Before making an important retirement decision, make sure you understand not only what you’re getting—but what you may be giving up.
One thing I often remind clients throughout the Greater Milwaukee area is that retirement decisions rarely affect just one part of your financial life. A decision you make in one area can sometimes affect several others, which is why I believe these decisions should always be considered within the context of your overall retirement plan.
I’ve also learned that some decisions can be very difficult—or sometimes impossible—to undo once they’re made.
That’s especially important as you get closer to retirement.
You may have spent decades building your retirement savings, but eventually you’ll begin making decisions about Social Security, pensions, retirement accounts, healthcare, and other benefits you’ve accumulated along the way.
And sometimes, once you’ve made the decision, you can’t simply say: “You know what? I’ve changed my mind.”
A Few Examples
Here are a few situations that illustrate what I mean.
Taking a Large 401(k) Distribution Too Early
Let’s say someone is still working and decides to take a large cash distribution from a traditional 401(k).
Depending on their circumstances, that withdrawal could be subject to ordinary income taxes and, if they’re under the age of 59½, potentially an additional 10% tax unless an exception applies.
But the bigger long-term issue may be what happens next.
Once that money is spent and no longer invested, you’ve also lost the potential future growth that money might have generated for retirement. This is a classic example of what we previously discussed as Opportunity Cost. (See: “Why the Order You Withdraw Retirement Money Matters.”)
And you can’t necessarily turn around several years later and simply put the entire amount back into your 401(k). Annual contribution limits still apply.
That’s why a short-term financial decision can sometimes have a very long-term retirement consequence. It’s also why I believe financial decisions – especially those related to retirement – should always be made within the context of an overall financial plan.
Taking Social Security Early
Social Security is another good example.
You can begin retirement benefits as early as age 62, but taking benefits before your full retirement age generally means accepting a lower monthly benefit.
There are limited ways to reconsider that decision, but this isn’t something I’d approach with the attitude of: “I’ll just change it later.”
Here are a couple of other things many people don’t realize:
What if you decide to take Social Security early, but you’re still working? Did you know that depending on how much you’re earning, some of your Social Security benefits could actually be withheld until you reach Full Retirement Age?
Then there’s taxes…fun. Depending on where the rest of your retirement income is coming from, a portion of your Social Security benefits could potentially be subject to federal income tax as well.
These are the kinds of things that can easily get overlooked when someone looks at Social Security as just one decision: “When should I take it?”
That’s one reason I believe Social Security deserves to be evaluated before you file, and again, within the context of your overall retirement plan.
Making a Pension Election
Here’s another one I’ve encountered many times over the years.
Suppose your employer offers you a pension and you’re deciding between a lifetime monthly income and a lump-sum benefit.
Before deciding, one of the first questions I believe you should ask is:
“What am I giving up?”
If you take the lump sum, you may be walking away from a valuable lifetime benefit that is guaranteed.
And if you elect a particular pension payment, that decision may also affect how much – or if – your surviving spouse will continue to receive that income after you die.
This one really hit home for me. My dad nearly made this crucial mistake when he claimed his pension—a decision that could have resulted in my mom receiving nothing from the pension if he passed away before her. Thankfully, I just happened to visit that day, learned what had happened, and we were able to have the election reversed. I owe that to Divine intervention.
Getting back to pension decisions when a lump-sum option is offered, I like to first understand what the pension would otherwise provide. Then we can ask:
“Do I want to retain some form of guaranteed lifetime income?”
If the answer is yes – and especially when someone still has several years before needing the pension income – there may be other strategies worth comparing against the pension benefit.
Could another strategy potentially provide guaranteed lifetime income while offering different levels of control, liquidity, or legacy benefits?
Maybe.
But we need to do the analysis first.
Because once again, the question isn’t simply, “which option gives me the most money today?”
It’s understanding what you’re getting and what you’re giving up.
The Common Thread
These examples may look completely different:
- A 401(k) withdrawal.
- Social Security.
- A pension election.
But they all have something in common:
Today’s decision can potentially affect your retirement for years to come.
That’s why I don’t believe major retirement decisions should be made based on a rule of thumb, something you heard from a friend, or simply because one option looks more attractive today.
Sometimes there are consequences you won’t see until much later.
So, before making an important retirement decision, instead of simply asking:
“Which option looks better?”
Perhaps the better questions to ask are:
“What am I giving up by making this decision?”
and…
“If I change my mind later, can I get it back?”
Because sometimes you can.
And sometimes you can’t.
That’s why some retirement decisions simply don’t come with an undo button.
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