As you start to save for retirement, you’ll receive a lot of advice about different strategies. While some of this advice is good, the truth is that new laws and investment products continually change, which means that advice also needs to shift over time.
Before following any advice, you should think critically about whether it works for your goals and makes sense in the current market. If you are unsure, you can always consult a financial professional for guidance. Much of the advice that you hear frequently is, in fact, outdated.
Some of the common pieces of advice that you can safely ignore include:
Follow the four-percent withdrawal rule.
One of the most dangerous pieces of advice that people still follow is the rule pertaining to “safe” withdrawal levels. The four-percent rule is meant to keep people from running out of money in retirement. According to this advice, you should withdraw four percent of your savings in the first year of retirement and then adjust this amount for inflation in subsequent years. The problem with this rule is that it is inflexible. First, many people spend more in their early years of retirement as they travel, establish hobbies, and incur other one-time expenses. These expenses decrease over time, so it is not uncommon for people to need less monthly income later in retirement. The other issue with this rule is that it does not account for changing market expenses. When the markets are down, you may want to withdraw less. Then, when the markets are up, you can withdraw more. Talk to your financial advisor about different withdrawal strategies for your specific circumstances.
Aim for about 70 percent of pre-retirement income.
Another outdated piece of advice is that you will need about 70 percent of your pre-retirement income once you stop working. While many retirees do spend less than they did in their working years, expenses vary significantly between people. People who want to travel or embrace an expensive habit may end up needing more than they did while they were working. Some people have more expensive healthcare needs. Banking on the 70-percent figure blindly just isn’t accurate enough. A better approach involves creating a retirement budget and figuring out exactly how much you’ll need for the lifestyle you envision. People often budget less money than they currently spend, but many are surprised that they need just as much, if not more.
Pay off all debt before you retire.
Not long ago, experts advised everyone to pay off all debt before retirement. This advice no longer makes sense for many people. Often, focusing on this goal causes people to delay their retirement unnecessarily, which keeps them from enjoying their senior years. It’s true that people with a lot of debt will likely need to keep working for as long as possible, and that paying off debt isn’t a bad idea. However, if you can still make your debt payments on a fixed income, there’s no reason not to retire. The other issue with this advice is the assumption that all debt is bad. Debt is not created equal. You should certainly focus on paying off high-interest debt as quickly as possible. However, a mortgage is not necessarily a debt that needs to be paid off prior to retirement. Low-interest debt, like a mortgage, does not always need to be prioritized, since your money can often earn more interest than what is charged on the debt.
You’ll be fine with a $1-million nest egg.
For a long time, the traditional advice was that $1 million is enough for retirement. In reality, this amount is no longer enough for many American workers. The fact that people are living longer and have limited access to pensions makes it much more difficult to make $1 million stretch the entire length of a retirement. Today, people may live 30 years into their retirement, if not more. Furthermore, inflation will continue to drive up the cost of living. According to the Bureau of Labor Statistics, the average household headed by someone of retirement age spends $50,000 per year. This means that you would need to save $1.5 million before inflation and more than $2.3 million assuming an inflation rate of 3 percent. The bottom line: make sure you understand how much you will need to retire based on your specific budget, rather than sticking to an outdated figure.
Tax rates will fall once you retire.
Many people falsely believe that their tax rates will fall significantly once they retire. This belief stems from an assumption that they will bring in less income and will thus fall into a lower tax bracket. However, you should keep in mind that taxes are due on 401(k) distributions, and minimum distribution requirements can push you into higher tax brackets than you planned for. For some high-earning households, the tax rate may actually increase after retirement once all the required distributions are made. Pay close attention to how much money you put into your 401(k) to make sure that you will not be forced to take higher minimum distributions than you planned. If it seems like this might happen, it may be time to open different types of accounts, such as a Roth 401(k), which does not have the same disbursement rules.