IRA if your modified adjusted gross income is below $161,000 for the current financial year or $240,000 for those filing jointly.

Moving Money Inefficiently Leads To More Taxes And Lower Returns

Roop shared that people transferring their money inefficiently, like withdrawing huge sums from an investment account to buy a house, can result in thousands of dollars in avoidable taxes. "There are rules that the IRS has set up for us, and they're there to pay the government, not you," he said. Roop recalled how a client, expected to retire this year, broke his IRA nest egg to purchase a house after a sudden parting with his girlfriend. He chose to withhold the tax, estimated up to $40,000. Roop was shocked that his client had made this big tax mistake because he already had the money for the down payment in another account, which would have incurred no taxes. Furthermore, Roop was planning to roll over the client's IRA funds to an annuity, which would have earned a 10% bonus or $15,000. Ultimately, using an IRA account to buy the house cost the client up to $55,000 in taxes and missed bonuses.

Retirement Withdrawals During Stock Market Upheavals

While the S&P 500 returns have averaged nearly 10% in the last half-century, investors can expect returns between 9% and 11% over the coming decades. However, Roop said that people retiring don't know the sequence of returns. Let's say you retire in 2025 with $1 million. If the market tanks by 15% in the same year, your net worth falls to $850,000. While that is not a problem since the market moves in cycles, portfolio recovery can get tricky if you withdraw when the market is down. Hence, diversification through stocks and bonds isn't enough. To avoid withdrawing from stock portfolios during market downturns while protecting the principal deposits, Roop believes that retirees must explore options like a certificate of deposit, fixed annuities, and government bonds.

Taking Low-Risks During Working Years

As people age, they transition from aggressive, high-risk investment options to conservative, secure instruments generally paying regular income while protecting principal deposits. However, Segment Wealth Management CEO Gil Baumgarten explained that many people run out of money in retirement because they didn't take any risks in their working years. He thinks a low-risk decision to earn interest on cash isn't the most intelligent way to compound money since it's taxed higher than regular income with lower returns. Elsewhere, stocks can offer much bigger returns, which aren't taxed until you sell shares. Furthermore, you can avoid taxes entirely on capital gains via a Roth IRA while diversifying your portfolio with more personalised investment options.

"People don't take into account how expensive things get over time, not realising that they can live another 40 years in retirement. You can't get rich investing your money at 5%," he said. In contrast, most risk-takers often adopt a wrong approach, like being swayed by market hype and betting on speculative investments to end up losing money and developing the idea that any form of risk isn't worth it. Baumgarten recommended that if someone can afford risks, they can gain exposure to stocks via low-cost index funds and blue chip stocks.

Disclaimer: Our digital media content is for informational purposes only and not investment advice. Please conduct your own analysis or seek professional advice before investing. Remember, investments are subject to market risks and past performance doesn't indicate future returns.