There's a lot of misleading information out there about retirement planning. Unfortunately, many investors aren't properly educated on the challenges presented by financial planning or the solutions to overcome them. If you want to build confidence and reduce your stress levels, consider these popular myths and embrace the tried-and-true methods to enter your golden years comfortably.
1. You can calculate exactly how much you need to save for retirement
It's very common to wonder how much money you need to retire. Unfortunately, there's no concrete answer to that question. Everyone's circumstances are different, so the answer is different for everyone. That's especially complicated for young people because there are so many things that can change over the decades between now and the day they stop working.
The real answer is that you need enough to cover your basic needs and desired lifestyle. That might be frustratingly unspecific, but it's better than a specifically incorrect number. Luckily, there are some important things to consider to make sure your bases are covered, no matter what your retirement goal number winds up being.
First, you need to know what your annual cash needs are. It's easier if you're close to retirement because you know what your monthly bills are. If you're younger, you need to adjust for inflation — $5,000 in monthly bills today will probably cost closer to $9,000 in 20 years, assuming 3% annual inflation. For reference, the median household retirement income is around $60,000, and the average person incurs $300,000 in healthcare expenses during retirement.
Your need to save enough to produce enough income to cover those costs. The 4% Rule indicates that you can safely spend 4% of your savings each year in retirement without running out of money. However, financial planners are now speculating that the 4% Rule needs to be revised downward, due to low interest rates and rising life expectancy. It's fair to assume that for every $10,000 in expenses you incur each year that aren't covered by Social Security, you'll need at least $300,000 saved up. To ensure that you'll meet your cash needs down the road, you should strive to save and invest 15-20% of your income each year.
2. Medicare will cover all your healthcare costs
Most retirees rely on Medicare, the health insurance program for seniors provided by the Federal Government. Most people are entitled to Medicare Part A for little or no premium. Part A is hospital insurance, and it covers inpatient procedures, skilled nursing, hospice, and some home care. That's a great way to cover catastrophic medical events, but it does not cover routine care, less acute treatments, most dental, most vision, or pharmaceutical prescriptions.
That's a major gap in coverage. You'll need to pay out-of-pocket for those services or find a supplemental plan. Medicare Part B is a supplementary plan to cover many forms of care not covered in Part A, and Part D covers prescription drugs. Both plans are usually available for monthly premiums. You can also purchase supplemental plans from private carriers. Make sure you're prepared for these additional bills to cover you during years in which you'll likely be incurring most of your largest medical expenses.
3. Taxes are always lower in retirement
Conventional financial planning wisdom generally assumes lower tax rates in retirement than during your working years, and that's usually a fair assumption. Most retirees live in homes that are fully paid off, they no longer have dependents, and they no longer need to set aside a portion of income for savings. That allows retired households to take lower income, and therefore fall into a lower tax bracket.
That's not a guarantee, however. Some people encounter unexpected expenses in retirement from supporting their family or maintaining a relatively affluent lifestyle. Some retirees aspire to travel and dine out with all their free time, so they don't always want to live on a tighter budget in a lower income bracket. If you're several decades away from retirement, you also need to consider the potential for higher tax rates in the future, even if you aren't spending more than average.
To manage this uncertainty, make sure you're saving enough each year so that you'll have plenty of room to absorb higher-than-expected tax bills. You should also take advantage of a Roth IRA if you're eligible. Roths allow you to make tax-free withdrawals in retirement — remember, distributions from your 401(k) or traditional IRA will be taxed as ordinary income.
4. Social Security will provide all the income you need
Social Security is an important piece of the cash flow puzzle for most retirees. The average senior receives over $1,500 each month in Social Security benefits. Some people even get more than $3,000 each month from the program.
That might be enough for some households to live comfortably, especially if two spouses are receiving benefits. However, median retirement income is substantially higher than the average Social Security benefit. Clearly, there's a gap to overcome. There's a further complication for younger workers. The Social Security fund is no longer producing enough cash flow to cover monthly benefits paid. Without meaningful reform, the program may not be viable in several decades.
The solution, once again, is saving systematically and building your own pool of assets. Having your own investments that produce income is the key to financial freedom and self-sufficiency.
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