4 Disastrous Retirement Mistakes and How to Avoid Them
Submitted by Wealth Management Services Group LLC on July 19th, 2015No two rollover disasters unfold the same way, but these four rollover problems tend to crop up the most.
1. High Fees Chip Away at Your Savings
Lured by a promise of higher earnings or guaranteed returns, you could roll your money into an investment that’s far more expensive than what you already own. Financial advisers gunning for IRA rollover dollars like to pitch variable annuities. Variable annuities are insurance products that allow you to invest in stock and bond funds, tax-deferred, and later convert your balance into regular income.
The drawback is the high fees you’ll pay every year for a Variable annuity. According to Morningstar, the average internal costs of a Variable annuity is 2.8%. Some of the more popular VA’s offer enhanced death benefits and guaranteed minimum monthly payouts that sound like a guaranteed return, but are not. They simply give you your principal back and guarantee that you will get that monthly payout even if your account runs out of cash. Typically, they will promise a 5% guaranteed payout every year until you die. I Like to make this analogy to demonstrate the minimal benefit that you might pay as much as 3.5% for. If you buried your cash in the backyard and dug up 5% of your money each year, without earning 1 cent of return, it would take you 20 years to deplete your funds. if you simply earned 3% per year on your money, then it would take 34 years to deplete your funds. For most entering retirement, this is much longer than their life expectancy and makes the guarantee useless. To further make this worse. The additional fees for this benefit could erode your funds much faster as the fees are taken out of your account each year just as your 5% withdrawal is. So for argument sake if we round out the fees at 3%, then each year you get your 5%, you are really eroding by 8%. To illustrate a typical year, here is the math. Assuming a $1,000,000 account, if you took your guaranteed 5% payout, you would receive $50,000 of income, but $80,000 would actually be the amount taken from your account (5% + 3% fees = $80,000). This would wipe out your principle balance in 12 years. The only real benefit to the VA is that they will continue to pay you the $50,000 per year as long as you live, you just will have no funds left for your heirs and will have lost your liquidity. Most will only realize the mistake when it is far too late to do anything about it.
2. You Make Bets That Are Foolhardy
Chasing high returns can get you in trouble and become disastrous. Rolling money into what’s known as a self-directed IRA so that you can shoot for the stars is especially perilous. The SEC estimates that in 2011 investors had $94 billion in this type of IRA, which lets you invest in pretty much anything, from real estate to tax liens to Viatical settlements and even IOU’s.
Last year the state securities regulators association warned that because self-directed IRAs can hold exotic assets, which IRA administrators don’t generally vet, the accounts leave you vulnerable to risky pitches.
In a video of a 2013 sales presentation, Curtis DeYoung, founder of American Pension Services, a Utah-based retirement plan administrator, promised retirees the freedom to “take control of your own destiny” with a self-directed IRA. At the end of 2013 his nearly 5,500 clients had IRA accounts worth $352 million. But a lawsuit filed in April by the SEC claims that DeYoung steered $22 million in clients’ money into now worthless real estate investments and loans to friends. A lawyer for DeYoung told MONEY that the retirees chose the investments; the firm was merely an administrator.
3. You Go Through Your Money Too Fast
This is the mistake I see all too often. As you age, during your retirement years, you become less able to earn a living. A 65 year old can still have the ability to continue being productive, but an 85 year old most likely has very little earning capacity. It is just a fact of life that as we age in our golden years, most of us simply lose our capacity for work.
The act of withdrawing funds to live on in retirement becomes a balancing act to preserve principal. Inflation can have a dramatic eroding effect on cash, therefore retirees must invest in a way that allows for a reasonable withdrawal rate to enjoy life while growing principal to match inflation. Risk management also plays an important role as taking too much risk can result in losses to principal at the worst possible time, while not taking enough risk can fall short of providing enough return to keep up with inflation and the retiree’s withdrawal rate. Every dollar of principal that leaves the retiree’s account must be able to be replaced through earnings. When this fails to occur, the future withdrawals must be reduced permanently to protect the remaining principal. Just when you need more income to keep up with inflation, you are forced to withdraw less resulting in a negative multiplication of the problem almost like a vortex vacuuming up your principle. The retirement account essentially becomes the worker, or wage earner in the family and as such, should be taken care of by paying attention to these details.
4. Keeping your 401K at your former employer may not be the best move
Many believe that leaving your retirement with a former employer will result in paying low or no costs. This is not the case. Employer retirement plans pay for investments just like everywhere else. These costs come out of the investments by the custodian or fund families and typically have a monthly fee as well. Some can be as high or higher than a typical fee based advisor charges. Some are funded with Variable Annuities as the platform (typically 403b, or 457 plans). The problem is that you are not getting any advice or help but are still paying as if you did. Paying the cost of advice, without the advice is not a very good decision.
Another problem is that the employer retirement plan is usually a trust. The entire plan can be moved from one platform to another resulting in the sale of all your investment positions without your permission. This would require you to pick from a new list of investments that you may not like or want to use. You will only be able to pick from a pre-determined list of investments instead of the choices you might have if you rolled over to an IRA. additionally, work retirement plans usually will not allow you to take systematic disbursements such as a monthly income as they are not set up like a typical brokerage account with the usual bells and whistles.
If you die while your retirement is still with your employer, your family could have limitations on the way payouts are made. Without knowing the provisions of the trust, there is no way to know if things will be handled the way you want. The trust document will determine how your family will get the funds. This can really complicate things unnecessarily.