Myths of Retirement Planning

Financial planners and others have a lot of rules of thumb for your sources of retirement income — including ones regarding Social Security, your nest egg's mix of stocks vs. bonds, and your retirement accounts' required minimum distributions — but not all of them should be part of your financial plan.

It's difficult to shake old beliefs and the opinions of friends, family, co-workers and even financial advisers when talking about planning for retirement. Nevertheless, several old chestnuts simply are not true — rely on these rules of thumb at your peril.

Myth 1: Don't Touch the Principal as a Source of Retirement Income

Once upon a time, you might have been able to live off the interest and dividends of your portfolio. You still can, if you’re willing to accept much lower income, have a portfolio large enough to generate more income than you need, or you’re determined to leave the maximum inheritance. When bonds paid 6-7%, stock dividends were 4-5%, and CD rates were 10-12%, it seemed easy. But we forget about the corollaries of exploding inflation and slow company growth.

Your portfolio needs to grow enough to exceed inflation and cover your withdrawal rate. If that adds up to 6% you’re going to have a difficult time finding stable and growing companies, or high-quality bonds, that can deliver dividends and interest in that amount. Right now, S&P 500 dividends are hovering around 2.5%. Dividends that are higher than average signal a risky sector, a no-growth company, or a low-rated (junk) bond or bond fund.
Your allocation to stocks should be 100 minus your age.

You should determine your allocation to stocks by your risk tolerance. Subtracting your age from 100 gives you a very conservative portfolio. If you are very nervous, inexperienced, or limited income for retirement, that may be appropriate. But if you hope to maximize your return, especially if you’re far from retirement, have a pension or maximum Social Security, or a sizable portfolio, you may be able to tolerate more risk in return for long-term higher reward.

Regarding long-term returns, there's no question that when it comes to stocks vs. bonds, stocks are the better tool for building your nest egg. You can learn how to create a portfolio of individual stocks today that will help you for age 65 and beyond by taking advantage of BetterInvesting's free 90-day membership offer.

Myth 2: Take Your Dividends in Cash

Many people, especially retirees, love that check every month. The best portfolio growth comes from reinvesting all earnings, so that your money is always working for you and you benefit by compound growth. Under this system, you rebalance once a year and sell of enough to give you spending funds. If you need portfolio income for living expenses and would prefer to have the income distributed periodically, however, you could have dividends sent to you (provided they don’t exceed your safe withdrawal rate) and top off your withdrawals by sales one time during the year. Or reinvest some earnings and have other investments distribute them to you in cash.

Myth 3: You Have to Spend Your Required Minimum Distribution

Many clients tell me the required minimum distributions from their retirement accounts are higher than they need. Great! There’s no obligation to spend them! The government simply wants its cut (via taxes) after giving you a break all these years. There’s nothing to stop you from reinvesting your RMD in a regular brokerage account. In fact, you don’t even have to sell the investment — you can transfer the equivalent value of shares from your retirement account to your brokerage.

Myth 4: You Should Take the Lump Sum Payout for Your Nest Egg, not the Pension

That huge lump sum sure looks attractive. But the pension is guaranteed and generally pays you a higher rate than you could withdraw from the same portfolio. Your own investments are subject to far more risk. Most clients I see who have pensions are in far better financial shape than those who must depend on Social Security and their own investments.

Pensions are most worthwhile if you have a long lifespan. If you die five years after starting, the money’s gone. Pensions generally do not have inheritance benefits, although you can select options to cover your spouse’s lifetime at a lower rate, or guarantee a minimum period the pension will be paid.

If your health is poor, or you have enough money to guarantee your basic living expenses, then the lump sum may just be gravy. Be aware that most companies will encourage you to take the lump so, because it is far less burdensome on them.

Myth 5: For Your Life Expectancy, You Should Withdraw 4% of Your Portfolio Annually

This is a useful rule of thumb for estimating how large a portfolio you will need for sufficient income. However, like all general rules, it may not apply to the individual situation. It depends on what you are invested in (with some proportion of stocks), how old you are, your health, the size of your portfolio, what your income needs are, and whether there has been a string of really bad or really good market years. Various investment researchers have suggested personalized withdrawal rates from 3.5% to nearly 6%.

Myth 6: Take Social Security Benefits as Soon as Possible or You Must Wait Until 70

Despite the advice of every financial planner, 57% of Americans take their Social Security before full retirement age. The lure of collecting money you’ve paid into for so many years appears irresistible. If your health is poor or you can’t survive without it, early claiming may be your best choice.

But be aware that you permanently reduce your benefit (no re-dos, any more). If you get a job, you may have to give some of it back. And calculations show that collecting the money and reinvesting it for yourself are unlikely to yield as much as waiting would increase your benefits.

On the other hand, if your health is poor, your family is not very long-lived, or the Social Security is adequate to guarantee your basic living expenses at the amount you’d get at full retirement age, then you don’t need to wait until 70. Some clients I see are on the edge financially, and waiting until the increase at 70 would have made all the difference.

Myth 7: Social Security Benefits Won't Be Around

I’ve heard this since I was in grad school, back when dinosaurs roamed the earth. Changes in government policy happen, but I think it’s very unlikely that Social Security can be eliminated—it’s just too necessary, as recognized by every Western country. However, I’m pretty confident that we will see changes: while I’ve been waiting to collect, I’ve seen the full retirement age significantly raised (it used to be 65), and ability to restrict claims to spousal benefits eliminated for anyone born after 1953. I think we can expect tinkering and alternations. Thirty years from now rules and benefit will probably be different. Hey, they might even improve. We can dream.