Don’t make these dumb moves with your nest egg
By Sarah O’Brien | Special to CNBC.com
Published: November 3, 2015 8:00 AM ET
By now, we all know we should be saving for our golden years. But financial advisors caution that retirement planning goes far beyond simply building a nest egg.
While the mistakes that people can make are myriad — after all, who’s a pro about the many aspects of retirement planning except the pros? — here are some of the situations that seem to often crop up.
1. Inappropriate investments. Sometimes advisors review a potential client’s financial picture and are dismayed to discover that although decades were spent saving for retirement, the money was languishing in cash or bonds instead of invested in the stock market. That means the person’s retirement portfolio could be worth about a third of what it could have been if it had been invested more aggressively.
Other times, people take too much risk in the market at a time when they absolutely should not.
Advisor Jennifer Landon had a client who, before he came to her, cashed out of his pension plan when he retired in his mid-50s. He put the money in an individual retirement account and went whole hog in the stock market.
However, because he no longer had a source of income, he took advantage of Internal Revenue Service Rule 72(t).
Rule 72(t) allows you to take advantage of your retirement savings before the age of 59½, when there is otherwise a 10 percent penalty on early withdrawal. The withdrawals, however, are still taxed at your income rate. The drawback to taking advantage of Rule 72(t) is that you may deplete your retirement accounts well before the end of your life expectancy. By taking out your funds early, you are putting yourself in jeopardy in the future.
Once a 72(t) plan is implemented, you are locked into it.
The problem was that he did all this right before the market imploded. And because he was required to take the 72t payments — which totaled roughly $50,000 a year — he was forced to liquidate stock holdings when the market was low.
“You can’t have money you need in the short-term invested in a lot of risk,” said Landon, owner of Journey Financial Services.
Advisors also see people invested too heavily in one asset. Craig Ferrantino, founder and principal of Craig James Financial Services, had a client who received nearly $900,000 as a lump sum from his pension plan. Despite Ferrantino’s advice, the client invested most of it in a real estate property in Florida. Its value has been cut in half.
“Don’t sacrifice your retirement for the sake of a fly-by-night exciting thing, because it might not work out,” he said. “You should also always be diversified.”
2. Failure to update. Ferrantino also had a married couple as clients who, after their marriage failed, each separately retained his services. The wife was a penny-pincher and the husband a spendthrift.
After the divorce, the wife changed her will to make sure that only her children would be entitled to her estate.
Ferrantino reminded her several times that she needed to update the beneficiary form for her retirement portfolio — which was worth seven figures — to ensure that it reflected what was in her will. But the client, who was in her 50s and still working, probably thought she had plenty of time to make the change.
Unexpectedly, she suffered a heart attack and passed away, which meant her ex-husband remained the beneficiary of her retirement funds.
“She went through the process of changing her will but not changing beneficiaries, so the ex-husband was entitled to all her retirement money,” Ferrantino said.
While it might seem odd that a simple beneficiary form for a retirement account supersedes intentions stated in a will, the fact is that it typically does.
In simple terms, retirement accounts such as IRAs or 401(k) plans are not considered part of the estate covered by a will. The same goes for other financial accounts, such as insurance policies and annuities.
And while a person named in the will can challenge an account beneficiary, doing so can be a drawn-out, pricey legal process that might still result in the listed beneficiary receiving the money.
So what is the lesson? “Make sure you keep all your records updated, particularly when you have a material change in your [life],” Ferrantino said.
3. Giving away too freely. The mother of a client of certified financial planner Mark LaSpisa had a charitable heart. While that was an admirable quality, the mom, in her early 60s, was susceptible to giving away so much of her money that she was in danger of compromising her own retirement.
The final straw for the son — LaSpisa’s client — was when the mother’s favorite local charity called to ask if she could replace its broken-down bus and she wrote the organization a check for $80,000. And that’s when her son put his foot down.
That $80,000 represented about 20 percent of her estate. In other words, she could not afford that kind of donation.
