Top 10 retirement myths
Debunking common misconceptions about taxes, Social Security and more.
Retirement is a stage of life that many of us eagerly anticipate. It's a time when you can finally bid farewell to the daily grind and enjoy the fruits of your labor. However, there are numerous myths and misconceptions surrounding retirement that can hinder your ability to plan effectively for this important life transition. Let’s debunk the top 10 retirement myths and share some knowledge that can help you retire with confidence.
Myth 1: you will pay less in taxes in retirement
It's a common belief that your tax bill will decrease once you retire. However, this doesn't always hold true. The reality is that your tax situation in retirement could become more complex and may not necessarily result in lower taxes.
For example, some people believe they will pay fewer taxes in retirement because their income will be lower. While this may be true for some retirees, others may face unexpected tax liabilities due to Required Minimum Distributions from retirement accounts and other sources of income.
As a high-net-worth individual, you likely have substantial retirement savings in tax-deferred accounts like your 401k and IRAs. When you start withdrawing from these accounts in retirement, you'll owe income tax on those distributions. This can lead to a significant tax liability.
To navigate this, consider a diversified tax strategy that includes a mix of tax-deferred, tax-free and taxable accounts. Edelman Financial Engines can help clients who are within five years of retirement or already retired with a tax-efficient drawdown approach,* which optimally aims to maximize your after-tax wealth by strategically making upfront tax payments. This can help you optimize your tax situation in retirement and potentially reduce your overall tax burden.
Myth 2: you can expect your expenses to decrease in retirement
Many people assume they can maintain the same lifestyle in retirement as they did during their working years. However, retirement often entails a shift in spending habits. While certain expenses may decrease, others tend to rise into and through retirement.
High-net-worth individuals may choose to continue to maintain a comfortable lifestyle, which often includes travel, hobbies and leisure activities. Additionally, health care expenses tend to rise with age and grow faster than annual inflation, and it may be necessary to plan for long-term care costs. These expenses – both planned and unplanned – can quickly offset or outweigh any reductions in housing, child care, community or work-related costs.
In some cases, your expenses may eventually decrease to the point where your household no longer needs to withdraw funds from your investment accounts. In these cases, you may be forced to withdraw funds from tax-deferred accounts to satisfy the legal requirement and then end up investing those funds in a taxable account, resulting in an inefficient withdrawal strategy. This is another example of where a tax-efficient drawdown strategy can help you potentially avoid this scenario.
In any case, it’s important to consider that retirement can span several decades. Inflation can erode the purchasing power of your savings over time and may significantly impact your retirement income. With your goals and risk tolerance in mind, it's essential to invest in assets that have the potential to outpace inflation and regularly review your retirement plan with your financial advisor to make necessary adjustments.
Myth 3: you should always stay in the lowest possible tax bracket
While it’s true that staying in the lowest possible tax bracket might be an appealing strategy for any given year, this may turn out to be suboptimal if you consider a multiyear strategy, where incurring higher taxes in one year can lead to several years of potentially lower taxes. Paying at a higher rate in some years may result in a lower overall tax burden over time.
Striving to always stay in the lowest tax bracket could limit your financial flexibility and result in missed opportunities for tax-efficient planning.
Myth 4: everyone should take social security at their full retirement age
While waiting until your full retirement age to claim Social Security benefits can result in higher monthly payments, it's not always the best choice. You may have unique circumstances and financial goals that warrant a different approach.
Consider factors like your overall financial health, other sources of retirement income, and your life expectancy when deciding when to claim Social Security. Delaying benefits can provide a guaranteed income boost, which may be beneficial for individuals who want to maximize their retirement income.
If you’re not able to work past age 62 – or do not want to – and you need the Social Security income to withstand accelerated withdrawals and protect you from unforeseen events, like medical expenses, it may make sense to take your Social Security early.
While Social Security provides essential income during retirement, it's not intended to be your sole source of support. The average Social Security benefit is modest, and relying solely on it may leave you with an insufficient income to maintain your desired lifestyle. Your plan should include drawing on your additional retirement savings to complement your Social Security benefits.
For some, the idea of working indefinitely may sound appealing, but it's not always within your control. Health issues, caregiving responsibilities, or unexpected job loss can force an early retirement. Planning for retirement means preparing for the possibility of not being able to work as long as you'd like. Your financial planner should advise you when to ideally draw on Social Security and how to balance your other retirement income to meet your lifestyle needs.
Myth 5: social security benefits cannot be taxed
Speaking of Social Security, we should also dispel the notion that your benefits can’t be taxed. Your Social Security benefits can indeed be subject to federal income tax, and they often are, especially for high-net-worth individuals with other substantial sources of income. The portion of your benefits that may be taxed – up to 85%1 – depends on your combined income, including your Social Security income and other taxable income.
Understanding how Social Security benefits are taxed and planning accordingly with your financial advisor can help you manage your tax liability – including using a tax-efficient drawdown strategy with your investment accounts to potentially avoid paying taxes on Social Security whenever possible.
Myth 6: Once I choose my withdrawal rate, it's set in stone
Some financial advisors use a single withdrawal rate and a predetermined account source as a simple way to calculate cashflows for several years in the future. But this simplistic approach misses the opportunity to adjust withdrawals to meet your particular needs as they arise in any given year.
