What are the worst retirement mistakes?
Whether these five are “the worst” is certainly up for debate. (They’re not the only ways you can complicate your life in retirement.) But these errors are common—we see them all the time.
Let’s describe these mistakes and offer tips to avoid them.
Mistake #1: The TSP Beneficiary Issue
The first common retirement mistake is the TSP beneficiary issue.
If you die and leave the money to your spouse, the TSP will establish a beneficiary participant account for your spouse. If they die, the new beneficiary will not be allowed to continue to maintain an account with the TSP. Also, the death benefit payment cannot be rolled over to another type of IRA or some other plan.
This means the second beneficiary must take all the TSP account money out. When they do, that money is 100% taxable!
How does this compare with having an IRA instead? In that case, when you die, your spouse inherits the money and he/she can then roll it over into their own IRA or open an inherited IRA—and not be facing a huge, immediate tax bill.
If your spouse then dies, their beneficiary can then inherit the money as well. And they won’t have to take a giant taxable distribution all in one year. They can roll the money over into an inherited IRA, and they’ll be able to stretch out required distributions over a 10-year period.
You can imagine the difference in taking, let’s say, a $500,000 distribution all in one year compared to stretching those distributions out over 10 years.
In short, there’s no need to be penalized with higher taxes, if you can work around it. And the way to work around it is to not hold all your money in the TSP.
So, when can you move your money out of the TSP? If you’re still working, you can start moving it into an IRA at age 59 and a half. Or, if you’ve retired or are separated or are no longer a federal employee, you can move the money out at any time at any age.
Mistake #2: Planning with Gross Numbers
The next big mistake is doing retirement planning with gross numbers instead of net numbers.
You only get to spend net numbers. So whether it’s your pension, your special retirement supplement, or Social Security–all these numbers need to be planned with net numbers after taxes.
Usually, people understand with their pension and retirement budget, “I have to use net numbers in my planning.” But what about when you’re planning distributions from your TSP? That’s where you have to remember your TSP balance is a gross number. It’s not a net number. (Unless you are taking distributions from a Roth TSP. Those are net numbers. No taxes are owed on Roth TSP distributions.)
I talk with clients all the time who erroneously think of their TSP balance as being 100% “mine.” They forget the reality that the TSP balance is not 100% theirs.
Distributions from a traditional TSP will be taxable. And this gets tricky because we don’t really know the exact tax rate we’ll be paying in the future. So, you can’t know precisely how much of that TSP balance is “your money.” That makes planning hard.
And it underscores the value of doing Roth conversions. If you’re interested in learning more about that topic, check out this video.
Mistake #3: Tax Bracket Planning
Another common retirement mistake involves taxes–specifically tax brackets.
Many people we talk to are married and fall into the “married filing jointly” tax bracket. That designation determines how we help them plan. Using that information, we can look into the future to see if projected RMDs (i.e., required minimum distributions) will push them up into a higher tax bracket. (Almost all our clients want planning strategies that will keep this from happening.)
The mistake comes in not considering “But what happens if a spouse dies?”
When this occurs, the surviving spouse is suddenly in the single tax bracket–and may potentially remain there for years.
This is a problem because the single tax bracket is only half as generous. You reach the top of that bracket sooner and easier. So, depending on:
- Your ongoing pension
- Any survivor benefit (from the pension)
- Any adjustments to your Social Security (i.e., whenever a spouse dies, the survivor gets the higher of the two benefit payments)
- Any distributions you’re forced to start taking from a traditional account…
You can quickly exceed the limits of the single tax bracket–and find yourself in a higher bracket. This means higher taxes on your income than you would have owed if you had done some Roth conversions.
That’s a wise safeguard against this common predicament. If you’re able to convert most (or even all) of your traditional money to Roth, those distributions will not be taxable. This strategy keeps many widows and widowers out of higher tax brackets.
Consider utilizing this conversion strategy in your planning. With traditional balances, there are required distributions, and all those distributions will be taxed. With Roth balances, there are no RMDs, and distributions are not taxed.
Mistake #4: Not Retiring to Something
Another mistake people make is not retiring to something. Not only do you need to be financially ready, but you also need to be emotionally ready.
This means asking and answering the question: What will I do with my time? For the record, that common retirement practice of “just doing whatever I feel like doing” gets old quicker than you think.
People are happiest in retirement when they know and “live into” their passions. What are you good at? What do you enjoy doing? How could you use your strengths to benefit your family, a nonprofit, or the community at large?
Finding a significant purpose or “mission” makes retirement more meaningful and enjoyable. And the best time to figure this out? Now, while you’re still working.
At Christy Capital, we see it every day: The people who retire with a clear vision of what they want to do in retirement…they just retire better.
Mistake #5: Annuitizing Your TSP
The last mistake is a potential mistake. (For some, it’s a wise move.) It’s where you trade out your TSP balance for a guaranteed monthly payment.
The reason this is potentially a mistake is that many people who choose this option don’t need an additional monthly payment.
Remember, you’ve got your pension check. And you have a Social Security payment. (If you’re married, your spouse is probably getting Social Security as well.) For many people that combined covers most, if not all of the bills.
The problem: When you exchange your TSP balance for another guaranteed monthly check, you give up access to that money.
(Question: Did you even check to see if your TSP allows you to take similar withdrawals from your TSP without giving up control and access to that balance? This isn’t guaranteed, but it’s worth checking into.)
What’s appealing about annuitizing one’s TSP balance is that it means a guaranteed check. It’s certain. Depending on your situation and personality, that can be a huge comfort.
The drawback to this strategy is that when you do this, you lose access to that money. If you suddenly needed a new roof, you wouldn’t be allowed to dip into that money for a lump sum. Instead, you’ve agreed to a monthly payment.
This also gets into the gray area of what happens when you die? What box did you check when you filled out the paperwork? What happens to the unpaid funds? Did you agree upfront to a smaller monthly check so that you could be sure to leave more to your beneficiaries?
If you can get past the word “guaranteed,” it’s possible in many cases to take similar withdrawals from a TSP or IRA and not lose control of your funds.
Is it always a mistake to annuitize your TSP balance? Of course not.
You just want to make sure that the strategies and solutions you choose actually solve the problem you have. For some, annuitization solves the problem of “I need a guaranteed check for the rest of my life.” For others, that’s not a problem. With their pension(s) and Social Security check(s), their living expenses are covered. For them, there’s no need to have an additional guaranteed check. They should perhaps follow the rule of, “If I don’t need it, maybe I shouldn’t get it.”
How do you know if you need it or not? It never hurts (and usually helps) to talk to somebody about your retirement situation.
If you don’t have a financial advisor you trust, I’d encourage you to visit christycapital.com. There–in the top right corner of the page–you’ll see a green TALK WITH AN ADVISOR button. We’d love to help you avoid all these common retirement mistakes.
And if you’d like to learn more about how RMDs can negatively affect your retirement, watch this video with Tommy Neesmith.