Dos and Don’ts of Retirement Planning

Planning for retirement is like running a marathon. Set a steady pace and keep going. It is also important to have a strategy in place to reach retirement and do something each year that moves you closer to realizing it. Here are some dos and don’ts to help you reach your retirement goals.

Do Eliminate Debt

This probably doesn’t sound like it has anything to do with retirement, but there are two parts of the retirement equation – saving and spending. Just making the decision to get out of debt can subconsciously help you reduce spending, which may ultimately lead to increased savings. Psychologically, many people are more comfortable in retirement when they are not responsible for making debt payments.

Don’t borrow from a 401(k) to pay off debt

Some people believe their 401(k) is the first place they should turn to for money because they are really just paying themselves interest. Interest rates vary on 401(k) loans, but they are typically a point or two higher than the prime rate. You would think that with an interest rate of 5%, you are paying that 5% to yourself, for a net cost of zero. That is not quite the case, as there is usually an origination fee for the loan and then annual servicing fees. These custodian processing fees can severely dilute the “interest-free” nature of the loan.

The worst part of a 401(k) loan is the tax trap that can be created if you retire while the loan is still outstanding. The loan must either be repaid as a lump sum or it will be considered a taxable distribution. Borrowing from your 401(k) should be a last resort. Make saving for retirement a priority. The longer the money is left to grow in your 401(k), the easier it may be to reach your goal.

Do review your asset allocation

The right allocation for equites (stocks) and fixed income (bonds) should be based on the rate of return needed to produce the best statistical chance for a successful retirement. Research has shown us that investment rate of return is derived primarily by the allocation between stocks and bonds. This nugget of information can be the key to determining your asset allocation.

Don’t adjust asset allocation by your age

One of the most quoted retirement myths is that you should have less money in stocks as you get older. This myth is often followed by the formula of taking your age minus 100 to get the correct allocation of stocks. This myth began fifty years ago when most people were only expected to live 5–10 years in retirement. Today, there is a 25% chance that a couple retiring at age 65 will have one of the spouses live to age 95. You cannot fight 30 years of inflation with a portfolio over-weighted in fixed income.

Do make a plan to pay off your home mortgage

The decision whether to retire with or without a primary residence mortgage is a key planning issue for most retirees. This has become even more of an issue as fewer people are able to deduct mortgage interest on their tax return and mortgage rates are at historic lows. Does it really make sense to pay off a mortgage when rates are hovering around 4%?  Finding the money to pay off your mortgage can be a tax issue as well. The right answer will vary depending on each individual’s circumstances. Often, this will take us back to the first “Do”. Psychologically, many people are more comfortable in retirement without debt of any kind.

Don’t take a lump sum distribution from your IRA to pay off the mortgage

Generally, it’s not a good idea to withdraw from a retirement plan such as an IRA or 401(k) to pay off a mortgage. A lump sum distribution could move the retiree into a higher tax bracket. A taxpayer in the 22% tax bracket would need to withdraw more than $128,000 to net $100,000 after taxes. It would take a withdrawal of nearly $154,000 to net the same amount for someone in the 35% tax bracket. A strategy of using retirement funds to pay off a mortgage should be carefully developed with a tax adviser. The goal should be to accelerate paying off the mortgage while minimizing income taxes.

Do review your Social Security statement

Everyone who has paid into the Social Security system and is not drawing benefits should review their statement annually. Pay careful attention to the record of earnings. Check that earnings are being recorded correctly. Each person’s monthly benefit is based on their earnings history. It is easier to fix mistakes as soon as they happen. Taxpayers will be required to show proof of earnings and the amount of Social Security taxes paid. Most people can produce this easily for the last few years. Going back 10 years is a lot harder.

Don’t take Social Security benefits for granted

Social Security benefits are an important part of everyone’s retirement plan. Developing a strategy before retirement is important to maximize benefits and minimize taxes at the same time. Many articles say retirees should wait until 70 to draw Social Security benefits if they are healthy. Waiting to draw is not always the best choice. It is best to work with an adviser who understands Social Security benefits to determine the best strategy based on your unique circumstances.

Rick’s Insights

  • Borrowing from your own 401(k) is not the same as paying yourself interest.
  • An investor’s asset allocation should be based on achieving the rate-of-return they need to achieve their long-term goals.
  • Eliminating debt is an important financial goal, but investors should consider the cost when developing a plan. The goal should be to pay off debt quickly and efficiently. Visit Rick’s original post here.

1 Brinson, Hood and Beebower “Determinants of Portfolio Performance” Financial Analysts Journal, 1991

By Rick Rodgers

Read more from Rick Rodgers by clicking here to purchase his book.

Don’t Retire Broke:

An Indispensable Guide to Tax-Efficient Retirement Planning and Financial Freedom, by Rick Rodgers

Using easy-to-understand language and real life examples, Rick teaches you how to avoid savings pitfalls and costly tax mistakes – many you may not even know about – so you can enjoy the retirement lifestyle you want.

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