For any retiree, there are a number of risks that are inherent to life —risks that can’t be completely avoided.
When evaluating these retirement risks, there are generally three options. First, you can retain the risk and hope it doesn’t affect you. The second option is to shift the risk to someone else, often an insurance company. Finally, you can manage the risk through thorough and continued evaluations over the course of your successful retirement.
A sound retirement plan should evaluate the level of risk inherent in your retirement plan, stabilize those risks with a systematic process, and strategize to address the risk should it rear its ugly head.
Let’s look at a few of the risks that should be considered:
1 – Risk of running out of money
Hands down, running out of money is the biggest fear for most retirees. Can you imagine reaching into your empty wallet only to find the leftover pennies from your final $10?
The difficult part is that no one knows how long they’ll live, which means that no one knows when it’s okay to spend that final dollar.
In order to protect against this risk, it’s critical to consider all the possible scenarios such as: Living only a few years in retirement due to a premature death, living exactly to your life expectancy, or living well beyond your life expectancy.
The reality is that likely most retirees may not run out of money in their 60’s and 70’s, but rather more likely in their 80’s or 90’s, even IF they planned adequately. It’s also important to remember that running out of money does not mean running out of income. Running out of money means running out of investable and cash assets (maybe even losing home equity). Even if you do run out of money, you may still have your other income sources, such as your pension, your social security, or other annuities.
2 – Risk of your investments losing value
No one likes to lose money in the market, but for retirees, the fear of losing that money is enhanced. That invested money may be what they need to live on for the remainder of their lives. Without additional income from working, this may be the money they rely on to meet their monthly living expenses.
When the markets do lose (or gain) value, it could impact some retirement plans.
Retirees who pulled the trigger at the end of 2007 have experienced a significantly different retirement than those who have retired between 2010-2015.
For those who retired in 2007, the first 18 months of their retirement couldn’t have been worse! The market, depending on how you measure it, lost more than 40% from top to bottom. To put this in perspective, a retiree with $2,000,000 may have lost nearly $800,000 in 18 months! However, to be fair, most retirees may not have been invested in a 100% equity investment like the one used for this example. Either way, many people most likely lost huge sums.
Retirees during this time could have been forced to re-evaluate their spending needs, adjust their investment allocation, or correct their long-term retirement plan. Above all, these retirees most likely experienced the emotional rollercoaster of market volatility coupled with sleepless nights.
On the flip side, those who retired in 2010 or later could have benefited from the extraordinary bull run of the market. They may have experienced seemingly linear positive market returns for six years running.
3 – Risk of being too safe with your investments
If the possibility of your investments losing money and negatively impacting your retirement plan is real, why would anyone ever want to invest their money in retirement? It could make sense that every retiree should keep their money in the safest possible instrument that allows them to meet their retirement needs.
The problem arises when retirees become too safe with their investments. Oftentimes, retirees might choose to invest their retirement assets “safely,” in that they don’t lose value, but they are actually too safe because they don’t earn enough. For example, if you allocate your retirement assets to cash and other money market type instruments, you may not lose value. However, it is very possible your assets could not earn enough to keep up with inflation. While the cost of living continues to rise (think paying more for milk, gas, rent etc.) at approximately 2% per year, your cash might be earning less than 1%. In this example, you ARE actually losing value; it’s just harder to measure.
4 – Risk of a Premature Death
When you think of retirement planning, you rarely consider that dying early will be a problem. Furthermore, for the deceased, it won’t be, but imagine what life will be like for your surviving spouse and/or family.
If one spouse dies early, it’s possible that the surviving spouse may live a long, full life. Therefore, it is important to consider what will happen to your income if your spouse dies. Often, income from pensions, social security, and other annuities will be adjusted upon the death of the primary recipient. Sometimes, that adjustment is minor, while other times it could mean that an income source disappears entirely.
A sound retirement plan should consider the impact and change of income that occurs as a result of death. If a majority of the income is tied to one spouse and that spouse dies, the survivor might be left in a less than desirable scenario.
A quick look at retirement income will consider the following:
- Social Security – For married couples, the surviving spouse will retain the larger of their own Social Security income or their deceased spouse’s income. In a scenario where both spouses have maxed out their social security benefits, this might mean the loss of $30,000-$40,000 per year of total income.
- Pensions – When electing a pension income, it is not uncommon to have choices which may include: maximize the annual income by electing a single life only (this means that once this person dies, no benefit is paid to the surviving spouse), protect the spouse by electing a 100% survivor benefit (as long as one of the two spouses is alive, the benefit will be paid), or a number of choices in between. When a retiree chooses a single life only and subsequently dies, a reliable and large portion of retirement income may be lost.
- Annuities – Annuities may look very similar to pensions, but it’s important to know what income benefit was selected, and how long the money will last.
5 – Risk of Long-Term Care Need
The cost of long-term care is very expensive.
Unfortunately, long-term care insurance can also be costly, depending on how much coverage you purchase.
This leaves retirees in a pickle.
Should a retiree run a simulation and see the possible negative impact that a long-term care event has on their income sustainability, they might be less than pleased. Some long-term care needs, depending on where you live, could exceed $75,000 per year. Even the most conservative retirement income plan could be thrown off course by an additional withdrawal of $75,000 per year.
In order to shift the risk to an insurance company, the cost could run from $1000-$2,000 for a “Chevy” plan to $8,000-$10,000 for “Cadillac” coverage. Even for a retiree spending $150,000-$200,000 per year in retirement, this is often a big task.
There are other risks that could be added to this list, such as healthcare expenses, the risk of Social Security running out (not a risk that I am overly concerned with), and the risks associated with economic and political policy (to name just a few).
A successful retirement consists of continued projections and permanent evaluations. It is a moving target being pulled in different directions by the risks mentioned above.
Even so, it is a target that can be hit by appropriately identifying, evaluating, and addressing the risks mentioned above, and the unforeseen risks that may be coming in the future.