Will I be able to retain my lifestyle without running out of money? Am I protected from a long term care event? What happens to me when the market conditions such as 2008 happen again?
These are a few of the many questions we receive from soon to be retirees all the time. Transitioning into retirement seems to be one of the most stressful points in a person’s life. There are more questions than answers, and there are many hazards that retirees are unaware of.
The following are a few of the risks retirees should be aware of while planning their transition from wage earner to living on investments and other sources of income such as social security.
- Inflation Risk (also known as purchasing power risk): Inflation risk is one of those risks that retirees don’t usually think about until it starts to affect them. The cost of goods increases over time, and most cash and income vehicles have trouble keeping up. A bond investment paying $1,000 per year will buy more for a retiree this year than it will when the same payment comes out 10 years from now, so we need to prepare a plan for an increasing cost to support the same lifestyle in the future. The longer someone lives, the more this risk can become a problem. With 3.6% inflation, lifestyle costs will double every 20 years. Someone retiring at 65 with a $3,000 per month lifestyle will have to pay $6,000 per month at 85 for the same lifestyle and $12,000 per month at age 105.
- Market Risk: Market risk is the most obvious retirement risk. Retirees often want to avoid the market altogether, because the downs seem much worse when there is no other source of income or time to supplement or refill the lost investments. Although there are risks in the market, some assets need to be set aside for the long term in order to combat the inflation risk listed above.
- Liquidity Risk (accessibility of funds): For many, retirement consists of an income stream from things such as social security, a pension or annuity. While these can provide a consistent stream of income, they do not provide money for lifes what-if’s. Balancing the inflation and market risks listed above is very important. Having enough liquidity, or easy access to funds, even though it may not keep up with inflation, is a necessity.
- Health risk: Health risks are another more obvious risk while in retirement, but it can come in many forms. There are many health factors that can affect a plan in a significant way. For instance, a simple fall can create a very large hospital bill. There are also health risks that can creep up over long periods of time such as a memory issue like Alzheimer’s. Although these are not fun to think about, we should be aware of how a plan would respond to different heath events that could take place over time. A healthcare need is not only a financial burden on the person affected, but it could also be a weight on the shoulders of a surviving spouse or other family members.
- Taxation Risk: While looking at a retirement nest egg, it is important to note which accounts will be taxed on withdrawal, and which are not. A good plan will take into account taxation when developing income. These rates can and will change over time, and not everyone will be in a lower tax bracket in retirement.
While building a plan, it is not possible to eliminate all of the risks. The key is to balance the risks the best you can with the resources you have. Every case is different. Once the plan is set up, update it as the environment changes. Changes in health, taxes, inflation, the market, etc. are all reasons to take a look at the plan and tweak where it’s possible.