Avoid Financial mistakes

Alexandra Armstrong, CFP
Armstrong, Fleming & Moore, Inc.

A young person who squanders his/her nest egg may have decades to recover. But seniors cannot afford to make big financial errors.

Common financial mistakes — and how to avoid them…

Mistake: Taking Social Security too soon. Many people begin collecting Social Security when they turn 62. But the earlier you start taking benefits, the smaller your monthly check. It is usually better to postpone taking Social Security until you reach the full retirement age. That age varies — for instance, it’s 65 years and 10 months for those born in 1942.

Example: If you were born in 1950 and currently earn $70,000 annually, according to the Social Security calculator (www.ssa.gov), you would receive monthly benefits of about $1,307 starting in 2012, when you turn 62. If you wait until age 66 (your full retirement age) in 2016, you will get $1,780 a month. You’ll get $2,407 at age 70 in 2020.

Besides receiving smaller payments at 62, you run the risk of having your checks further reduced if you decide later to go back to work. That’s because if you’re under full retirement age and earn more than a certain threshold amount ($12,960 in 2007), you lose $1 of benefits for every $2 of earnings over this limit. But if you are above your full retirement age, your payments will not be cut — no matter how much you earn at a job.

If you wait to collect until you are age 70, you will receive the maximum monthly check. But you are taking a larger gamble on your longevity — that is, you may not live to age 70.

Calculated risk: If you wait until age 70 to start receiving Social Security payments, therefore getting the highest payments, and then live past 78, you will have received more total income from Social Security than if you had begun receiving checks at age 65 and 10 months. Nonetheless, my advice is generally to take the checks as soon as you reach full retirement age. If you don’t need the money, you can invest it for a rainy day.

Mistake: Failing to take required minimum distributions from retirement accounts. When you turn 70½, you must begin taking payouts from your traditional IRAs. If you fail to take withdrawals on time, the IRS can impose a 50% penalty. This means that if you are late to withdraw $10,000, the government will charge you $5,000. The rule is so tough because Washington doesn’t want money to stay tax sheltered indefinitely.
The IRS Web site (www.irs.gov) spells out correct withdrawal amounts. There, you can find your life expectancy according to IRS tables.

Example: If you are 70 in May, the IRS figures you will live another 27.4 years. The government wants to spread your withdrawals evenly over your lifespan. Say you have $100,000 in your IRA. You must divide that figure by 27.4. The result is $3,649.63 — the amount you must withdraw the first year. Consult the table each year because this withdrawal figure changes as you age.

If you forget to take a withdrawal the first year, correct the mistake and send a written notice to the IRS. The IRS is often lenient with someone who is struggling with the tables for the first time. The tax collectors may let you off with a warning about not making the same error next year.

Best: To avoid problems, contact the custodian of your IRA to have the withdrawal amount paid directly to your bank well before the end of the year — then check to make sure it happens.

Mistake: Paying off mortgages too soon. As they approach retirement, some people feel that they must pay off their mortgages. For peace of mind, this may be important. But if you plan to sell off other assets to accomplish this, you may do better by keeping the mortgage debt.

Example: You have a $100,000 mortgage with an interest rate of 5.75%. Because you can deduct the mortgage interest (even if you pay the alternative minimum tax), the after-tax cost of the mortgage if you are in the 25% tax bracket is about 4.3%. You could pay off the mortgage by selling $100,000 worth of investments to raise the cash.

Better: Instead of selling your assets to pay off the mortgage, keep the money invested in a portfolio that is expected to earn more than 5.75%. That way, you can use the earnings to cover the mortgage and still have some investment income left.
Mistake: Ignoring inflation. Many people figure that inflation won’t erode the value of their investments in a significant way. After all, the consumer price index (CPI) has historically risen at an average annual rate of only 3%, and a well-constructed investment portfolio should do much better than that over time. But over time, even small price increases whittle away at your purchasing power.

Example: Your investments earn 8% annually, while inflation runs at 3%. So, you will only have 5% left after inflation. And there is a chance that you can face above-average inflation rates. A sudden spurt in energy or health costs can wreck your budget. (Historically, people who live in big cities on the coasts have faced inflation rates that are much higher than the long-term averages.)

For protection, emphasize dividend-paying blue-chip stocks in your portfolio. These tend to appreciate over time, and many raise their dividends at annual rates that are well above the long-term average increases in the CPI. Don’t rely exclusively on income from fixed sources, such as bonds or pensions, which can be eaten away by inflation. If inflation is at 3% and you receive $50,000 a year from a pension or annuity, during your second year of retirement your purchasing power will have dropped to $48,500. The third year, the real value of the income will be $47,045.
Mistake: Paying bills by check. Many retirees insist on paying by check because they don’t trust electronic systems. But the more important danger is that you will forget to pay on time — incurring penalties. That can hurt your credit rating and increase borrowing costs. What to do…

Automate deposits. Have your Social Security checks automatically deposited into your checking account. If you are working, ask your employer to also make automatic deposits. This saves time and reduces errors. If the account is interest bearing, automatic deposits will boost your income, since payments will spend more time in your account and less time in the mail.

Automate payments. Pay as many bills as possible automatically. That way, you won’t miss payments — even if you take a trip overseas.

Examples: Many cable TV companies and Internet service providers allow you to charge your monthly bill automatically. Many banks and brokerages offer electronic systems that enable regular payments — such as utility bills — to be withdrawn automatically from your account. For extra efficiency, do all your business with one bank or brokerage. There is no reason to have six different accounts spread around town.
Mistake: Holding stock certificates personally. Many people insist on holding paper stock certificates in their bank safe-deposit boxes because they are afraid of losing the securities. When they need to make sales, these investors run to the bank vault, retrieve paper shares and mail them to their brokers. Investors who hold old-fashioned paper certificates must round up individual records of dividends and transactions for each stock or bond — a time-consuming and error-prone process. This is a throwback to the Great Depression, when many stock brokers went bankrupt, and investors found that their securities had vanished. But all reputable brokers are members of the Securities Investor Protection Corporation (SIPC) and covered for up to $500,000 for stocks, bonds and other securities and up to $100,000 for cash. Most firms also have additional coverage.

It is now very efficient to have your broker hold the certificates. That way, you can sell shares immediately with a phone call or computer key stroke. At the end of the year, the broker will send you a record of all dividends and transactions. At tax time, you have one convenient record.


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