3 Financial Mistakes People Make When They Retire

A lot of personal finance advice focuses on how to save enough for a secure retirement. But what happens when you’re actually retired?

The money decisions you make as a retiree can still affect your financial security.

And bad choices can be harder to recover from, because you can’t necessarily just work more and increase your earnings to get back on track.

You don’t want to run out of money too soon as a retiree, so it’s important that you avoid a few big mistakes when it comes to handling your finances.

Here are three of them.

1. Drawing down your retirement accounts too quickly

When you’re retired, you’ll need to start taking money out of your investment accounts, since you likely can’t live on Social Security alone. But you don’t want to take out too much money too soon. If you do, your balance could decline so much that you don’t produce enough returns for your money to last.

This could happen to you if you don’t calculate a safe withdrawal rate. While financial experts used to recommend withdrawing 4% of your account balance in year one and then increasing withdrawals each year to account for inflation, this 4% rule is outdated and leaves you at risk of running out of money if you follow it.

Instead, the Center for Retirement Research recommends using tables prepared by the IRS to calculate the appropriate withdrawal rate for your age. The chart below shows how much you’d withdraw if you follow this strategy.

IMAGE SOURCE:CENTER FOR RETIREMENT RESEARCH

Consider erring on the side of caution and withdrawing less than 4% of your retirement accounts so you don’t find yourself broke in your later years.

2. Failing to understand your IRS obligations

Those IRS tables that the Center for Retirement Research used to calculate your safe withdrawal rate are called required minimum distribution tables. They exist because you are required to begin making withdrawals from tax-advantaged retirement accounts once you hit 70 1/2. You must take these withdrawals each year from most retirement accounts, with the notable exception of Roth accounts.

If you do not take required minimum distributions when you’re required to, you face a huge tax penalty. You will owe taxes equal to 50% of the amount you should have withdrawn. This means if you were supposed to take $10,000 out of your retirement account at 70 1/2, you will face a $5,000 tax penalty.

Figuring out your required minimum distribution can be complicated, but the IRS has a worksheet to help. You can also learn more in our guide to required minimum distributions.

You could also find yourself in tax trouble if you don’t have enough money withheld from your Social Security or pension checks to fulfill your tax obligations.

Social Security benefits aren’t taxable on the federal level until income exceeds a certain threshold. And the percentage of your pension that’s taxed varies based on whether you invested in it. But if you owe taxes and don’t have enough withheld, you could be hit with a huge tax bill at the end of the year. This could even include penalties for not paying as income was received.

Fortunately, you can specify how much you want withheld from taxes when you first sign up for Social Security benefits and can adjust your withholding by completing Form W-4V, Voluntary Withholding Request.

3. Making poor investment choices

As a senior, you must be smart about what you do with your retirement savings. Avoiding scams is of paramount importance, since seniors are often considered vulnerable targets by dishonest actors. But you also want to make sure you have an appropriate asset allocation.

Seniors shouldn’t have as much money invested in stocks as younger people, because you don’t have time to wait out market downturns once you’re drawing from your retirement accounts. But having too little invested could mean your rate of return is so low that your savings runs out too soon.

A good rule of thumb is to subtract your age from 110 to determine the percentage of your portfolio that should be invested in the market. So if you’re 70, you’d invest 40% of your portfolio in stocks.

You owe it to yourself to avoid these big money mistakes as a retiree

Running out of money in retirement because you drew down your accounts too fast, incurred big tax penalties, or mismanaged your investments would be an absolute disaster. Be sure to avoid these errors so your hard-earned retirement fund lasts and provides the security you deserve in your golden years.

— Christy Bieber

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Source: The Motley Fool