11 High-Net-Worth Retirement Planning Mistakes
There is an abundance of retirement planning advice available online and in the media. The problem for high-net-worth individuals is that it's often not appropriate for them and rarely comes with a high-net-worth warning. In retirement planning it often takes no more than a mistake or two to go from financial independence to shattered dreams. Numerous studies over the past decade have shown that almost half of all retirees (including high-net-worth ones) will be forced to significantly alter their lifestyle because of unforeseen financial issues.
While this is a disturbing fact to contemplate, the good news is that in the majority of cases, a better retirement plan with ongoing monitoring would have likely prevented most heartaches.
Here are 11 of the most significant problems high-net-worth individuals face when it comes to thinking about retirement — and how to avoid them. (For related reading, see: What Will Healthcare Cost After Retirement?)
1. Liability/Asset Protection
The insurance needs of high-net-worth individuals are significantly different from the average investor's. This is especially the case with asset protection. It's vital for high-net-worth individuals to have multimillion-dollar umbrella liability policies in place that cover their entire estate and activities. For many, especially small business owners and physicians, it's also important to consider using liability protection trusts and other options designed to further protect their assets.
In our highly litigious society, it's especially pertinent for the wealthy to periodically conduct a personal liability review. It's often the unexpected areas that pose the most risk, like with hobbies, collectibles, extended family activities, board memberships and volunteer activities. The good news is that it's usually easy and inexpensive to correct. The bad news: most people (and financial advisors) are simply unaware of the risks and don't take the necessary steps to protect assets. (For related reading, see: 5 Tax(ing) Retirement Mistakes.)
2. Poor/Negligent Investment Management
There are numerous issues with this risk; let's focus on the three most common issues.
The first is related to investment products. At best, investment product mistakes are an expensive waste of money; at worst they could threaten your financial security. Whether it's at your own hands or a salesperson acting as your advisor, the percentage of high-net-worth investors buying chronically underperforming and expensive investments — some of which are very common — is much higher than most realize. A great starting point is not to purchase some of the most common products including hedge funds, private equity, and venture capital. The performance of these investments is so distorted in the media that it's highly unusual for investors to know that, as a group, each of these charge more than ten times the annual expense of the total market index. They've also underperformed that same index over the past three, five and 10 years.
Typically, the big draw to investment products is two-fold. The first is that products are often tied to the most recent best-performing sectors of the market and appeal to the tendency of investors to endlessly chase performance. Unfortunately, chasing the hottest sector of the last few years is likely one of the surest ways to underperform in the future. The second aspect is the pitch that you're investing with an elite group. But there is no such thing as an elite club that through exceptional intelligence, quant models, advanced education, or sophisticated networks is able to consistently achieve extraordinary investment results. To the contrary, Wall Street "geniuses" on average underperform the markets year-in and year-out. Historically only about 10% of products beat their index, and identifying in advance who that 10% will be has been shown to be complete folly.
What's a high-net-worth investor to do? Stop chasing performance and avoid active investment products that lock up your money and charge exorbitant fees. In this day and age, there is rarely a valid reason to own these types of investment vehicles. If investors avoided most products and demanded trade-based liquidity, transparency of fees, and independent custodians, most of the expensive underperforming products (and the financial scandals) would likely be a thing of the past. Working with a fiduciary advisor that is required to act in your best interest and doesn't push investment products is likely one of the best ways to avoid this high-net-worth pitfall. (For related reading, see: Where Do Investment Returns Come From?)
Another common investment problem for high-net-worth investors is the inappropriate extremes in risk. Being too conservative or too aggressive can be a costly mistake, especially when nearing or in retirement. The too-conservative tendency is by far more common. Retirees or soon-to-be-retirees who don't address their investment extremes are quite possibly the most at risk of financial strife. A great example is the 2008 financial crisis when a third of individual investors went to cash and stayed in cash for years after the crisis. In the process, most of these folks severely damaged their retirement plans. It was a difficult time, but the mistake made by many was to reduce their risk to an extreme.
One of the best ways to avoid this mistake is to comprehensively review your retirement and financial life plan with illustrations of your long-term numbers. In doing so, you'll see that market events typically don't alter the long-term figures. The impact of this is usually significant since it helps you put dramatic current events in a much less dramatic perspective. Another good way to combat this issue is to not look at things from an all or nothing view. For example, if you feel a strong desire to act, instead of selling a large portion of stock, maybe you just trim 10% and then consider another 10% in 15 days, and so on. In other words, consider your investment activity in small incremental steps rather than all or nothing positions. Typically, after a small move, even the most anxious of investors begins to feel better. That's because they took action and exercised some control over a situation that made them feel out of control.
