If you’re gearing up for a restful retirement (or already enjoying this next phase of life), you know that every financial decision has the potential to create long-term impacts on your financial well-being. From creating your custom retirement “paycheck” to thinking about healthcare coverage and taxes, there are plenty of opportunities to optimize your financial well-being in retirement.
To help you keep things moving forward in a positive direction before and during retirement, we’ve identified a few common money mistakes and shared our top tips for avoiding them.
Mistake #1: Not timing Social Security benefits strategically
If eligible, you may begin collecting Social Security benefits at age 62, though you can delay benefits up until age 70.
When you choose to begin collecting has major long-term consequences on how much Social Security you’ll receive throughout your lifetime. Your “full retirement age” is around 67 years old, meaning your benefits will be permanently reduced if you begin collecting before then.
Assuming you were born after 1960 and your full retirement age is 67, your benefits would be reduced by 30% if you chose to begin collecting at age 62 (60 months early). For each month you wait, up until the full retirement age, that reduction gets a little smaller.1
On the flip side, if you opt to delay benefits until after full retirement age, you can receive a monthly increase of ⅔ of 1%, or up to 8% if you wait until age 70.2
Purely from a benefits standpoint, you will receive the most monthly benefits possible if you wait to begin collecting at age 70. But your retirement income landscape is multifaceted, and we believe the decision regarding when to collect should be based on the broader picture.
For example, if you do choose to delay benefits… Do you have a plan for covering your expenses earlier in retirement? Or will delaying benefits put you in a financially precarious position?
Or, let’s say your family has a long history of health concerns and you anticipate a shorter-than-usual life expectancy. If that’s the case, would you be better off starting early and collecting a smaller monthly benefit?
This decision should be based on your unique circumstances and other sources of retirement income.
Mistake #2: Not proactively planning for RMDs
When it comes to tax-deferred retirement accounts like 401(k)s, 403(b)s, and IRAs, the contributions are created with pre-tax dollars, and earnings within the account grow undisturbed as well. It’s only when you make a withdrawal that you’re required to pay income tax on both the amount originally contributed and the account growth.
The thing is, the IRS wants its cut of your earnings eventually—it won’t allow you to sit on the funds indefinitely (as is the case with Roth accounts, which are funded with after-tax dollars). For that reason, tax-deferred retirement accounts come with required minimum distributions (RMDs).
If you haven’t begun taking RMDs already, you will be required to do so starting at age 73 (or age 75, starting in 2033).3 RMDs are based on the size of the account and the IRS’s life expectancy factor (in other words, your life expectancy in retirement).4
Everyone’s views on RMDs are different. If these retirement accounts are your primary form of retirement income, then you probably plan on withdrawing from the accounts anyway—and likely for more than the required minimum amount. But if you have a diversified set of retirement income sources, RMDs could be more of a tax burden than a blessing.
When unaccounted for in your long-term retirement income planning, RMDs can unintentionally increase your taxable income, potentially pushing you into a higher tax bracket.
But with some consideration and strategy, you can help minimize the impact RMDs may have on your tax bill in retirement. Some common tax-focused strategies include:
Roth conversion: If you’re still several years away from needing to access the funds, consider rolling all or a portion of your tax-deferred accounts into a Roth IRA. You’ll need to pay the tax liability that year, but this strategy can help you reduce RMDs while also producing potentially tax-free income for retirement.
Qualified charitable distributions (QCDs): If you don’t need your RMDs to support your financial needs in retirement, and you’d like to incorporate charitable giving into your retirement plan, QCDs can help you address both. When funds are donated directly from the tax-deferred account to a qualified charity, they’re considered QCDs and can be used to satisfy RMDs, without increasing your taxable income for the year.
Begin withdrawals earlier: You may start drawing from your 401(k) or IRA penalty-free at age 59.5. Remember, RMDs are based on the account balance—meaning the smaller the balance by the end of the year prior, the less you’ll be required to withdraw. Of course, withdrawing at any time should be done thoughtfully and intentionally, and you should have a plan for those distributed funds that aligns with your retirement goals and financial well-being.
Mistake #3: Assuming Medicare covers everything
Once you hit age 65, you will be eligible to sign up for Medicare, the federal government’s health insurance program for older adults. When enrolling, you’ll have several plan options, as well as the option to expand coverage through supplemental coverage or gap policies.
One common misconception about Medicare, however, is that it will cover anything and everything relating to your health. This is not true, and it has the potential to be a costly mistake, should you incur surprise medical bills in retirement.
Some common items or services not covered by Medicare include:5
- Long-term care (personal care assistance, home-delivered meals, adult day health care, etc.)
- Eye exams
- Dental exams or services
- Hearing aids
- Cosmetic surgery
Medicare may also not cover services or treatments given by healthcare providers who don’t participate in the Medicare program, aside from emergency care.5
Healthcare costs are expected to continue rising for adults in retirement, with estimates running as high as $413,000 for a 65-year-old couple today.6 While everyone’s health status and medical needs are different, it’s important to incorporate your future healthcare needs into your retirement savings plan. You may want to set aside an emergency fund for medical expenses, leverage a health savings account (HSA) if available, or research additional insurance policies, such as long-term care.
Mistake #4: Not creating income sources with different tax treatments
Did you know that not all retirement income is created equal? In fact, each source of retirement income will fall into a tax “bucket” based on how it’ll impact your tax bill in retirement. These tax buckets include:
Tax-deferred: Your traditional retirement accounts, like a 401(k) or IRA, are funded with pre-tax dollars. You are not responsible for paying income tax on the contributions or growth within the account until you take withdrawals, ideally in retirement. Tax-deferred retirement income increases your total tax bill.
Tax-free: You may be able to secure some tax-free income in retirement, namely by funding after-tax accounts like a Roth 401(k) or Roth IRA. Municipal bonds (or “munis”) have the potential to produce tax-free retirement income as well. Tax-free income can help offset some of your tax liability in retirement.
Tax-advantaged: If you contribute to a taxable brokerage account, or earn interest or dividends from certain assets, you may be able to benefit from a more favorable long-term capital gains tax rate. For reference, long-term capital gains tax is capped at 20%, while ordinary income tax can go as high as 37%.
Preserving your wealth is likely a top priority for retirement, and minimizing your year-to-year tax liability will play a major role in achieving this. To keep your tax bill manageable, it’s important to incorporate income that falls into all three tax buckets.
Make the most of your retirement by avoiding these money mistakes
We all make mistakes, but when it comes to retirement, one wrong move could create lasting impacts on your future financial wellbeing. Whether you’re already enjoying retirement or still preparing for this next phase of life, remain vigilant with your wealth and proactive where possible. Some simple, strategic planning could help you make the most of this exciting chapter.
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