A timely reminder of three easily avoided retirement mistakes is offered up by advisor Jason Hull, who U.S. News and World Report describes as a candidate for the CFP certification and a Series 65 license holder.
Hull, proprietor of Hull Financial Planning, notes that a quick check of a client’s investment accounts isn’t going to truly answer the question of whether or not they have the appropriate mix of assets to see them through to retirement. Here are usually the reasons why:
1) They’re including their house in their assets.
Hull often hears people describe their net worth in a conversation like this: “I have a $200,000 house and $800,000 in investments, so I have a net worth of a million dollars.” The problem with this description, he says, is that your house cannot independently generate income except in a reverse mortgage, which has its own twists.
“Basically, owning a home free and clear eliminates the need for you to have housing expenses—save, of course, for property taxes, insurance, and home maintenance costs. If you were to sell your house, then you’d need to use the money that you generated to create a stream of income to pay for your subsequent living arrangements, whether that means buying another house, renting one, or moving into an assisted living facility.”
2) They don’t include Social Security and pension payments as part of their fixed income.
“Let’s say that you receive a Social Security payment of $2,000 per month and a pension of $3,000 per month. That’s $5,000 in reliable monthly income—just like the sort you expect from the fixed income portion of your portfolio.
“To properly figure how to include that money in your fixed-income allocation, calculate how much it would cost to buy an annuity that would pay out that same $5,000 each month,” Hull writes. “The cost is roughly $1 million. (Remember: This amount needs to be adjusted for inflation in the case of Social Security, and possibly for your pension payment as well.) That ‘fictional’ annuity amount should make up a big chunk of your fixed-income exposure. In fact, if you have a total portfolio worth $2 million, you’d need just $200,000 in bonds or other fixed-income securities on top of the fictional $1 million to get your fixed-income allocation to 60% of your total portfolio. Be sure to include it, otherwise you might have too much invested in bonds or similar investments.” 3) They confuse pretax and after-tax assets.
Hull gives a “hat tip” to Bob Veres at Advisor Perspectives for the following example:
“Let’s say that you have $500,000 in a Roth IRA and $500,000 in a traditional IRA,” Hull relates. “You’ve already paid taxes on the Roth IRA; however, the traditional IRA is tax-deferred. When you withdraw taxes from the traditional IRA, then you’ll have to pay income taxes on your withdrawals. If your effective tax rate is 20%, that means that for every $100 you withdraw from the traditional IRA, you’ll only wind up with $80 in your pocket after, so the effective value of your traditional IRA, when compared to the Roth IRA, is $400,000.
“So, whether you’re already sitting on the porch watching the world go by, or you’re just dreaming of the day,” Hull concludes, “it’s important that you have a full picture of what you have and what it will take to make those days ones of idyllic bliss rather time spent worrying over your next meal.”