Six common misconceptions empty nesters have about retirement
We have been advising retirees and aspiring retirees for over 20 years. Recently a conversation occurred about what lessons retirees could teach aspiring retirees, especially those empty nesters who are zeroing in on retirement. What resulted from that conversation was a list of six common misconceptions aspiring retirees had about retirement.
I will just live off interest and not touch principal
This is a favorite for people wanting to be conservative. While we love this concept, this has never really worked, at least over any substantial period.
Empty nesters were kids at the time, but many can recall their parents talking about the high interest rates of the late 70’s and early 80’s. Why was it possible to get CDs and Treasury securities paying more than 10% interest? Because tax and inflation rates were so high, no one would buy them if the rates paid were not also high. What is often missed in the storytelling is that those who bought the high interest instruments seldom got the high interest for very long, which is not what people wanting to “just live off interest” want.
Recent years show we don’t need a high tax, high inflation environment for “just living off interest” to not work well either. In early 2000, one could get 6% from a money market fund. By 2003, 0.6% was common. A 90% decline in spendable cash is not what one would expect from a “conservative” strategy.
I won’t need to worry about my budget
After a lifetime of delaying gratification and saving, many retirees find there is still a need to watch their spending. In some cases, they worry more as retirees than they did when they were working.
During your career, for the most part, if you show up on time and do a decent job, you get a paycheck. That can create a sense of control.
In retirement, much of your cash flow comes from your savings – the value of which can be affected by economic, political, and financial market gyrations which are completely out if your control.
In retirement, much of your cash flow comes from your savings – the value of which can be affected by economic, political, and financial market gyrations which are completely out if your control. That can cause a lot of anxiety.
Other unknowns can be just as puzzling and distressing. How long will I live? Will I be healthy the whole time or need long-term care? From which accounts do I take withdrawals? Will my pension stay solvent? Will Social Security be altered? Will a family member need some financial help? Will so and so politician take things in a direction that I don’t like?
Retirement can be the best time of your life, but it takes planning, perspective, and a different skill set from what is required leading up to retirement.
My kids will be “off the payroll”
Maybe, maybe not. No matter how well they are raised, children cannot be fully protected from life’s ups and downs.
We have seen the adult children of our retired clients lose their jobs, get sick, be injured, battle addiction, get ripped off, and become embroiled in legal disputes. The list is endless.
No matter how sure a client is that they are not paying for things for children once the nest empties, there are events that simply cannot be ignored. Would you refuse to help pay for a lawyer to get a child out of an abusive relationship or say “no” if one of your kids needs money for medical care? Probably not.
Required Minimum Distributions will put me in a higher tax bracket
For some clients, all they know about Required Minimum Distributions (RMDs) is they are forced to take them at age 72 and pay taxes. They often fear a huge increase in their tax bill. In many cases, RMDs are not the disaster they are made out to be.
RMDs apply to IRAs and most retirement accounts such as 401(k)s. They are determined each year based on the balance of the account and a life expectancy factor. The older you get, the more you must take from the accounts. However, the life expectancy scale is a generous joint life expectancy and not just the life expectancy of the account owner. The first year RMD for 2021 is roughly 3.9% of the IRA and it rises only to about 6.25% by age 85.
As a result, clients with smaller retirement accounts or conservatively positioned accounts often do not experience the jump in taxes they fear because the accounts do not grow as large.
I shouldn’t take money from retirement accounts before age 72 unless I need it
This is the opposite situation from above. Instead of fearing RMDs, the account owner ignores them. The common scenario is an early retiree who loves paying as little in taxes as possible. To keep the taxes down, he takes nothing from his retirement account. When he reaches 72, he has a large balance and the resulting RMD kicks him in a higher bracket.
For married persons, a sneaky tax increase comes when one spouse dies. The surviving spouse will file as a single taxpayer the year after the death. The tax brackets for single filers are higher than for joint filers for similar levels of income.
My tax situation will be simpler as a retiree
This is a classic case of “it depends.” For many, tax planning is more complex due to all the moving parts.
The first dollar of income for a new retiree is not taxed. Exactly when taxes begin to be applied varies as income rises. The source of the income matters as well. Most retirees see variability in the sources of income during their retirement, as investment income changes and pensions, Social Security, and RMDs kick in.
As income goes up, Social Security becomes taxable. Further income increases make capital gains taxable. More income can result in a loss of tax deductions for medical expenses or charitable contributions. More income triggers other costs such as the notorious Income Related Monthly Adjustment Amount which is not technically a tax but an increase in the cost of Medicare premiums determined by income from two years prior.
Lastly, even if one gets their tax situation simplified, it may not stay that way. It is a near certainty the tax code will change several times during the course of an average retirement period.
Many of our clients make retirement look like a lot of fun because it is – but it isn’t without its challenges. Being prepared with a realistic plan makes the transition easier and helps avoid misconceptions or painful surprises.
Moisand Fitzgerald Tamayo, LLC is an Orlando, Tampa and Melbourne, Florida based fee-only financial planner serving central Florida and clients across the country. Moisand Fitzgerald Tamayo, LLC specializes in providing objective financial planning, retirement planning, and investment management to help clients build, manage, grow, and protect their assets through all phases of one’s life and the many transitions in between. If you have any questions or would like to discuss anything further, please give us a call or send us a note. If you are not a client and wish to receive emails notifying you of new posts – no more than once per month – fill out the subscription information in the sidebar to the right. For more frequent updates, follow us on Facebook, LinkedIn, or Twitter.
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