Did your parents drill into your head that old adage from Ben Franklin: “A penny saved is a penny earned”? Mine did. But my parents and old Ben were wrong, a penny saved can be worth more if it is invested. This is just one minor example of outdated retirement “rules of thumb”. There are new and better ways to think about wealth and how you should prepare for retirement. Here are a few bits of other financial advice you should rethink.
You should save as much money as you can for retirement. It’s true that not saving enough money and not starting as early as you can, may leave you with a shortfall, and you could face a retiree’s biggest fear: outliving your money. But saving too much money can present its own challenges.
“How much is too much?” Investopedia.com asks. “That depends on your age and your financial situation. Most financial experts say you should have saved a certain portion of your earnings based on your age group: 1x your salary by 30, 3x by 40, 6x by 50, 8x by 60, and 10x by 67.
If you're saving too much, you could be putting aside more money that you will need during retirement. Put simply, you may not use all the money you saved after you leave the workforce. Some of that money may be put to better use during your working years for other purposes, including:
- Paying off your debt: This is important, especially if you carry a lot of high-interest debt.
- Setting up an emergency fund: You should have a reserve fund used to cover your expenses in the event of an emergency, such as a layoff or job loss. The amount varies based on your lifestyle, but experts say you should save anywhere between three to six months' worth of your household expenses.
- Saving for education: If you or your children want to go to college or university, you may want to set aside money for tuition and other educational expenses.”
To estimate your expenses in retirement, use the 80% rule. The 80% retirement rule is an old guideline suggesting that in retirement you will need approximately 80% of your pre-retirement income to maintain a comparable standard of living. This rule is based on the idea that certain expenses, such as commuting, work-related clothing, and contributions to retirement accounts, will decrease in retirement, potentially making 80% of pre-retirement income sufficient. But it’s time to retire this retirement rule.
Kiplinger.com notes that “the reality is that retirement spending doesn’t move in a straight line. According to a J.P. Morgan study, spending varies from year to year and is far from predictable for most retirees. Some retirees experience a ‘retirement spending surge’ during the early years when they’re eager to enjoy life and tackle their bucket lists.” Instead of an 80% estimate, design a retirement plan around your needs and interests.
In retirement you should only withdraw 4% or less of your nest egg each year. This has been the basic advice from financial advisors for decades. For a projected 30 years of retirement adjusted for inflation don’t withdraw more than 4%. But Barron’s magazine says “it’s time to throw out the 4% rule and give your retirement paycheck a raise. New research indicates that a 5% withdrawal rate is “safe”—although how you invest and tap your portfolio is critical to keep the cash flowing.”
An even better plan than just using a set percentage is to develop a plan around what you want to do after you stop working. Do you want to travel? Buy a second home on a lake? Leave an inheritance for your children or grandchildren? Most retirees just wing it; drawing money from their retirement funds as they need it. Instead, why not build a financial blueprint for your life and then monitor it regularly to gauge whether you are spending too much or too little? If you need a little help, engage a financial advisor well-versed in retirement planning to help you create a plan tailored for your needs.
You should claim your Social Security benefits early. “When to claim Social Security benefits is a personal decision based on factors unique to you,” AARP Magazine observes. “But the longer you wait to collect Social Security benefits, the more money you’ll earn. If you begin collecting at age 70, your monthly check will be 24 percent more than if you start collecting at your full retirement age. Draw benefits at the earliest age of 62 and your earnings will diminish further. Despite that, many people choose the smaller payout for the immediate cash flow. They either need the money or figure they aren’t going to live forever. When the opposite happens, they realize they need more.” If you take your benefits too early that decision is final. You can’t go back and change it.
You need a $1 million nest egg to retire. Actually, the right number depends on your lifestyle, where you live, your health, and your other income sources like pensions and Social Security. It may need a lot less than you think. Some past financial advice encouraged those planning for retirement to focus on income, but a better approach is zero in on projecting your expenses and then work back to how much money you will need to set aside. (And that brings us back to either putting in the work to develop a detailed plan or hiring a financial advisor to help you build a plan.)
Downsizing will benefit you financially. If the kids are gone, do you still need a big house? Moving to a smaller house is sometimes an emotional issue, but it is always a financial issue.
One reason to stay put is the rising cost of homes in the U.S. Once you factor in the cost of fixing up the current house to appeal to buyers, real estate agency commissions, and moving costs, the financial gain might be small or even non-existent. Additionally, if you have a low interest mortgage, new, higher, rates may put a strain on your budget. AARP Magazine suggests that “if you’re otherwise happy where you are, consider renovations to keep your home accessible and safe as your needs change, such as installing a bathroom on the main level or improving the lighting. Many state and local agencies offer guidance on aging-in-place renovations and may provide financial assistance.”