If you struggle with this problem and a financial advisor isn't able to help, consider seeking out the assistance of a therapist to help you better understand your investment behavioral tendencies. This may sound odd, but sometimes it simply is the most productive route. And don't underestimate the importance of this issue — understanding your investment psychology is likely one of the single most important aspects of financial success. (For related reading, see: How to Budget and Spend Your Way to Maximize Your Happiness.)
3. Adult Children
There are two common issues with this risk. The first is the transfer of a business to adult children.
Succession in a family business is particularly risky; the vast majority (70%) of family business transfers fail within a decade. Also, something rarely talked about is the family strife that business transfers can create. It's very common for sibling relationships to become strained in families where a business is passed down. Often these rifts are lifelong. Some retired business owners create retirement plans dependent on receiving income from their business, and if that business begins to fail, it can put their retirement at risk — especially if they are unable to return to work and help right the ship. There are ways to improve transfer risks. It's important to begin the transfer planning process years before the exit target date — ideally 10 or more. The odds of success can likely be improved with a well thought out multi-faceted long-term plan, but even then the risk of failure and family strife are still high.
The second risk component related to adult children of high-net-worth individuals is providing kids with financial support. This is a difficult topic for a lot of high-net-worth retirees. The reality for many is that their adult children may not be as financially successful as they were, and the tendency for some is to risk their own financial independence to help their kids. From a strictly financial perspective, you need to be mindful of where your financial limits are and stay within them. Having periodic conversations with your children to discuss this issue is also a good step in creating boundaries and preventing faulty assumptions.
The best way to find your financial limits is to run alternative retirement income and planning scenarios with a retirement planning expert. Start with your dream retirement and then work backwards to establish an acceptable worst-case scenario. In addition, for one-time large expenditures like business start-up loans, it's important to stress test your retirement plan to get a full understanding of the risk being taken. (For related reading, see: Make Your Nest Egg Last by Not Selling Stocks When They're Down.)
4. Retirement Income Planning
The consensus in the media is that everyone should put as much money as they can in tax deferred vehicles, but for high-net-worth individuals that could be an expensive mistake. What many high income earners don't realize is that tax sheltering too much of their money before they retire may lead to a tax bomb in retirement. The problem is that assets distributed from tax deferred accounts are usually fully taxed as income upon withdrawal. This may not only lead to a retirement income tax problem, but can also complicate estate planning options. To avoid this problem, a tax smart strategy needs to be in place well before you retire.
Likely the best way to combat this issue is to have a relatively large portion of your assets invested in a taxable account. And importantly, your taxable account should likely never own tax inefficient vehicles such as mutual funds and most other investment products. Instead, strive for the much more tax efficient indexes, ETFs, and individual equities. Ideally, when you retire you'll not only have significant assets in tax deferred accounts, but you'll also have a substantial taxable investment account where distributed assets are not taxed as income. This way you'll likely have much more strategic flexibility in your retirement plan — especially in the early years.
Converting a portion of tax deferred assets to a Roth IRA is a consideration for some high-net-worth individuals. But this option is far from a sure thing and should be thoroughly analyzed so there is a good understanding of the pros and cons. The one thing the wealthy should likely never consider is tax-deferred annuities. Another area to avoid is permanent life insurance purchased for the promise of tax-free income in retirement.
5. Retirement Transition
Upon leaving a lifetime of day-to-day work-related activities, it's not at all unusual for former executives and busy professionals to struggle. Retirement planning counselors will tell you one of the most common problems is the disbelief that excess leisure time could possibly be a problem. Nonetheless, study after study shows that too much idle time is directly correlated to a lesser degree of happiness in retirement. This is a problem for many retirees, but is especially destructive for high-achieving wealthy retirees. (For related reading, see: Why Rollover Your Retirement Assets Into an IRA?)
