5 Retirement-Planning Pitfalls

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Retirement planning can be complicated, and it's easy to make mistakes. Joining me to discuss some key retirement-planning pitfalls is Tim Steffen--he's director of financial planning for R.W. Baird. Tim, thank you so much for being here.

Tim Steffen: Thanks.

Benz: You put out a terrific piece highlighting 10 retirement-planning mistakes that folks often run into. Let's cherry-pick some of them. The first--and you think sort of an overarching issue with a lot of people--is that they come into retirement without a plan. Let's talk about the pitfalls of doing that. And even if you have been a dedicated do-it-yourself investor, what are some ways to ensure that you have a plan for retirement?

Steffen: The common joke in the planning industry is that people spend more time planning vacations than they do their retirement. So, if you are going to head into retirement, you need to have put some sort of a plan together. Just assuming it's all going to work out just fine is not a plan, that's a wish. Sitting down with a qualified advisor who can help guide you through some of the planning process [is a good idea]. There are a lot of ways to do it yourself; you can go online to find a lot of the tools that are out there. But sometimes those plans are only as good as the assumptions you make, and ultimately you can make a financial plan say whatever you want it to say by using incorrect assumptions. So, working with a good advisor who has some experience doing this and can lead you down the right path on how to put a plan together is the best way to start.

Benz: One of the other big pitfalls for retirees, especially those who have worked for the same employer for many years and maybe have gotten company stock over the years, is being too concentrated in a holding or maybe a handful of holdings. Why is that such a big risk and what steps can people take to mitigate it?

Steffen: The best line I ever heard on that was that a concentrated position is a great way to create wealth but a horrible way to maintain it. So, you've got all of these people who have done very well with their individual stocks and are afraid to make the transition into a diversified portfolio, but the reality is that that's the best way to maintain the wealth you've accumulated. And you can talk to anybody who lived through the tech bubble about what it was like to hold a single position.

So, it's a tough conversation to have with somebody who's seen a very successful position grow over the years, but it's one that advisors need to have with their clients. And what we try to do with individuals on that is to take the emotion out of it. We say, "What is a piece of the portfolio you are comfortable having in that stock or that fund--whatever it may be? And how soon are we willing to get there?" And then we just do the math and say, "All right, every quarter we're going to sell a bit so that, on a pro-rata basis, we get to that target by your date." And again, take the emotion out of it; let's just focus on the big picture and be able to move out of that position.

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Benz: And the idea of having that phased withdrawal from that holding is that it gives you a variety of selling points so that you experience a variety of different market environments.

Steffen: And what we tell our clients is to not delay it. Just because the stock is going up doesn't mean you're going to wait for the right price, because if you are waiting for the right price, you are never going to find it. There is always going to be a reason to wait. So, we say that you're certainly able to accelerate your sales if you want to move out faster, but we are not going to push anything off. We're going to commit to this process.

Benz: Another pitfall that you highlighted here is having too little in stocks. So, let's talk about why retirement portfolios should arguably look different than perhaps they did 30 years ago.

Steffen: There's the old rule of thumb that your allocation to stock should be 100 minus your age. So, as you get older, you should wind down your exposure to stocks, and I think that's a really scary thought. The fact is a lot of people these days spend a third of their life in retirement, and we're going to have that much of your time spent where you are not contributing to the portfolio anymore. You need your portfolio to continue to grow.

So, the common mistake is that when you hit retirement, you take your foot off the gas pedal and wind down the exposure to stocks. And maybe you do a little bit of that, certainly, in the concentrated-position side. But you still need that growth in your portfolio because it has to last you a long time. The idea that pensions aren't what they used to be [means that] you have to provide more of your own resources in retirement. So, you need that growth in the portfolio, whether that's through funds or individual stocks--whatever it may be--you need to have some exposure to equities going forward.

Benz: Is that, arguably, especially important right now, given how low yields are on bonds and cash?

Steffen: You've got to be careful with that because a lot of people--because yields are so low--are trying to find other ways to get that yield. So they find themselves [investing in]--

Benz: Dividend-paying stocks.

Steffen: Dividend-paying stocks, junk bonds, [master limited partnerships]. All good investments in the right allocation, but don't let your allocation get out of whack just because you are trying to chase some yield. So, you've got to be careful about that. We've seen a lot of clients who become way too heavily allocated for what their risk profile is, just because they are trying to chase that yield. It's a tough balancing act, but that's where a good advisor comes into play.

Benz: One other pitfall that you highlight is being too generous, and this is something that I have certainly observed with people I've talked to. This issue of wanting to give to adult children, give them what they need. A lot of folks encountered hardships in the wake of the financial crisis. Retired parents are wrestling with this. But you say that that can be a big pitfall, being too generous with those kids particularly.

Steffen: Absolutely. Every parent wants to do the best they can for their kids, and you don't want to see your kids struggle. You've learned how to resolve those things, and you want to help your kids get past those struggles as well. So, they want to be able to help them out, whether it's financially or putting them up in a house or whatever it may be. But you've got to look at your longer-term picture first. You've got a shorter time horizon than your kids do. They've got time to be able to bounce back perhaps. You've got a limited pool of resources for your retirement, and you've got to make those last. And so, you've got to be careful. You want to help the kids out, but you've got to look at your retirement picture first.

Benz: And there can also be tax issues associated with those big withdrawals, too.

Steffen: Absolutely. Depending on what age you are when you are helping out--especially if you're in pre-retirement and you're trying to help those kids out--it can get very expensive to use IRA withdrawals or whatever else it may be.

Benz: One other area that you highlighted as a potential area for mistakes for retirees is in the realm of health-care planning. Let's talk about health-care costs, long-term-care costs and why people can really shoot themselves in the foot if they're not planning for those costs appropriately.

Steffen: It's no secret that health care is a big chunk of what retirees spend their money on, and it's the fastest-growing piece of what they spend money on, from a year-over-year cost standpoint. Some people still are struggling to accept that and maybe aren't doing everything they can to plan for that. [The first] part of it is being realistic about what health care is going to cost you in retirement. And [the second part] is finding ways to supplement some of the options you have out there, beyond Medicare--supplemental policies and long-term-care policies, in particular.

That's one that a lot of people struggle with is the cost of long-term care. It's like any other insurance policy; you are protecting against a catastrophic expense. Nobody would ever think about not having insurance on their home or their car; but on their health, they are less concerned about that. Long-term care is very expensive. And while the coverage options are a little bit more limited maybe than what they were years ago and it can be expensive, you are protecting against a future cost that could be even more so.

Benz: Can you share any guidance on who should self-fund long-term-care costs? I know that in the past there have been some income bands bandied about like, [for instance,] if your overall net assets are over this level, you may be OK paying out of pocket. Any thoughts on that topic?

Steffen: That's going to be different for everybody. Their willingness to pay that out of pocket is going to be different at each level. Certainly, as your portfolio gets larger and larger and your net worth is larger, you are more able to sustain that and cover those costs. But writing that check is difficult for anybody at any income level; so when it comes to paying for nursing-home costs, I think you've got to be careful. I don't know if there is any rule of thumb on that specifically. It's going to be an individual choice.

Benz: Tim, thank you so much for being here to share these mistakes as well as ways that people can avoid them.

Steffen: Thanks, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.