Top 5 Risks in Retirement

One thing that I have learned over the years is that life holds many surprises – both good and bad.  Most retirees try to predict if they have enough in assets and pension or social security income to maintain their lifestyle.  What they sometimes fail to plan for are the risks that are out of their control that can erode even significant life savings. Unless people understand these risks and plan to manage them, their lifetime income may be in jeopardy. Working with a CERTIFIED FINANCIAL PLANNER™ can help with this process.  These are the top 5 risks that we see to sustaining one’s lifestyle in retirement:

1. Longer Life Spans

For many people, the fear of outliving their money is greater than their fear of dying, and for good reason. Americans are living longer than ever.  The average 65-year-old male has a 50% chance of living to age 87 and a 25% chance of living to 92.  For women, the lifespan is even longer.  50% of females age 65 will live to age 90 and 25% will live to age 96!  When planning, remember that half of the population will live longer than the average life expectancy, yet studies show 37% of people underestimate their own life span by 5 years or more.

Tip: If you can, consider delaying the start of social security benefits to maximize your lifetime income.

2. Inflation

Inflation impacts retirement planning by increasing the future costs of goods and services. While inflation is typically associated with an increase in asset prices, not all asset prices will rise uniformly or even keep pace with inflation. Furthermore, some assets (such as traditional fixed-rate bonds) may decrease in value if inflation runs hotter than expected. When we are working, we tend to underestimate its effect.  Raises (hopefully) keep pace with inflation and we do not feel the pressure of increased prices as much.  However, in retirement on a fixed income, inflation can be devastating.

If inflation runs at its historical average of about 3%, the purchasing power of a given sum of money will be cut in half in 23 years. However, what happens if inflation rises to 4% or higher?  If you need $50,000 today to cover your expenses, you will need $133,000 in 25 years at 4% inflation rate and $169,000 in 25% at 5% inflation! Therefore, to outpace inflation, you need to have a strategy in place that allows your income stream to grow throughout retirement.

Tip: Consider investments that will outpace or increase with inflation such as Treasury Inflation-Protected Securities (TIPS), real estate investment trusts (REITs), and equities. 

3. Taxes

The effect of taxes (both state and federal) on your retirement savings and income is an often overlooked but significant aspect of retirement income planning. Taxes can impact your available retirement income, especially if a significant portion of your savings has been dedicated to tax-qualified accounts such as annuities, pensions, 401(k)s, and traditional IRAs, since most, if not all, of the withdrawals from these accounts are subject to income taxes. Understanding the tax consequences of these investments is vital when making retirement income projections.  Remember that states tax retirement income differently.  When considering where you may wish to retire, review that state’s tax treatment of retirement income.

Tip: Before retirement, diversify your holdings across both retirement (qualified) and non-retirement accounts as the tax treatment on withdrawals is different. 

4. Asset Allocation

To be sure, your asset allocation should be aligned with your risk profile, but it also needs to factor in your long-term need for growth.  Although common wisdom is that one should get increasingly more conservative with their portfolio in retirement, allocating too much to bonds and cash can sacrifice long-term growth and put you at risk for outliving your money.  On the other side of the spectrum are those who take too much risk in retirement by over-allocating to riskier investments.  Asset allocation and diversification are important strategies to consider when choosing investments. The right asset allocation will help you avoid two costly mistakes: being overly cautious or taking excessive risks.

Tip: You should choose a balanced portfolio of financial assets that works best for you by considering your personal goals, retirement timetable, and tolerance for risk.


5. Health Care Costs

Retirees’ finances can be dramatically affected by the state of their health. Most people are surprised to learn that many healthy couples spend more money on medical care during their retirement than unhealthy couples. This is because healthy people live longer, eventually develop health problems, survive longer after an illness develops, and are more likely to need chronic care.

According to the latest retiree health care costs estimate calculated by Fidelity Benefits Consulting, a 65-year-old couple retiring in 2019 was estimated to need $285,000 to cover medical expenses (such as supplemental insurance, co-pays, and out-of-pocket costs) throughout retirement. And since medical costs are increasing faster than the rate of inflation, they will consume a larger percentage of retirement income in the future.

Tip: Long-term care insurance and adequate supplemental medical insurance may help retirees mitigate this risk and if it is available, contribute to a Health Savings Account (HSA).