Throughout my career, I’ve witnessed it all. And I do mean all of it — from careful savers who pinch every penny long after they should be enjoying their wealth, to newly independent investors who make decisions that threaten their long-term security. After guiding clients through the labyrinth of retirement planning for years, two distinct types of people emerged who consistently struggle, often to the point of never retiring in peace.
For example, I recall a client, newly retired and seemingly well-prepared, who approached me with an unusual request that, at first glance, appeared counterintuitive to our initial plans. Although I will elaborate on his story later, it illustrates a core challenge many face: managing retirement income effectively. It’s a struggle that can transform retirement dreams into a perpetual state of financial unease.
Do you belong to either of these types? Read on to find out what these pitfalls are and how you can avoid them.
The Pre-Retirement Puzzle: How Much is Enough?
When it comes to saving for retirement, one question looms large: How much should you save? Is it 10%, 15%, or maybe even more? In the popular ‘early retirement movement’, people often save between 50% and 70% of their income. You can’t deny that the amount you save and where you save it, be it in a 401(k), Roth IRA, or other investment vehicle, materially influences your eventual nest egg.
The accumulation phase, however, ends when you retire. After that, the percentage you saved during your working years is less relevant. The most important thing is how you manage your withdrawals and how much you’ll spend.
The Two Extremes of Retirement Spending
In my experience working with hundreds of clients in their retirement phase, I have observed two distinct categories of people: underspenders and overspenders.
The Underspenders: Fear Over Abundance
On the one hand, we have those who, despite having plenty of savings, cannot justify spending anything. I vividly remember a widowed elderly client who lived in constant fear of running short of money. She would spend only her husband’s Social Security and pension, barely even touching them.
For example, despite having more than enough in her investments to cover her monthly bills and living expenses, she couldn’t lower her thermostat below 80 degrees in the scorching summer heat due to financial anxiety. To convince her that she had enough money to live comfortably, her children and I intervened. Even though her case was extreme, I’ve seen countless instances in which individuals with ample savings have denied themselves basic comforts because they fear depletion.
According to a 2018 study by the LIMRA Secure Retirement Institute, approximately three out of ten retirees don’t withdraw their retirement savings. In other words, they live off other sources of income rather than their nest eggs.
Furthermore, 64% of Americans worry more about running out of money than dying, according to a survey from Allianz Life. Inflation, insufficient Social Security benefits, and high taxes are among the reasons cited for these fears.
The Overspenders: The Allure of Immediate Gratification
Overspenders are at the other end of the spectrum. The recently retired client I mentioned at the beginning of this post exemplifies this scenario perfectly. As part of our retirement planning process, we meticulously created a customized spending plan for the future, which makes his request all the more surprising.
He already had a nice, well-functioning truck. However, after retiring, he came to me planning to pull a large sum of money from his investments to purchase a brand-new, high-end luxury vehicle. The request alone was enough to stress me out since it was not part of our agreed-upon plan.
Even more concerning to me? He wanted to withdraw the funds from his IRA. Just to cover the taxes on the distribution, he would have had to withdraw an additional $25,000 to cover the purchase price of this luxury vehicle.
But that’s not all.
Always think twice before tapping your IRA early.
Dipping into your IRA, especially before age 59½, might make sense. It can, however, derail your retirement plans due to its significant downsides. In general, it is best to avoid early withdrawals due to these significant disadvantages:
- Taxes hit hard. Traditional IRA withdrawals made before age 59½ are typically taxable. As a result, you’ll have to pay both federal and possibly state income taxes on the amount you withdraw.
- The 10% penalty. If you do not meet a specific exception, the IRS will likely hit you with an extra 10% early withdrawal penalty.
- Lost growth potential. When you take money out early, it can’t grow. As a result, you’ll lose compound interest and long-term investment gains in retirement.
- Shrinking savings. Ultimately, early withdrawals will reduce your retirement savings. To compensate for this loss of funds, you may be forced to lower your standard of living in retirement or even work longer.
In short, accessing your IRA early can significantly reduce your retirement savings and result in unexpected tax and penalty consequences.
Thankfully, I was able to convince him to put off the vehicle purchase and not withdraw funds from his IRA. His story illustrates how sudden freedom in retirement, coupled with a lack of a clear spending strategy, can lead to impulsive and potentially detrimental financial decisions.
Finding Your Retirement Sweet Spot
There’s a good chance that you can relate to one of these stories, and perhaps even find yourself leaning towards one of these spending styles. However, regardless of whether you’re an underspender or an overspender, you can find strategies and resources to help you plan for retirement.
For a peaceful and fulfilling retirement, effective retirement income management is essential. You want to ensure that you’ve thoroughly reviewed and double-checked your financial plan, so you’re well-prepared for success. As a result, you’ll have one less worry to worry about, allowing you to spend more time enjoying your retirement years.
Knowing your retirement costs and planning your income can help alleviate the fears and uncertainty of your golden years.
FAQs
How do I know how much I can safely spend in retirement?
When determining your safe spending rate, consider several key factors, including your retirement savings, life expectancy, and expected expenses. As a general rule of thumb, withdraw no more than 4% of the value of your initial retirement portfolio in the first year, and then adjust that amount each year for inflation. However, this is only a guideline, and a personalized plan is always best.
What are the biggest risks to my retirement income?
Over time, inflation erodes the purchasing power of your money; unexpected healthcare costs can be significant; and longevity risk, the possibility of outliving your savings, is a concern. A market downturn can also be a risk, especially in retirement.
Should I prioritize paying off my mortgage before retirement?
Generally, yes.
If you retire without mortgage payments, you will have more money available for discretionary spending and reduce financial stress. But if you plan to use that capital for other purposes, you should consider your overall financial picture and all potential uses as well.
How can I ensure I don’t run out of money in retirement?
A comprehensive retirement income plan is essential. It involves analyzing your income sources (Social Security, pensions, investments), estimating your expenses, and planning a withdrawal strategy that balances your spending needs and your portfolio’s longevity. It is also essential to diversify your investments and maintain a sufficient emergency fund.
Is it ever okay to take a large withdrawal from my retirement account for a big purchase?
There are some situations in which a large withdrawal might be advisable, especially if it is for an essential expense or an investment that significantly improves your standard of living. Take the time to do the due diligence, consider the tax implications, and the long-term sustainability of your portfolio when withdrawing from a pre-tax account, such as an IRA. Before making such a decision, you should consult with a financial advisor.
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