December 3, 2013

10 Retirement Planning Myths

There are a lot of bad ideas, mistaken information and half truths out there about retirement planning that gets perpetuated and stated as fact.   These myths can lead people to make poor choices with their retirement finances.   

Myth #1 - Social Security will run out of money and you won't get any
Reality : Social Security isn't going anywhere and if the trust fund runs out there will still be funds to pay most of the current benefit level 
This is a pretty common view nowadays.   In an AARP 2010 study only 35% of people surveyed had  confidence in the system.   79% of people didn't realize that if Social Security depleted its trust funds that it would still be able to reduced benefits while at the same time 70% of people think they are well informed about how it works.     In other words people think that if it 'runs out of money' that there will be no checks.   Thats not the case.  Social Security is a pay-as-you-go system by design so current retiree checks are mostly paid from current worker tax funds.   In addition its certainly not a given that SS will ever run out of trust funds, thats just a projection base on estimates about what we think will happen 15-20 years from now.    Even if it did run out of money,  Congress can simply change the rules and keep it solvent again.

Myth #2 - Your pension will go bankrupt and you won't get anything
Reality : Pensions are guaranteed by the PBGC
Private pensions are regulated by federal law.  Pensions themselves are setup as trusts outside of the company that establishes it so they can't simply 'raid' the money as simply as emptying a bank account.  If a company does go bankrupt then pensions are backed by the PBGC.   So if the company goes bankrupt or the pension runs out of money then you will not lose your benefits.   There is however a limit on PBGC protection so your benefits may be limited to a maximum amount, currently at about $52k

Myth #3 - You only have to plan for 20 or so years since life expectancy is only 70 something years
Reality:  Retirees typically live 20-30 more years after 65.
Most people are aware that average life expectancy in the USA is over 70 years.   As of 2011 the average was about 78.6 years.   They then base their retirement planning on the assumption that they'll live 10-15 years after retiring at age 65.   But the average life expectancy for the population is factoring in people who pass away early due to things like illness and injury before age 65.   You can look at the social security administration mortality tables to see the average life expectancy at various years.  If you look at only the people who are age 65 then their average life expectancy after that is actually another 17-20 years.    The typical retiree will live into their 80's on average.   On top of that a married couple has a 40% chance that one spouse will live past 95 years.

Myth #4 - Social Security will be enough to retire on
Reality:  Most of us will need additional savings and income in addition to SS.
Social Security generally replaces roughly 20-40% of your working income.   Usually that isn't enough to support you as most people spend more than 20% of their income.   Most people won't be able to adequately support themselves with just Social Security.

Myth #5 - Medicare will pay for your nursing home
Reality :  Medicaid will only pay for nursing home care if you've spent all your money
Medicare does not pay for your nursing home expenses.  Medicaid might pay for nursing home expenses but only after  you've exhausted all your assets.    Planning for that is not a great choice.   Its a particularly bad choice if you're married since it will leave one spouse with an empty bank account.

Myth #6 - The government will change the rules and tax your Roth IRA
Reality : There is no plan nor strong incentive to tax Roth IRAs.
I've seen a lot of people voice this opinion.   I have no idea where the basis is other than simple paranoia.  There is no agenda nor plan to tax Roth IRA withdrawals at any time.   Roth IRA valances are actually not much compared to the other retirement plans so if they were taxed it wouldn't lead to much of any tax revenue and would upset a lot of people considerably due to the broken promise.  While I can't say its impossible such a law could be passed in the future it would be extremely unlikely that they'd take such a measure.    And if you're going to assume the government would resort to such a thing then there wouldn't be anything stopping them from taxing anything or everything else so your money is no safer elsewhere.

Myth #7 - Taxes will go up in the future so you'd better put your retirement in a Roth
Reality:  Taxes may or may not go up but that doesn't necessarily impact your tax rates or change your retirement planning priorities.
Taxes might go up in the future.  Its probably a likelihood that we'll see increased taxes in fact.  But that doesn't mean that your tax rate will increase.  It doesn't mean your marginal rate will change.  It doesn't mean that your post retirement tax rate will be higher than the tax rate you pay during your working years.

Myth #8 - Annuities are awful investments and you should never buy one
Reality :  It depends on the annuity.
Annuities can be poor investments.   But it isn't a rule.   Some annuities are perfectly fine investments.    You simply need to be careful about the kind of annuity you buy and make sure the fees associated with it and terms are reasonable. 

Myth #9 - Roth IRAs are the best choice for everyone
Reality :  Sometimes Roth IRAs are a poor choice.
A lot of people are hopelessly in love with the Roth IRA.    I guess the appeal of not paying taxes in the future is overwhelmingly better in their minds than not paying taxes today.   I'm not against the Roth IRA at all, in fact it is a great retirement vehicle.   However the problem is that Roth IRAs are not always the best choice.   Your best choice depends on your marginal tax rate today versus your marginal tax rate at retirement as well as your taxable income level versus your deductible incomes.  There are many situations where 401ks or traditional IRAs are a better choice than a Roth IRA.

Myth #10 - Social Security is an awful investment
Reality : The return you get depends and can be good.  
Many people feel they are being 'robbed' by social security.   First of all Social Security is not really an investment.  It is a tax and a social insurance and entitlement benefit program.    That is not 'investment' just like you don't look at Microsoft and say its a tax or insurance program.    So its not like putting money in a CD or buying stock.   But then maybe thats just a semantics argument.   You can figure your individual rate of return on your social security taxes versus the checks you receive after retirement so its pretty natural for people to think of it like an investment and calculate rate of return.   If you do figure that then the rate of return depends on variables.   The Social Security Administration has figured returns for different scenarios.   Given current law the rate of return can be as high as 9.02%.   Is that an awful investment?  Certainly not.   Thats actually a great investment.   Theres nowhere else you can get a guaranteed benefit with a return that high.    OK now thats the best case and yes there are situations where SS is a poor return.   And if you figure in that SS might not have money to pay all the benefits and might reduce benefit rates in a couple decades it gets even worse.    In fact for the worst case scenario the returns are about -0.5%.   But lets now think about the best and worst case scenarios for other investments.   Whats the worst case for the stock market?   It isn't good.  But that doesn't mean that the stock market is an awful investment.


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