The leading cause of death in the United States today is heart disease. Cancer is a close second, followed by COVID-19, accidents, stroke, and chronic respiratory diseases. But what is the leading cause of death to retirement? Running out of money before running out of life.
Protecting yourself against this common retirement risk requires looking at your investments not in terms of the returns they earn but rather the income they can produce.
As economist Robert Merton wrote in his paper for the Harvard Review, the seeds of the crisis in retirement planning lie in the fact that investment decisions are being made with “a misguided view of risk” and, given today’s interest-rate risk and government policy, “a time has come where we need to actually put risk and uncertainty in the structure.”
What follows are the big 5 risks in retirement to be aware of, along with some retirement advice to help you set yourself up for success in your golden years.
Risk 1: Taxes
During your working years, you’re told not to worry about taxes during retirement. Given the option to pay our taxes now or later, most people would rather pay them later.
That is exactly what happens if you save in a retirement account such as an IRA, 401(k), or Thrift Savings Plan (TSP), and the deal starts out as a pretty good one. The money comes out of your paycheck before this income is taxed, and it goes into your retirement account where it grows without being taxed, compounding interest. This allows you to accumulate a nice big pot of money.
Now, the closer you get to the time of retirement, the bigger that pot of money grows. For most people, their retirement account is the single largest monetary account they own. But whether you own a TSP, a 401(k), or a 403(b), what you have is a tax-deferred account.
The problem? You haven’t paid any taxes on this money. Not on the amount you initially put in, and not on the growth.
Unless your money sits inside a Roth IRA, you still owe income taxes on every penny you have saved. That means Uncle Sam will be getting a certain percentage of your retirement account.
But wait—it gets even worse. He also has rules about when and how much money you must take out, and failing to follow these rules will cost you even more in penalties and fees. This is why some experts call the money sitting in these accounts a ticking tax time bomb—whenever you go to spend this money, you never know what unintended side effects might be triggered and how much your tax bill will explode.
Withdrawals from these accounts can increase your income, your marginal tax rate, the amount of tax you pay on your Social Security income, and the amount you pay in Medicare premiums. One withdrawal can have a domino effect, resulting in more of your money falling away. While you have zero control over tax law and Uncle Sam’s rules, you do have 100% control over what you do with this money. That is the difference between planning for vs. paying your taxes.
The good news? We offer a helpful Retirement Tax Calculator that you can use to help you plan.
Risk 2: Longevity Risk
These days, people are living longer and spending more time than ever in retirement. Obviously, this stresses your portfolio.
Longevity risk in retirement magnifies all of the other big 5. Whatever is weak in your plan will get severely tested the longer you live. One area, in particular, has to do with the rising cost of healthcare and the types of services you may need later in life as your body ages.
It has long been reported that more than half of all 65-year-olds will require some form of long-term care (LTC), but LTC is often misunderstood. Long-term care refers to a wide range of services that you might need as you age, and these services could be performed in an assisted living center, an adult day care facility, a nursing home, or in the comfort of your own home.
Services include simple custodial duties such as meal preparation or taking out the garbage to more intrinsic nursing care or twenty-four-hour supervision.
Don’t just take our word for it. These statistics from the Assistant Secretary for Planning and Evaluation show us how longevity risk in retirement is a common occurrence:
- 48% of people turning 65 will need some form of paid LTC services during their lifetime.
- 24% of people turning 65 will require paid LTC for more than two years.
- 15% of people turning age 65 will spend more than 2 years in a nursing home.
- Men will need LTC for an average of 2.2 years.
- Women will need LTC for an average of 3.7 years.
- The national average for the cost of a private room in a nursing home is $108,405 annually.
Paying for these expenses is not only unpleasant to think about, but it’s a complicated problem to solve. Insurance companies have been rapidly exiting the long-term care market because of rising claims, low mortality rates, and higher prices in coverage than what most people can afford. At the same time, innovative solutions are being offered using other policy options.
This is an area of planning that became personal for me when my mother was diagnosed with dementia. She was the last person in the world whom I thought this could happen to, and so I no longer believe it’s okay to avoid this planning and think, “This won’t happen to me.”
When a long-term care event happens, it happens not just to one individual but to the whole family. And this isn’t just a financial issue; it’s an emotional one. We have little control over when or if these events will happen, but anything we do now to make the money side of things worry-free will allow you to focus all of your efforts and attention on where it should be—taking care of that individual in the way they deserve.
Risk 3: Death of a Spouse
This is a risk specific to married couples or anyone cohabitating with someone they love. It’s a common misconception to think that after your partner dies, all your expenses suddenly get cut in half.
Sorry, but that’s not what happens. Your homeowner taxes, insurance, and mortgage expenses still need to be paid. Even if your house is paid off, the taxes and insurance do not get cut in half.
Most people in this situation find that the cost to maintain their lifestyle stays relatively the same, yet studies find that widows experience an income reduction of 35 to 40% upon their spouse’s death.
Here’s why:
- When your spouse or partner passes away, your household automatically loses at minimum one source of guaranteed lifetime income—Social Security.
- You might also lose pension income unless that person did some planning.
Losing these guaranteed income checks creates a huge income gap that somehow needs to be made up.