The son came in and said, ‘No more. She is not to make these donations,'” said LaSpisa, president and managing advisor at Vermillion Financial Advisors.
“He wanted to make sure someone was watching the cookie jar so it wouldn’t happen again,” he said.
The mom began meeting monthly with LaSpisa to have her checkbook balanced and her expenditures monitored.
LaSpisa explained that living beyond her means is one thing that can derail her retirement.
“This can be spending too much or giving away too much,” he said.
4. Failure to strategize. DC Chamberlin, a CFP with the Chamberlin Group, said his firm often sees mistakes involving Social Security payments.
Eligibility for Social Security benefits starts at age 62, but full retirement age — as viewed by the government — ranges from age 65 to 67, depending on when you were born. If you start taking benefits before your full retirement age, your monthly check will be reduced.
Say your full retirement age is 66 and you’re due $1,000 monthly. If you start taking Social Security at age 62, your payment will be $750, a 25 percent reduction.
But if you wait until age 70, your monthly benefit will be $1,320 vs. $1,000.
“If you start taking it at age 62 vs. 70, you’re losing out on [a lot] of your potential benefit, and that can cost you down the road,” Chamberlin said. “If you can, delay taking it until age 70.”
Other mistakes that advisors see run the gamut from being taken advantage of by predators (whether for financial products or other things, like late-night TV product sales) to not maximizing favorable taxes and having inadequate insurance.
“Even if you have a good plan going into retirement, be proactive about the … potential things that can blow it up,” LaSpisa said.
—By Sarah O’Brien, special to CNBC.com
Additional thoughts from Mark La Spisa,
In the article above, I say “be proactive about the potential things that can blow it up”; “it” meaning your retirement. Unfortunately, the article didn’t focus on those “potential things” as I would have had I been the author.
The article mainly focused on how IRS regulation 72T is available for some retirees to avoid penalties if one is under the age of 59 ½ and needs to access an IRA for income. The article cites the need to plan for a proper social security distribution, which is important but not considered a “move” with your nest egg of accumulated retirement assets. The author also warns you to be sure to update your estate plan and beneficiary designations. That always makes sense, but it has nothing to do with retirement assets. Therefore, in my opinion, the article fails to focus on what is truly important for retirees to avoid.
Myself and the other advisors here at VFA always explain to clients that there are four critical factors that can seriously derail your retirement security.
They are 1) inappropriate investments, 2) overspending, 3) health care costs, and 4) predators. These are the real issues that all present and future retirees should consider.
1) Inappropriate Investments… This is the #1 risk to retirement. The key to a secure retirement is making sure your portfolio has quality investments that are suitable for a retiree. You need to develop a portfolio of quality investments, and one that focuses on a suitable asset allocation policy. This should be determined after considering many factors like risk tolerance, cash flow needs, and minimum rate of return requirements. An inappropriate investment that seems too good to be true can cost you the whole asset!
A retirement projection prepared by your VFA Advisor can give you a more realistic view of what your future finances will look like, and help you choose investments that provide a higher probability of fully funding your financial goals.
Investment monitoring is critical to maintaining appropriate investments. Monitoring helps prevent your portfolio from going too far off course when the economy changes or an investment mixture under-performs. It provides discipline for those who have a tendency to take the high risk approach of either overactive day trading, making emotional investment decisions during times of high volatility, or neglecting their investments by being an uninformed investor.
Monitoring also allows you the flexibility to instantly adjust your investments and make beneficial adjustments as the economy and your needs change. VFA Advisors want to reduce risk whenever possible while still achieving a target return to meet your financial goals – an even more challenging task these days in light of current low interest rates on cash and bonds.
2) Overspending… It can be very difficult to make the adjustment from a lifetime of spending with a regular pay check, to being comfortable with drawing down on a retirement portfolio. In most cases, income will be a monthly direct deposit instead of the usual weekly or bi-weekly pay period.
