Six Most Common Retirement Myths
Author – Lane Keating
There are certain widely accepted retirement planning principles and beliefs that, on closer inspection, turn out to be mostly myths. These include:
- Social Security is Inflation-Adjusted
In fact, it is adjusted in accordance with the Consumer Price Index or CPI. The weighting used in compiling the CPI is unlikely to match that of typical retirees especially as they age and incur larger medical, dental, eye, hearing, and in-home service expenses. Seniors consume roughly double the amount of medical care as consumers as a whole. These expenses tend to go up faster than the other items used by the government to calculate overall inflation.
Additionally, local property taxes, state, and Federal taxes and fees, and homeowner’s insurance are not included either. These items can go up significantly, year after year. Seniors are often forced to sell their homes because they can no longer afford property taxes and insurance.
So, even though Social Security sometimes gets an annual Cost-of-Living Adjustments (COLA), the adjustment does not really reflect the real inflation factors for seniors.
- Your Pension is Insured
Think Enron, WorldCom, Arthur Anderson, Lehman Brothers, Bear Stearns, General Motors, and other financial meltdowns that involved the pensions of thousands of workers. Bernie Madoff and a score of other prominent Ponzi schemers made off with millions of dollars more. Add to that the looming problem of under and un-funded public service pensions that are threatening to bankrupt our cities and towns – even states – across the country. Even financially solvent companies are getting out of pensions entirely, leaving the responsibility for retirement savings to the employees themselves.
- You Won’t Pay Federal Income Tax After You Retire.
Just the opposite is true. The most significant tax affecting you as a retiree is the Federal income tax. Your gross income is used to determine your Federal tax and it includes: pensions, annuities, Social Security benefits, interest, dividends, rents, gains on property sales, alimony, and distributions from estates and trusts.
Any required minimum distributions from regular IRAs and 401(K) savings plans are taxed as ordinary income. And you must begin taking distributions and paying taxes once you reach the age of 70 ½.
- There are “Safe” Withdrawal Limits
This means if a retiree withdraws the “safe” amount (commonly considered to be 3-5% of a balanced portfolio) in the first year, he can increase that withdrawal amount each year thereafter by the amount of the previous year’s inflation and not run out of money before he dies.
But what happens if you live an extra-long life or there is a period or more of significant market turbulence and failures like has happened in 2001 and 2008 when home owners lost 30% of their equity and the stock market lost 50+%? What happens if inflation ends up being higher than 3% like it was in the 1970s?
- It is Easy to Get High Returns
Just ask Bernie Madoff. Even though it was once commonly accepted that stocks will return 10 – 12% a year over the long haul, this is often not the case. In just the last 15 years, we have experienced the dot.com bubble, the mortgage meltdown, and the collapse of the housing market – all of which took a heavy toll on stock market returns.
- Inflation Will Average 3%
This is a widely-held belief. But few realize that the inflation rate is derived based on a period of history that includes the Great Depression of the 1930s. If you start after the Depression and extend to current times, you’ll see that inflation averaged closer to 4.5% - and there were periods like the 1970s when inflation was extraordinary and particularly devastating to retirees on fixed incomes.
With an annual inflation of 4.5%, every dollar loses 36% of purchasing power in 10 years, 59% in 20 years, and 73% in 30 years. So, if you are 65 and have $100,000 in savings today, when you turn 85 in 20 years, that same $100,000 will only have an inflation-adjusted purchasing power of $41,000, even if you never spent a dime.