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The Most Overlooked Threats to Your 401(k) or IRA Retirement Plan

The Most Overlooked Threats to Your 401(k) or IRA Retirement Plan

September 28, 2021

We recently had a distressed client ask how a chunk of her 401(k) seemingly disappeared. The truth is, when new clients ask us what the biggest threat to their retirement plan is, they are often surprised when we give them a list of answers. Most people are aware of the common problems in retirement, like the potential dangers of outliving your wealth and rising healthcare costs. While these can be major threats to retirement plans, there are other dangers that many people overlook.

You don't want to be thrown any extra financial curveballs in retirement (or have to come to a financial planner after  the damage has been done.) We hate to see good people make the same mistakes. So, we wrote a list of the most common—and most surprising—factors that could upend your retirement plan. Even if you don't read the whole article, please read the dangers of not knowing how your 401(k) is invested. 

Threat #1: Taxes

We have seen new clients make the mistake of thinking that their taxes will be lower in retirement. The thought is this: since we won’t be drawing a salary, our tax burden will be reduced. The fact is, most people want to maintain their current lifestyle when they retire. This requires almost the same amount of monthly income they enjoyed while they were working — and that comes with similar tax consequences.

What's more, some of your tax deductions may disappear. By the time you hit retirement, your home will likely be paid for which means you will no longer have mortgage deductions.You may stop making tax-deductible contributions to charity or your church. Not to mention that tax rates seem likely to rise for the wealthiest taxpayers under the Biden administration.2 It all adds up. 

Fortunately, there are strategies you can build now to offset taxes in retirement. Workers generally have tax-advantaged ways to save for retirement. Not participating in your employer’s 401(k) may be a mistake, especially when you’re passing up free money in the form of employer-matching contributions. For high-earners, consult a financial planner to configure specialized strategies for your situation, like a Roth conversion or an IRA rollover. 

Threat #2: Inflation

One of the biggest threats to your retirement savings is inflation. We wrote a post back in June about the effects of inflation on retirement plans and it's no secret that prices are continuing to rise. This past April, the Consumer Price Index (which measures a variety of goods) jumped by a greater-than-expected 4.2% from last year. Just this past week, The Fed raised its inflation forecast from 3% to 3.7%, which caught some by surprise. The Fed news on inflation came at the same time several large companies warned about higher prices.3,4 Be prepared: higher costs of living can quickly erode even a well-designed plan.

Other factors added to inflation can create a major threat. A record number of older Americans still have mortgages, credit card debt and student loan debt. This debt will act as an anchor as inflation rises. Paying off debt should be a top priority for anyone worried about late-in-life inflation. 

Even those reluctant to invest may need to consider investing. Keeping a lot of cash might seem like a safe play, but you need to consider the loss of purchasing power. The below chart illustrates the rise of inflation compared to different wealth-building strategies. As shown below, cash (treasury bills) only barely keep pace, while investing is historically a smarter move. 

Growth of Cash vs Stock and Bonds

Source: Dimensional Fund Advisors, as cited in Darrow Wealth Management. In US dollars. US Small Cap Index is the CRSP 6–10 Index; US Large Cap Index is the S&P 500 Index; Long-Term Government Bonds Index is 20-year US government bonds; Treasury Bills are One-Month US Treasury bills; 1-Month Treasury Bills Index is the IA SBBI US 30 Day TBill TR USD. *5

Savers need to take on some risk to outpace inflation. Having personal investments with the right asset allocation is an essential part of keeping your retirement on track.

Threat #3: Longevity

When our parents retired, living to 75 amounted to a nice long life, and Social Security was often supplemented by a pension. Today, the Social Security Administration (SSA) estimates that today’s average 65-year-old woman will live to age 86½. Given these projections, it appears that a retirement of 20 years or longer might be in your future.6,7  

While the risk is prevalent for men, the greatest risk to women's retirement planning is longevity. Women tend to live longer than men and thus often have to draw down their retirement wealth over a longer period of time. As a result, for a given level of retirement wealth at age 65, women can afford to consume about 7 percent less per year than men.8

Women are more likely to run out of retirement savings, especially because older women are more likely to be the surviving partner, living on less Social Security income and with their partner’s medical bills. These facts may seem scary, but there are ways women can prepare for retirement. 

