Watch Out For These Retirement Risks!
by Gabriel Lewit
Knowing what risks you face can be important in every aspect of life. You know, for example, that when driving you face the risk of a car accident. What do you do to protect yourself? You wear your seat belt. When you head onto the lake to go boating or canoeing, you run the risk of falling in the water—so, you wear a life-jacket.
The more you know about the risks you’re facing, the better prepared you’ll be to address those risks and protect yourself. This is especially true for your retirement planning.
The truth is, in retirement—more than nearly any other point in your financial journey—you’ll be facing a range of financial risks that you never had to worry about before. The best strategy for ensuring you don’t fall victim to these retirement risks is to be educated and informed.
Only then can you create the right strategies you need to protect yourself! Let’s dive in and see what risks are most pressing when it comes to your retirement.
Stock Market Risk
Stock market risk, or the risk of losing your principal to market volatility, has been present from the moment you invested your first dollar in the stock market. The only difference is, in retirement, you don’t have the time you need to recover from any sustained losses and you’re likely drawing on your portfolio annually for income. This combination of annual withdrawals, market loss, and insufficient time create a perfect storm that can potentially deplete your retirement funds.
There are a few steps you can take to combat this:
- Work with your financial advisor to create an accurate retirement plan.
- Stress-test your retirement plan to see the impact that market loss will have on your numbers.
- Assess the risk you’re taking in your portfolio. It may be time to focus on preservation vs. growth.
- Re-balance or adjust your overall investment asset-allocation to include additional bonds.
- Consider annuities in retirement to guarantee principal protection for a portion of your portfolio.
Utilizing these steps can help ensure that the next market crash or recession doesn’t cause you to inadvertently deplete your retirement nest-egg.
Inflation risk is the risk of losing purchasing power in the future due to the effects of inflation, which has historically averaged around 3.00% per year. For example, if you are living on $50,000 annually in expenses when you retire at 65, you would need $78,000 to maintain that same standard of living at age 80, only 15 years later. This poses a challenging problem to retirees because most retirees are living on fixed incomes. Social Security doesn’t provide the necessary increases you need to offset these rising costs, and, as a result, you have to pull more and more from your portfolio.
There are a few recommended strategies for ensuring you have inflation in check:
- Work with your financial advisor to create an accurate retirement plan.
- Ensure that plan includes an annual inflation-adjusted expense figure.
- We recommend using 3.00% inflation rate to plan on a more conservative basis.
- Assess your investment mix to ensure that you’re not being too conservative. If you have money earning 2.00% in CDs and inflation is increasing at 3.00%, you’re losing purchasing power!
- Develop an income strategy that provides for annually increasing income payments.
By focusing on inflation in your retirement planning, you can help protect yourself from the impacts that this “silent thief” can have on your retirement assets.
Longevity risk is the risk of outliving your assets. In today’s modern society, it’s a fact that people are living longer than they’ve ever lived before. While on one hand that’s great, it poses a particularly problematic challenge for retirement income planning. Imagine, for a moment, that you retire at 65. You think you’re only going to live to 85 and thus only have to plan income for 20 years. Lo and behold, not only are you healthy and still kicking at 85, you go on to live to 100. This means that your retirement money would have needed to last you 35 years! That’s an incredibly long time to go without a paycheck.
Interestingly enough, one of our client’s mother is 102 and incredibly active for her age. The more people you talk to, the more stories you hear about centenarians or people living well into their 90s. The point is, it can very well happen to you. Have you planned for that? What if you plan to live to 85 and run out of money, but then go on to live to 100? Who will you turn to for financial support? As with everything in financial planning, its safer to plan more conservatively for extra peace-of-mind.
Here are some strategies you can employ:
- Adjust your financial plan to run to at least age 90, if not age 100, and assess your results.
- Do you still have enough money to last you if you live a longer-than-expected life?
- Stress test your portfolio for more bear markets during this scenario. We recommend including approximately 2 – 3 bear markets for every 20-years of your retirement. How does that impact you?
- Consider incorporating a fixed index annuity with a “lifetime income rider.” Annuities do have some unfounded negative PR that is usually factually incorrect. Truth is, these are terrific products for providing guaranteed lifetime income that rises each year to offset inflation. At least explore and consider them in your income planning.
By creating a plan that addresses longevity risk, you can truly enjoy your retirement. Now, no matter how long you live, you know you’ll be covered with sufficient income.
Taxation risk is the risk of rising taxes in retirement. Taxes can be challenging to plan for because its an ever-shifting landscape. Tax rates today are unlikely to be the same as tax rates in the future. So how do we plan for the unknown? We make the best assumptions we can today based on current economic conditions, facts and figures. Today, we have some of the lower tax rates in history. Combined with national debt that is exceeding $22 Trillion and rising by nearly $1 Trillion per year, where do you think tax rates are headed? There’s a very good chance that they’ll go up.
The other issue is the Required Minimum Distribution (RMD) of your IRAs and 401(k)s. The government mandates these, and, as a result, once you hit RMD age of 70.5 (soon to be 72), you can inadvertently be bumped into a much higher tax bracket, and have no options of avoiding it!
Here are our top tips to prevent a big future tax bite:
- Be sure to include a rising tax-rate scenario in your financial plan to assess its impact.
- Look for opportunities to do systematic Roth IRA conversions before your RMDs start.
- Consider contributing to your Roth IRAs and Roth 401(k)s instead of their traditional counterparts
- Explore tax-free life insurance for retirement income. The younger you start with tax-free life insurance, the more tax-free income you can have in retirement.
- Create a plan to minimize or eliminate all taxes in retirement, based on your income sequencing, retirement date, and other facts!
By being proactive, you can not only protect yourself from rising tax-rates, you can work towards reducing the heavy tax burden that can drag down your retirement income.
Healthcare risk is the risk of an unexpected health incident and its financial ramifications. Look, if we knew when healthcare issues would strike, planning for them would be easy. However, despite all our best planning and best attempts to take care of ourselves, we get sick. We get injured. We get into accidents. Unfortunately, as you age, healthcare issues can start to pile up… along with the healthcare expenses. Medicare premiums, co-pays, surgeries, hospital stays, medication, home health care, aides, nursing homes, you name it. Have you planned for these costs in your retirement projections?
Here’s what to do:
- Ensure you’ve included all healthcare related expenses in your retirement plan budget
- Consider investing in an HSA today if you have a high-deductible insurance plan
- Run “what-if” scenarios to illustrate the impact of unexpected costs
- Consider buying LTC or a hybrid LTC policy to limit asset erosion and exposure in future years
- Explore options and strategies to lower your healthcare expenses as much as possible
Don’t let healthcare costs catch you unawares. It’s hard enough dealing with the healthcare issues themselves, don’t let the financial burdens make them even worse.
In today’s article we’ve covered a number of the most prominent retirement planning risks:
- Stock Market Risk
- Inflation Risk
- Longevity Risk
- Taxation Risk
- Healthcare Risk
That’s a lot to be worried and concerned about! The best way to gain peace-of-mind is to work with an advisor that’s dealt with all this before, and that specializes in creating a retirement plan that secures your future from all of these possibilities. That’s what we do at SGL Financial!
If you’d like to talk to SGL Financial about your retirement planning, give us a call at 847-499-3330 to schedule your complimentary financial review.
Or, click here to fill out our online contact form right now.
We’re a Fiduciary, we’re independent, and we’ve helped hundreds of retirees just like you to create a secure retirement plan and enjoy their golden retirement years.