Making sure you have enough money to retire can be the difference between enjoying life after medicine vs having to pick up a job or pinching pennies during your golden years. But even during retirement, you are not safe from financial setbacks.
Taking out too much can cause you to run out of money, but taking out too little can cause you to miss out on incredible experiences you may never get back.
A finance professional can help you figure out which accounts to withdraw money from, and how to do it in the most tax-efficient way.
Navigating retirement can be tricky. The skills and mindset you need to build wealth are different from those you need to preserve your wealth.
Whether you have just started your career, hit the midway point, or are on the verge of retirement, be sure to avoid these common money mistakes in retirement.
Mistake #1: Taking out too much, too soon
You should amass enough wealth for retirement to cover expenses for about 30 years. While the average lifespan is about 78 years, it’s good to assume you will beat this average, and be financially prepared accordingly.
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"A good rule of thumb is to assume you will retire in your 60s and live into your 90s—and you definitely don’t want to run out of money before then."
— Lisha Taylor, MD, MPH
In order to ensure that you don’t run out of money, researchers at Trinity University discovered a helpful formula: As long as you have half your money invested in stock-based index funds, you can withdraw around 4% of the total balance each year. Doing so will almost guarantee that your money will last about 30 years in retirement.
Unfortunately, many people are not aware of this. They take out too much money in their early retirement years, which puts them at risk of running out of money later on.Related: Retirement investing: Everything you need to know
Mistake #2: Not withdrawing enough money
While some may be at risk of taking out too much money too soon, others may fall on the opposite side of the spectrum, and take out too-little money in retirement, or much less than the recommended 4% per year. Research shows that the average investment portfolio of a retired person actually grows during retirement, meaning instead of spending down your money, you may actually accumulate more. While this may not seem like a bad thing, don’t forget about the opportunity cost.
People who don’t withdraw enough money in retirement are at risk of depriving themselves of incredible travel experiences and desirable luxuries, and they pass away before getting the chance to truly enjoy everything retirement has to offer.
"While delayed gratification can help you accumulate wealth, at some point you deserve to enjoy the fruits of your labor."
— Lisha Taylor, MD, MPH
Mistake #3: Not accounting for healthcare expenses
Many costs decrease in retirement. Your home mortgage may be paid off; you are no longer paying for childcare expenses or college tuition for your kids; you don’t have to invest/save as much of your income any longer; and so on. But one expense tends to rise dramatically in retirement: healthcare.
For many working people, their health insurance is subsidized by their job. They pay a small monthly premium while their employer pays the majority of the cost. When you retire, this will no longer be the case, especially if you retire early.
As of 2023, you won’t be eligible for Medicare until you turn 65. This means you may have to buy healthcare from the federal marketplace, which can cost thousands of dollars per month—if not more. Even once you turn 65 and become eligible for Medicare, you’ll most likely need a supplemental insurance plan to decrease costs.
Many people over 65 also see higher out-of-pocket costs for rehab services, prescription drugs, and increased doctor’s visits, compared with when they were younger. Failing to account for this increased cost may result in having to spend more each month than you originally planned.
Mistake #4: Not changing your asset allocation
Your asset allocation is the percentage of each type of investment you have in your investment accounts. Perhaps you started off your career with 90% stocks and 10% bonds, or perhaps you have 80% stocks or 20% bonds. Regardless of what you started with, you may need to change it in retirement.Related: Investing 101: 5 steps to build passive income
Instead of taking lots of risk by investing the vast majority of your money in stocks (or stock-based index funds), you may need to decrease this risk.
The more risk you take, the greater the fluctuations in the overall value of your portfolio. While that can be a good thing if your portfolio value goes up, it can be catastrophic if it goes down.
The last thing you want is for the market to crash the year you enter retirement, which could mean losing as much as 30% of the total value of your money when you need it most.
My point? Many people in retirement should re-examine their asset allocation. The general rule is to decrease the percentage of stocks and increase the percentage of bonds and cash. This will allow you to take less risk and “stabilize your portfolio.”
"Instead of wealth accumulation, you should be focused on wealth preservation, and this requires changing your asset allocation."
— Lisha Taylor, MD, MPH
Mistake #5: Not withdrawing money from the right accounts
Having enough money to be able to retire is one thing, but understanding how to withdraw the money in the most efficient manner is another. This can get even more challenging for those who are retiring before age 60.
Maybe you have money in a Roth IRA in addition to a few 401Ks from different jobs. Perhaps you have a health savings account (HSA), a taxable account, or even a 457b or 401a account. Consult a financial planner or tax professional to help you navigate withdrawals from these accounts in the most tax-efficient manner.Related: 6 investment accounts to help you retire early
Some accounts, such as a pre-tax 401K or 457b, require you to pay taxes on any money you withdraw. Other accounts, such as an HSA, are completely tax free when used on healthcare. Withdrawals from a Roth IRA are tax free to you, and the best kind of money for heirs to inherit.
The age you retire, the amount of money you need each year to live on, and the total amount you have in each type of account can drastically change how and when you should withdraw money in retirement.
Not doing things optimally can cause you to pay more taxes while you are alive and leave your heirs with huge tax burdens when you pass away.
What this means for you
Navigating retirement can be tricky. You will likely need to take less risk by changing the way you invest. It is also imperative to account for increased healthcare expenses when planning for retirement. Consider consulting a finance professional to help you figure out how much, and when, to withdraw money from your different accounts.