A retiree must create a workable monthly spending plan and portfolio distribution plan, and then have the discipline to stick to it! Good cash flow management will be critical in retirement. Some people find that having separate accounts helps them compartmentalize expenses. Others find that a cash reserve helps to avoid stress over market fluctuations and unexpected expenses.
We’ve all heard stories of older parents shortchanging their own actual needs to supplement their adult kids’ “wants”. VFA Advisors recommend that you never agree to loan or gift any assets to the detriment of your own retirement security – those are gifts you cannot afford. Do not abandon your good common sense by living beyond your means.
Ultimately, understanding and managing your portfolio distribution plan is very important to a spending plan’s success. That will include maintaining a reasonable distribution rate that your portfolio can sustain over time, minimizing the tax impact of retirement fund withdrawals, and knowing when it is safe to increase monthly income over time. Once again your VFA Advisor’s cash flow, retirement, and tax projections can provide significant guidance and value.
3) Be prepared for rising health care costs… Catastrophic health care cost can quickly deteriorate a retirement portfolio. A 65-year-old individual has an 80% chance to live to age 80. For a 65-year-old married couple, there is a 50% chance that at least one spouse will live longer than 30 retirement years. Planning and adjusting for the possibility of a lengthy and on-going retirement period is critical.
Modern medicine and technology are helping most Americans live longer and healthier lives. As a result, retirees will face higher lifetime health costs than their parents did. Planning for these higher costs will be challenging but very important, and this issue needs to be addressed earlier rather than later in retirement. You’ll want to be sure that all medical and health care items are covered.
The cost of long term care is the single largest challenge in the area of health care expenses for retirees, which is why advanced planning for these costs is very important. Long-term care costs are also steadily increasing – as is the percentage of the population that will need this kind of care at some point in their lives. Having a good plan for all contingencies will guard against the negative impact of unexpected and sustained expenses.
4) Beware of predators… As we age, even without dementia, everyone experiences some cognitive decline that impacts financial decision-making. Retirees are easy targets these days for charitable causes, unscrupulous caregivers, or a good story that leads to the next new scam. Having a process for charitable giving such as setting a charitable budget and an annual giving cycle will help avoid unwanted solicitation, and overspending in the name of good causes. Gone should be the days when credit card numbers or personal information is given out via the phone or e-mail to unknown parties that claim there is an emergency or a large expense outstanding. Do not be intimidated by threats or false claims.
Use your Advisor or a close family member as a planned “buffer” to avoid being taken advantage of by those who seek to steal your money. This way you can insert a third party into the situation to verify claims, see if major repairs are legitimate or truly needed, and be your second pair of eyes and ears whenever needed. Sometimes only the mention of your “buffer” is enough to discourage potential predators. Practice saying “Give me all your contact information and I’ll have my lawyer (advisor, daughter, guardian, etc.) call you back”, or “Sorry, but I’ve done all my charitable giving for this year”.
And by the way, while the article mentions estate planning and how it is very important to make sure retirees update their trustee and beneficiary designations on all accounts and insurance policies, do not be frightened by the example of an unintended ex-spouse receiving a beneficiary payout. The State of Illinois has laws in force that protect you from the claims of former spouses – even if you forget to change your beneficiary designations or you forget to update your estate plan to include your new spouse. An old spouse is presumed predeceased in Illinois.
In the end, it is most important to thoughtfully and realistically plan your retirement and continually evaluate your key expenses. The smartest move is to do so with a Certified Financial Planner® like your Vermillion Advisor, and definitely enhance your chances of a long and prosperous retirement.
Wishing you financial prosperity,
Mark La Spisa
Note: The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendation for any individual. Please remember that past performance of investments may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this post serves as the receipt of, or as a substitute for, personalized investment advice from Vermillion Financial Advisors, Inc. To the extent that a reader has any questions regarding the applicability of any specific issue discussed within this article to their individual situation, they are encouraged to consult with the professional advisor of their choosing. A copy of our current written disclosure statement discussing our advisory services and fees is available for review upon request.
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