Threat #4: Health Care Costs

If you are like most Americans, health care is expected to be one of your largest expenses in retirement. Fidelity estimates that an average retired couple (both age 65) in 2021 would need approximately $300,000 saved to cover health care expenses in retirement.9 If you're curious, we broke down the different types of health care costs that you could expect in retirement. 

Pre-retirees are faced with several crucial decisions before retirement, like when to take Social Security and how to pay for health care. These decisions are interconnected and could make a huge difference in your living costs and lifestyle in retirement—and when you can retire.

As you plan for health care expenses throughout your retirement, understanding your options can help you prepare. Having a basic understanding of Medicare costs and extended care options can help you visualize how paying for future health care expenses fits into your overall retirement income planning efforts. 

Threat #5: Financially Supporting Family

Any experienced parent will tell you that you’re never done “raising” your kids. This can turn into a surprisingly large expense in retirement. It happens more than you'd think: about two in five Americans provided financial support to a family member in 2018.10 Thanks to the recent pandemic, the number of families financially supporting their adult children has only risen. Almost half, or 45%, of parents with adult offspring have given their children money during the coronavirus pandemic and of those 79% said the funds would have otherwise gone towards their own personal finances.11 

One common mistake we see is couples prioritizing education savings over their own retirement fund. Your kids’ college education is important, but you don't want to sacrifice your retirement for it. Remember, you can get loans and grants for college, but you can’t for your retirement.

It’s only natural to want to help loved ones, just make sure that assistance does not jeopardize your own finances. 

Threat #6: Not Knowing How You Are Invested

In a recent survey, nearly half of pre-retirees said they had 'no idea' how they were invested.12 This may seem unimportant, but a big part of getting on track for retirement comes down to your investment strategy. Having the right asset allocation is an essential part of getting on track for retirement. For most investors, that means exposure to stocks and bonds. 

There are real consequences to ignoring how you're invested or holding too much stock in one company. Failing to regularly rebalance your 401(k) portfolio could result in significant losses during bad markets. For example, a participant with a 50% stocks / 50% bonds allocation at the start of 1995 would have a completely different portfolio five years later if they didn't reallocateThe portfolio would be 71% stocks / 29% bonds allocation if left unattended due to strong stock market performance during that period.13 

How is that possible? Reallocating means selling some of your recent winners and buying more of your recent losers, effectively adjusting the allocations to the funds in your account back to their original targets. Not reallocating could have the potential to put too much weight on the stocks and bonds that have recently gained the most.

As we know from experience, a stock may do well today and crash tomorrow. But that’s okay—because in asset allocation, today’s winners may be tomorrow’s losers and vice versa. It is the failure to diversify that opens you up to more risk exposure and losses in a downturnYou're probably young enough to remember the 2009 Auto Industry bailout, when Ford stock dropped to just a dollar.14,15 

Finally, there is an additional risk to not reallocating. While it's generally a great idea to invest in your employer's 401(k) plan, it's highly unlikely that the portfolio managers who are currently managing your investment options will be managing them 10 or more years from now.16 401(k) plans entail many compliance issues that have to be monitored and require constant service and administration. You may want to enlist your own financial professional that will be with you for the long run.

Now that you’ve made the right choice in deciding to save for retirement, make sure you are investing that money wisely. Get started with us today!

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Chart Treasury Index data sourced from Ibbotson Associates, via Morningstar. Direct Inflation is the Consumer Price Index. CRSP data provided by the Center for Research in Security Prices, S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Bonds, T-bills, and inflation data provided by Morningstar.*

The Federal Reserve’s forecasts or forward-looking statements are based on assumptions, subject to revision without notice, and may not materialize. 

Investing involves risks, and investment decisions should be based on your own goals, time horizon, and risk tolerance. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost.

The S&P 500 Composite Index is an unmanaged group of securities considered to be representative of the stock market in general. Index performance is not indicative of the past performance of a particular investment. Past performance does not guarantee future results. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite, LLC, is not affiliated with the named representative, broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.

1. Kiplinger, June 2017

2. Wall Street Journal, April 2021

3. The Wall Street Journal, September 22, 2021

4., September 24, 2021

5. Darrow Wealth Management, August 2016

6., January 2020

7., February 25, 2020

8. Bookings, July 2020

9. Fidelity, August 2021

10. The Simple Dollar, April 2020

11. CNBC, May 2021

12. Forbes, April 2021

13. Wilmington Trust, 2021

14. Macrotrends, 2021

15. The Balance, June 2020

16. Investopedia, May 2021