One way to manage risk and your retirement investments is to optimize your Social Security benefit. The longer you wait to file for your benefit, the larger the income benefit grows.
A strategy helpful to married couples is to allow the larger of the two benefit checks to grow as big as possible. Then, when one spouse passes away, the surviving spouse is able to claim the larger of the two checks under the guidelines stipulated for survivor benefits.
Risk 4: Market Risk
Market risk is the risk of losing principal and interest due to a market correction. If that correction happens sometime during the 10 years before or after you retire, you might not have the time to make up for those losses. That could seriously compromise your portfolio’s ability to generate income.
One myth commonly perpetuated by the industry is that “you can’t miss the best days.” A buy-and-hold strategy allows you to capture the full gains of the best days, but you also get the full losses of the worst days. Is this the best strategy to use for retirement accounts?
I’m a big believer in the philosophy that losses hurt more than gains help.
Let’s put this to the test using historical numbers:
From 1980 to 2015, the average return for the S&P 500 was 8.51%. If you had $100,000 in your typical buy-and-hold growth fund, and you missed the 30 best days, you would have received an average return of 3.64%. If you missed the 30 worst days, you would have earned an average return of 14.82%.
Miss both the best and worst days, and you would have averaged a tidy 9.44%.
If you want to remain in the market in the years just before and during retirement, it might be necessary to change your investment strategy.
Ask yourself:
How much could you lose before it made you extremely uncomfortable?
This is a crucial question about your risk tolerance. As you near retirement, your capacity to absorb market downturns diminishes. A significant loss could derail your retirement plans if you’re not prepared.
Do you need this money to cover all or some of your income needs?
This speaks to the purpose of your investment portfolio. If your portfolio must generate consistent income to cover living expenses, it needs to be structured with income-producing investments
How many years are you away from retirement?
This question gets to your time horizon. If retirement is still five or more years away, you might be able to ride out short-term market swings in favor of long-term growth. But if you’re retiring in one to two years, it may be wise to shift part of your portfolio into more stable investments to protect your nest egg from sudden downturns
Do you have the time to recover from a market loss?
This ties in with both risk tolerance and time horizon. When you’re younger, you have decades to recoup losses from market downturns. In retirement, this isn’t the case. The closer you are to needing those funds, the more important it is to consider downside protection strategies.
By answering these questions, you can determine the best way to manage risk and your retirement investments for your unique situation. Your investment strategy should reflect your risk profile, income needs, and retirement timeline.
The goal is to stay invested in a way that aligns with your goals and comfort level, ensuring that your money continues to grow while also preserving your financial security during retirement.
Risk 5: Inflation
Most people understand the basic principle of inflation: the cost of things you buy will rise. In other words, a gallon of milk today will not cost the same as a gallon of milk tomorrow.
The U.S. Inflation Rate is the percentage of increase in goods and services over a year and is one of the metrics used by the Federal Reserve to gauge the health of the economy. The targeted rate is 2%, but the current long-term average is 3.28%, which means prices will double every 20 years.
Retirees are especially vulnerable to inflation for several reasons:
- Fixed Incomes: Many retirees rely on fixed income sources like pensions or annuities that may not be inflation-adjusted. This means that as costs go up, the buying power of these income sources goes down.
- Conservative Portfolios: As people age, they often shift to more conservative investments to protect their principal. While this strategy reduces market risk, it can expose them to inflation risk, as lower-yield investments like bonds may not keep pace with rising prices.
- Healthcare Costs: Healthcare tends to experience inflation rates above the national average, and medical expenses typically increase with age. A retiree’s budget may feel a disproportionate impact from inflation in this category alone.
- Longevity Risk: The longer you live, the more time inflation has to erode your purchasing power. Even modest inflation can significantly impact your financial stability over a 25- to 30-year retirement.
Inflation is an unavoidable part of economic life, but it’s particularly critical to account for when planning for retirement. Ignoring inflation is one of the major early retirement risks that can lead to a situation where your savings no longer support your desired lifestyle. With thoughtful planning, you can help safeguard your future from its long-term effects.
Successful Planning Relies on Understanding Retirement Risks
One glance and it’s clear: During retirement, it’s not enough just to grow your money every year; you also want to grow your income.
Your income should not be stagnant. It needs to increase each year, just like prices increase each year and just like your Social Security benefit increases each year based on the consumer price index.
Prescription for Retirement Success: Solving the problem of risk during retirement involves choosing the right solutions at the right time so you don’t get unintended side effects such as a bigger tax bill or a smaller income.
To further complicate things, the financial industry is one that is ever-evolving. Whatever the rules governing products, solutions, and benefits today, you cannot be certain that those will be the same rules tomorrow. Tax brackets, income thresholds, and the age at which you must start taking your Required Minimum Distribution (RMD) have all changed in the last five years.
Policies also change depending on the person in the White House. This means the time to take action against these retirement risks is now before the current windows of opportunity close.
For more retirement advice and even deeper insights into retirement risks, get in touch to schedule your complimentary retirement opportunity conversation with one of our licensed financial advisors. We provide a full range of retirement planning services that prioritize you and your financial comfort.
