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Benjamin Franklin’s famous phrase on death and taxes – “in this world nothing can be said to be certain, except death and taxes” – is true, but lacking in reference to retirement. Death and taxes are inevitable and have a big impact on your retirement planning. But there is one other factor that impacts your retirement heavily: investment expense ratios. All three issues must be considered when planning for retirement.
Planning for Death, Taxes, and Expense Ratios
Knowing there are three certainties in retirement means you can effectively plan for them. Developing and executing a solid plan will help you avoid being surprised by any of these guaranteed items.
How Dying Impacts Retirement Planning
Talking about your own death is a macabre topic, but a necessary one. You will, eventually, die. Your retirement plan should take this into consideration.
How best to take this into consideration? Here are impacts to consider:
• Your death will cost money for a funeral and memorial service. At the very least you should do your heirs a favor and have enough money left to cover these costs.
• If you have heirs, consider how much money you plan to leave them and utilize a proper will so your wishes are executed.
• Knowing you will die should influence how much money you plan to spend. Will you enjoy life to the fullest and try to use all of your nest egg, or are you planning to hand it down to the next generation when you’re gone?
How Taxes Impact Your Retirement Choices
The government seems to have a hand in every potential revenue cookie jar, and your retirement is no exception. Whether you pay taxes before you invest money for retirement (as you would with a Roth IRA or Roth 401k) or if you pay them in retirement (as you would with a Traditional IRA or 401k), you will pay taxes. It is inevitable.
However, how you see tax policy and your financial goals greatly influences your retirement decisions. If you think taxes will skyrocket in the future, you will gladly pay today’s current tax rates and utilize a Roth investment if you qualify. If you think they will be the same or lower in the future, you’ll stick with using your employer’s 401k and taking the tax break today.
The impact of your decision will be felt in retirement. A miscalculation could cost you thousands in extra taxes to pay, so don’t take the decision lightly.
How Expense Ratios Impact Retirement
The fees you pay on your retirement investments can dramatically change the course of your retirement. While some choose to pick individual stocks and pay brokerage fees, almost everyone is better served to utilize low cost mutual funds. The low cost title is associated with low annual expense ratios. A mutual fund with a 0.1% expense ratio will charge $10 per year in expense ratio. A similar fund with similar invests might charge 1% – the current industry average – and charge you $100. It’s “just” $90 lost, but that 0.9% difference adds up significantly over the years leading up to retirement.
An investor who puts $10,000 per year into a portfolio for 30 years straight will have invested $300,000 of her own money. If her investments consistently earned a 7% return, she would end her 30 year run with $1,020,730.
That same investment with a heavier expense load might pull the return down to 6.1% per year. A small percentage difference, but the impact is huge. She ends up with only $863,720. Her heavier expense ratio load cost her $157,010 – that’s over 15% of what she could have had with a lower expense ratio.
You can’t avoid expense ratios, just like you can’t avoid death and taxes, but you can prepare for them and seek out the lowest possible costs. Failing to do so will cost you dearly.
This article is by Kevin Mulligan. Kevin is a debt reduction champion with a passion for teaching people how to budget and build wealth for retirement. He’s building a personal finance freelance writing career and has written for RothIRA.com, Moolanomy, ING Direct, and many others.