Are You Your Retirement Plan’sWorst Enemy?

BY TOM LAURICELLA

It seemed like a great idea at the time. The couple, in their mid 70s, had a spacious home in New York but felt they were ready to move to Florida. Central to their retirement plan was downsizing their house and reducing their spending.

But there were children and grandchildren who they would miss once they had moved to Florida. They would want to make sure they were all comfortable when they visited. By the time all was said and done, they ended up buying a home that would cost them just as much as in New York. Then, the couple discovered, they really missed being close to their family. That meant buying another small house back in New York.

"It totally blew up their financial plan," says David Schwartz, chief executive at Great Neck, N.Y., financial advisers FCE Group. "If they had stuck to their plan, they would have had plenty of money to live the lifestyle they wanted."

It's a common fear among retirement savers that an event beyond their control will come out of nowhere and wreck a carefully laid financial plan. But many retirees unwittingly make decisions that result in major, self-inflicted damage to their nest eggs.

The tricky part is that these mistakes can start out as decisions that seem like a great idea, such as buying a second home to which they'll eventually retire or taking an early-retirement buyout.

Or they're choices that have a strong emotional pull, such as helping a family member in financial trouble or writing a big check to a favored charity at a time when retirement accounts seem flush.

But any kind of significant financial decision needs to be viewed in the context of a financial plan aimed to play out over two or three decades. For most people, retirement planning requires discipline and careful balance when it comes to saving and spending. And especially early in retirement, that balance can easily be thrown off kilter.

As a result, advisers say, it doesn't take a crash in the stock market or massive medical bills to blow a big hole in a retirement plan-it just takes you tapping your nest egg.

Doubling Home Costs

"Your heart says, 'I can do it all,' " says Mr. Schwartz, "But when you start taking large chunks of money out of a retirement account, the effect is that you're going to run out of money."

Mr. Schwartz says he has seen second homes turn into financial disasters, as happened to the New York couple. "So they end up keeping two homes, with two of everything: two cars, two Internet services, cable, utilities, insurance," he says. "Everything is doubled…and what seemed to be manageable becomes unmanageable."

Michael Maloon, a financial adviser in San Ramon, Calif., has seen another version of retirement homes wreaking havoc on retirement plans when building a post-retirement "dream house" turns into a nightmare.

"These types of projects always come in over budget," he says. "They are tough enough to deal with when you are working."

The impact of an over-budget building or renovation project can easily get magnified when retirees find they have to withdraw more and more money from individual retirement accounts to cover the bills. Because that money is treated as taxable income, those withdrawals can lead to bigger-than-expected state and federal income-tax bills. It also can result in a higher percentage of Social Security benefits being taxed. In turn, that puts a further dent in the retirees' savings.

"It is also not uncommon for people to underestimate the tax burden and then have to take an additional taxable withdrawal the following year to pay the previous year's taxes," says Mr. Maloon. The result is "paying new taxes to cover old taxes."

"My advice is to address major projects while you are still earning a paycheck and can work yourself out of the hole," he says.

Lure of the Buyout

Larry Glazer, a Boston

Companies dangle attractivelooking lump-sum buyout offers as a way to reduce payrolls and future pension or health-insurance commitments.

"Many would-be retirees want to grab that check and sail off into the sunset," says Mr. Glazer, "but often these are employees that are still in their prime earning years."

Even if they realize they will still need to keep working, people often underestimate the challenge of matching their former salary. "Often, they are under the illusion that they can find another job and that may not happen, particularly in a difficult job market," says Mr. Glazer.

And managing a lump-sum payout presents its own risks, he says. "You must have the temperament to invest that lump sum to generate the income you need because that lump sum simply cannot be replaced."

Invest too conservatively and the retiree could end up running out of money sooner than expected. Meanwhile, today's low interest rates mean more pitfalls.

"Many retirees are tempted to compensate for the current low interest rates by locking up their lump sum in longer-term bonds or stretch for junk bonds" to grab their higher yields, says Mr. Glazer. But by doing so, they may be taking on more risk than is appropriate.

Generosity also can come back to haunt retirees. It's a temptation that is especially great early in retirement, when high savings-account balances can lead retirees to think they have more flexibility than they really do.

For example, says Mr. Schwartz, a retiree may lend money to a family member who has lost a job. But that money never gets paid back. Another typical example is offering to foot the bill for college educations or private schools.

Of course, it isn't easy to think of things like putting a grandchild through college or supporting an out-of-work son or daughter simply in terms of dollars and cents.

But the problem is that even if that money is someday repaid, a big withdrawal early in retirement will reduce the ability to compound those savings. Compounding is a crucial part of the calculus behind estimating sustainable rates of withdrawal from retirement accounts, Mr. Schwartz says.

"You're going to miss that money down the road," he says.

Email: tom.lauricella@wsj.com