- By Lani Luciano
At most stages of life, it’s fine to learn as you go. Poor choices can slow you down, but they can also wise you up for the future.
When it comes to retirement, though, short-sighted financial moves may permanently derail you. Years later, when your financial, family or health circumstances may have changed, it’ll be too late for a do-over.
“The same options that looked great in your 60s may not look so good in your 80s,” says Rick Mayes, a financial planner in Carlsbad, Calif.
(MORE: Is $1 Million Enough to Retire?)
6 Dangers to Avoid
To come out ahead, you need to think ahead, says Mayes. Here are six potential dangers to your eventual retirement that can result from making rash choices now:
1. Tapping your IRA too early You may be eager to break into your IRA before retirement due to heavy credit-card debt or steep medical bills. But early withdrawals can substantially weaken your future security.
“It’s a double-whammy with a traditional IRA,” says Mayes. “Besides depleting your savings, you’ll owe taxes on the withdrawals, which reduces your available investment capital even more,” says Mayes. With a Roth IRA, you won't need to pay taxes when taking money out prematurely, but you'll likely be hit with the 10 percent tax penalty.
2. Taking Social Security the minute you can It can be tempting to start claiming the retirement program’s benefits at 62, the earliest date possible. But if you hold off for a few years, the reward will be large. That's because benefits get sliced between age 62 and what Social Security calls "Full Retirement Age" (which is between 65 and 67, depending on when you were born), and they are pumped up by 8 percent a year between Full Retirement Age and age 70.
Here’s an example: Say you’d qualify for $1,000 a month from Social Security at 62. By waiting to collect until 67, that number climbs to $1,333; wait until 70, and you’d receive $1,760 a month.
In addition, by waiting to claim benefits, your annual Social Security cost-of-living increases will be calculated on a larger base amount for the rest of your life. “When you’re 80 and your savings have dwindled, you’ll really be glad for the extra money,” notes Mayes.
3. Dealing with your nestegg as if it were a windfall That big number showing up in your employer-sponsored retirement plan statement — your total 401(k) savings or the lump-sum value of your defined benefit pension — can look a bit like a lottery prize. You might then wind up frittering the cash away.
“Better to treat it like what it is: a big part of your future financial security,” says Mayes.
If you’re not sure you have the will or the skill to manage the money well, he says, you might want to hire a good financial adviser. Alternatively, you could take your pension as an annuity (if that's an option) or buy an annuity with your 401(k) money so the cash will be parceled out a little at a time for the rest of your life.
4. Buying long-term-care insurance you won’t be able to afford down the line There’s a good reason why you might want to own long-term care insurance: Long-term care itself is expensive. Unfortunately, that’s the same reason why insurers have been steadily raising policyholders' rates.
Be sure to factor in the potential for regular premium increases when determining whether you’ll have the money to keep your insurance in force for, perhaps, decades. Mayes suggests figuring on long-term-care insurance rate hikes of about 5 percent a year.
5. Choosing an annuity with no survivor’s benefit You may be lured by the bigger payout from a single-life annuity — covering only your lifetime — than the amount you’d get from purchasing an annuity with a survivor’s benefit. For example, a single-life annuity might give you $45,000 of income a year, but if you purchased a similar annuity with a survivor’s benefit (which would give your spouse about half your annual payout after your death), you might only receive $40,000 annually.
Going the single-life route could be fine if you’re single or you're confident your spouse won’t need your income to live on after you die. Otherwise, unglue your eyes from that bigger payout and choose one of the options for a reduced distribution that would deliver annuity income to your widow or widower.
6. Counting on a reverse mortgage to eliminate your housing expenses in retirement True, a reverse mortgage can provide you with cash to pay off your mortgage because it lends you the equity in your home and gets repaid when the house is sold or you move. However, a reverse mortgage won’t stop the clock on rising property taxes, homeowners insurance premiums or maintenance costs. You’ll still have to pay all of those.
If you don’t, you’ll be in default, and the reverse mortgage lender might demand immediate repayment as well as the sale of your home — or you could face foreclosure. In fact, nearly 10 percent of reverse mortgages are in default today because borrowers didn't pay their property taxes and homeowners insurance.
Don't take out a reverse mortgage unless you're certain you'll have the cash for those expenses. As Next Avenue recently noted, the federal reverse- mortgage program will soon require some borrowers to set aside a portion of their loans to avoid default.
Where to Find Long-Term Planning Advice
Figuring out the most appropriate financial moves for retirement starts with a clear-eyed understanding of your situation.
According to the 2013 Retirement Confidence Survey by the Employee Benefit Research Institute, however, only about half of prospective retirees have tried to determine how much money they’ll need to live on once their paychecks stop, much less the amount they’ll actually have at the time.
For help with both calculations, check out the articles and tools at the National Endowment For Financial Education’s website, Choosetosave.org.
Lani Luciano has written about health and personal finances for Next Avenue, AARP The Magazine, Money and other publications.