Seven Common Retirement Planning Misconceptions
I recently met with a 71-year-old retiree who relies on Social Security for a sizable share of her retirement spending. She’s concerned that the Social Security trust fund will run out in 2032—just six years from now. Having read just the headlines, she is now worried she’ll lose much of her retirement benefits.
In truth, payroll taxes will be enough to pay 78 percent of scheduled Social Security benefits. That means the worst case is that she’ll face a 22 percent reduction in benefits, something we could accommodate in her financial plan. But it shows how common misconceptions can cause us unnecessary stress and lead us to such fear-based decisions as living well below our means.
In my years as a financial planner, I’ve found that concerns tend to cluster around a handful of notions that are partially wrong at best. They include:
1. Social Security won't be there for me.
While Social Security faces a funding shortfall, the program also collects payroll taxes every year and has enormous political support. Even under the most pessimistic projections it will pay roughly 80 percent of promised benefits (per above) without any changes to current law. Congress has adjusted Social Security before and will almost certainly do so again. Plan for it as part of your retirement income—don't assume it won’t be there for you.
2. I don't need a long-term care plan because I'll stay in my home.
According to the Center for Retirement Research, about 80 percent of retirees will require some form of long-term care. Staying home may be a reasonable goal for some, but home health aides cost a median of $75,500 per year, and not everyone can remain at home as their care needs intensify. Only about four percent of long-term care in the U.S. is covered by insurance. Without a plan, many households are forced to draw down their savings and ultimately fall back on Medicaid. Don't confuse a preference with a plan.
3. Medicaid will cover my long-term care costs.
Related to #2, many people come to me with the belief that they can protect their assets even if they end up needing expensive long-term care.
Medicaid does cover long-term care, but only once your assets are nearly gone. In many states a single applicant owning more than just $2,000 in eligible assets will not qualify for Medicaid. While you could give assets to family or place them an irrevocable trust, that leaves you in a precarious financial position. And not all nursing homes accept Medicaid, which severely limits your options.
Bottom line, I generally advise people against getting rid of all their money in order to qualify for Medicaid.
4. Now that I'm retired, long-term investment returns no longer apply to me.
When I describe stocks as a "long-term" investment, retired clients often tell me that they "don't have a long-term." While I can’t predict how long anyone will, I often disagree.
If you retire at 65, your planning horizon is potentially 25 or 30 years. A dollar you won't spend until age 85 has two decades to lose its value to inflation if left in cash, or to grow if invested in stocks. Abandoning stocks in favor of cash or low-yielding bonds may feel safe but it introduces the real risk of outliving your money. Not only that, you may have other objectives for your investment portfolio beyond providing annual spending in retirement. You may be saving for long-term care or for your heirs, which in either case it may make sense to maintain a moderate or even aggressive allocation.
A well-diversified portfolio that includes stocks remains appropriate for most retirees, even as the allocation shifts slightly more conservative with age.
5. I shouldn't spend from principal.
Many retirees live unnecessarily frugally because they're committed to spending only the interest their portfolio generates. The dividend rate of the U.S. stock market has collapsed in the 21st century, and most people can't count on dividends and income to cover expenses. Your retirement portfolio is not a savings account or an endowment whose principal can’t be touched. Its purpose is to fund your retirement. A sustainable withdrawal rate of 3.5 to 5+ percent allows you to spend thoughtfully without running out of money.
6. My taxes will be lower in retirement.
Many people assume their tax burden drops when they stop working. That's often not the case.
If you've spent decades saving in a traditional 401(k) or IRA, every dollar you withdraw in retirement is fully taxable as ordinary income. Add Social Security income and required minimum distributions, and some retirees find themselves in a higher bracket than expected. This is one reason Roth conversions—paying taxes now to avoid them later, while earning tax-free growth—deserve serious consideration in the years before or early in retirement, especially while you're still in a lower bracket.
Drum roll, please. Image created with ChatGPT.
7. I need to hit a specific number, like $1 million, to retire.
Target savings amounts feel concrete, but they can mislead as often as they help. Whether $1 million is too much or not nearly enough depends almost entirely on how much you spend. A retiree spending $40,000 per year with Social Security covering half that amount needs a very different nest egg from someone spending $120,000 with no pension. Focus on your spending needs and income sources first. The right number follows from that.
The common thread running through all seven of these misconceptions is fear. Fear of running out, losing benefits, or making the wrong move. These fears often nudge people toward overly cautious choices. Getting the fundamentals right matters more than getting everything perfect.
This article first appeared in the “Squared Away” blog at the Center for Retirement Research at Boston College