High-net-worth individuals should approach retirement withdrawals with flexibility. Life circumstances can change, and your financial needs may evolve. Tax laws are consistently changing as well. Instead of rigidly sticking to an initial withdrawal rate or account source, consider periodic assessments and adjustments to help ensure your financial plan remains on track. Working with an advisor who can provide you with that flexibility is a good way to gain confidence that your plan can evolve with you.
Myth 7: you have no control over your required minimum distribution amounts
RMDs are a crucial aspect of retirement planning, and understanding both how they are calculated and their potential impact is essential for retirees. RMDs are mandatory withdrawals from tax-deferred retirement accounts, such as a traditional IRA or 401k, and they play a significant role in ensuring that retirees utilize their retirement savings as intended. RMDs are required by the Internal Revenue Service once you reach the age of 72 (73 if you reach age 73 in 2023 through 2032; and 75 if you reach age 74 after Dec. 31, 2032).2 The purpose of RMDs is to ensure you do not indefinitely defer paying taxes on your retirement savings. Instead, you must begin withdrawing a portion of your account balance annually, which is then taxed as ordinary income – just like the income you earn from a job or other sources – and the withdrawn amount is added to your annual taxable income. And in some cases, this could also trigger taxes on Social Security benefits or surcharges on Medicare premiums.
The RMD amount is directly influenced by the balance in your tax-deferred retirement accounts. A higher account balance will result in a larger RMD, which in turn means a higher taxable income. This could potentially push you into a higher tax bracket.
RMDs can seem inflexible, but high-net-worth individuals can exercise some control over them. This is where strategic planning with your financial advisor can be a big help. At Edelman Financial Engines, you can work with a financial advisor and an in-house tax planning expert on a tax-efficient drawdown strategy – if it’s right for you – using tactics such as Roth conversions or charitable contributions, which can help anticipate some of these consequences and reduce the impact of RMDs on your taxable income.
Myth 8: Medicare will cover all of your health care costs
While Original Medicare provides valuable health insurance coverage for retirees, it doesn't cover all of your health care expenses. High-net-worth individuals should budget for Medicare premiums, copayments and deductibles, as well as any supplemental insurance you may need. Long-term care costs are typically not covered by Medicare and should also be factored into your insurance planning and overall retirement plan.
Once your RMDs impact your adjusted gross income, some may also be surprised to find themselves subject to income-related Medicare surcharges. A tax-efficient drawdown strategy can help account for this and potentially avoid triggering such premium surcharges.
Myth 9: a tax-efficient drawdown strategy is the same as doing aggressive roth ira conversions
Roth IRA conversions are only one aspect of a tax-efficient drawdown strategy. In addition, it also provides suggestions for the type of accounts from which your withdrawals should come each year as well as the amount of those withdrawals. And it helps manage your withdrawals to maximize after-tax wealth by reducing the taxation of Social Security benefits, income-related monthly adjustment surcharges, capital gains tax and net investment income tax.
Myth 10: you can wait to start saving for retirement
The final and perhaps most dangerous retirement myth is the belief that you can figure things out as you go along. Retirement planning requires careful consideration, strategic decision-making, and a well-defined plan. Without a clear road map, you risk making costly mistakes that could jeopardize your financial security in retirement.
Life is full of unexpected expenses, and it's a mistake to assume you can easily catch up on your retirement savings later in life. Emergencies, family obligations, and other financial priorities can derail your plans.
Procrastination can also be costly. It’s wise to save as much as you can for as long as you can. High-net-worth individuals should start saving and working with a financial advisor early to build a robust retirement plan that aligns with their unique goals and financial circumstances. The earlier you start, the more time you have to leverage any compound growth and make informed financial decisions.
Not a myth: professional advice can help you optimize your plan
Retirement planning is a complex and multifaceted process that can be influenced by numerous factors. By identifying and dispelling these top 10 retirement myths, you can approach retirement from a more realistic and informed perspective. Remember, it's never too early to start planning for retirement, and seeking professional financial advice can be invaluable in helping ensure your retirement plan is well-structured and optimized for your unique situation. And if you’re closer to the finish line at work, remember – planning in retirement is just as important and complex as planning for retirement. Connect with an Edelman Financial Engines planner today to see if a tax-efficient drawdown approach is right for you and your retirement planning. They can help you make informed decisions, navigate tax planning implications and adjust your plan as circumstances change.
* Contact a planner for more information to see if a tax-efficient drawdown approach is right for you. Certain limitations may apply.
1 Social Security Administration. (2022, October 14). Must I pay taxes on Social Security benefits? Retrieved November 6, 2023, from https://faq.ssa.gov/en-us/Topic/article/KA-02471
2 IRS. (2023, March 14). Retirement Plan and IRA Required Minimum Distributions FAQs. Retrieved December 4, 2023, from https://www.irs.gov/retirement-plans/retirement-plan-and-ira-required-minimum-distributions-faqs
This content recommends that you work with your financial planner who can partner with your CPA or tax professional. Neither Edelman Financial Engines nor its affiliates offer tax or legal advice. Interested parties are strongly encouraged to seek advice from qualified tax and/or legal experts regarding the best options for your particular circumstances. Tax strategies are just one aspect of your overall financial plan. Certain services provided on an educational and guidance basis only.