Adequate financial resources are not a guarantee of happiness, and retirement is just as easy to screw up as any other part of life. Truly being prepared for retirement is about much more than just the numbers. The studies also show the happiest of all wealthy retirees are those with full schedules of meaningful activities which they feel passionately about. Whether you're soon to be retired, just retired, or have been retired for years, it's likely a good idea to periodically focus and crunch the possibilities related to your retirement activities. Here are some considerations:
- Don't lose site of the fact that retirement is a long-term venture.
- Be flexible in your thinking; the beauty of retirement is that it's your time, not your job.
- Try to find a middle ground of being challenged but not stressed.
- Consider doing something that helps others. This type of activity scores the highest in retirement lifestyle and happiness surveys.
- Whatever that "it" is for you, find it, pursue it, and enjoy. (Two additional resources to consider here: How to Retire Happy, Wild, and Free, a book on retirement that goes beyond the financials and RetireWOW, a website that helps retirees via ideas for creating a meaningful retirement.)
6. Elderly Parents
As Baby Boomers enter retirement, there is for many a relatively new area of risk that needs to be considered. Americans are living longer and for the first time, a slight majority of soon-to-be retirees have at least one living parent. According to a recent study, the number of adult children supporting an elderly parent has more than tripled in the past 15 years. The best time to address this topic is when parents are healthy. The key is to make sure they have an adequate and up-to-date retirement plan, elder care plan, will, and estate plan. If they are lacking in any of these areas, it's vitally important to comprehensively address it in their plan and yours.
7. Big-Ticket Purchases
Big-ticket purchases are risky for any retiree but are an especially prevalent risk for the wealthy. One of the most common problem areas are property purchases. The key to avoiding this problem is to update your retirement plan and stress-test your long-term income and budget projections before you make a big ticket purchase. By doing so, you should be able to clearly identify problems well before they become an issue. (For related reading, see: Financial Advisor Q&A.)
This is one of the biggest financial risks to retirees. Unfortunately, divorce is becoming much more common in retirement. Pre- and postnuptial agreements can be established to make the prospects of divorce less damaging for all parties, but the reality is few people will ever take that step. Divorce is especially risky for business owners and their spouses. Pre- and postnuptials can be particularly important to them.
9. Not Integrating Your Retirement, Estate Plans
Unlike most people, high-net-worth individuals need to fully integrate their retirement plan with their estate plan. There are numerous areas that require detailed and careful coordination, such as the timing of income, the timing of asset transfers, the type(s) of assets being held and distributed, tax considerations, how assets are legally registered/owned, etc.
The key to avoiding this problem area is to work closely with an estate planning attorney and have an advisor that recognizes the importance of coordinating your retirement and estate planning. The advisor aspect of this is often crucial since his or her role is to ensure the process keeps moving and is fully executed. It's also important to note that this isn't a one-time coordinated effort. Your advisor needs to be a proactive team leader who keeps everything up to date with periodic reviews. (For related reading, see: 6 Questions to Ask a Financial Advisor.)
10. Not Maximizing Social Security
The Social Security decision includes an inherent level of life expectancy speculation. As of today, both men and women are projected to live into their late 80s, and that means most people should likely postpone filing for social security until age 70. By doing so they'll prospectively maximize their lifetime benefit. This is especially the case for wealthier retirees, assuming they're healthy and optimistic about the future health of the country. The social security decision is uniquely individual, and as such, should likely be discussed with a retirement expert. The considerations are simply too numerous and personalized to feasibly do this any other way.
11. Long-Term Care Insurance
Long-term care insurance policies have some of the highest cancellation rates in the insurance industry. That likely has to do with the emotional scare tactics used to sell them. Regrettably, a lot of wealthy individuals buy expensive coverage only to realize years later that what they purchased wasn't ideal for their situation. When considering your long-term care options, it's vital that you talk with an advisor that understands the unique considerations of the wealthy; someone who is a fiduciary that doesn't sell long-term care products. In other words, you should talk with someone that has nothing to gain by your purchase, and will discuss all of your options. For many high-net-worth individuals, buying a long-term care insurance policy could be a costly mistake. The right option for you depends on your personal situation. (For related reading, see: Long-term Care: Traditional vs. Alternative Policies.)
In conclusion, the 11 high-net-worth retirement planning mistakes listed above are all avoidable. The best way to avoid them is by reviewing your plan and objectives with an expert on a regular basis.
This guide is for informational purposes; neither the information nor any opinion expressed constitutes personal advice. Please consult an expert before changing your personal finances, legal, insurance, or tax plan.