Saving for retirement can be a very stressful topic for many Americans. We want to have enough money to live without worries during our retirement years, but many of us do not feel like we are in a position to save adequately at the current point in our careers.
This stress can be exacerbated by the many prevailing myths and pieces of bad advice about saving for retirement. This misinformation can cause us to make poor investment decisions or panic about the good decisions that we have already made.
Understanding the myths out there can help people approach their own portfolios in a more balanced manner and make the best decisions for their future. Some of the biggest myths that need debunking include the following:
1. Monthly expenses decrease in retirement.
When thinking logically, it makes sense that your expenses would decrease after retirement. After all, you will have paid off many major bills and loans, and you will not incur daily expenses such as commuting to work.
However, many people end up replacing old expenses with new ones. For example, while retirees may not drive to work every day, they will still drive to volunteer, see friends, or engage in extracurriculars. Meanwhile, reduced household expenses are often replaced by the cost of new hobbies and travel.
In truth, about 20 percent of new retirees do see their expenses go down, but another 20 percent will actually experience an increase in spending. The majority of retirees will spend about the same. In other words, you should not bank on spending less once you retire. Making a personal expected budget can help you figure out your likely monthly spending.
2. Withdrawing 4 percent makes savings last.
One of the common rules of thumb when it comes to retirement savings is to withdraw 4 percent in the first year and then slightly more each subsequent year to adjust for inflation. In theory, this rule avoids touching the principal and allows you to live off interest alone.
While this guidance is good as a rule of thumb, you should not be dogmatic about it. Sometimes, it is necessary to touch the principal—after all, that’s why you saved the money in the first place. People may carry this mentality into retirement from their employed days. In truth, employees should avoid pulling on retirement as much as possible, but that rule does not hold in retirement. Many people will need to pull on their principal at some point, and they should not feel bad about doing so.
3. Annuities will provide guaranteed income.
A large number of people turn to annuities once they have maxed out their savings in their 401(k), individual retirement account, and pension plan. Retirees often see annuities as a source of guaranteed income, but that is not actually the case. If the insurance company issuing the annuity fails, then that person will no longer have that income. Resolution of failure will not include continued coverage of annuity payouts. This consideration is important since regulators are now allowing insurance companies to take on more risk, which makes it more possible for an annuity to fail.
Recently, the International Monetary Fund warned that life insurers were making risky investments that could threaten solvency. Moreover, these investments are being made because the companies are having difficulty keeping up with their future financial obligations.
4. You need $1 million saved before you can retire.
Whenever people try to put a specific number on the amount needed to retire, it is based on an ambiguous formula. The truth is that everyone will need different amounts depending on the lifestyle that they want in retirement as well as the financial obligations they will have.
Rather than picking an arbitrary goal, it makes sense to think critically about what you want after retirement and create a budget to guide savings. One of the most frequently quoted numbers is $1 million. While this can be enough for some people, others may need more, especially when factoring in inflation.
People who do not plan to retire for a decade or more will likely need to save more than $1 million, but it makes the most sense to figure out a personal goal rather than choosing an arbitrary number.
5. You can make up retirement savings later in life.
Many people choose to put off contributing to their 401(k) because they put other financial goals first. While it is possible to catch up with savings to some degree, doing so often means making sacrifices and working extra hard. Even people with a modest income should aim to save something toward the future, given the power of compounding interest. Money saved early will help the nest egg grow more over time, but catching up later on means contributing even more to the account than you would have if you started early.