Retiring involves a certain amount of risk even at the best of times. Some retirement funds, like a 401(k) or an IRA, are subject to market volatility. But what if you’re forced to retire early? Or if your spouse dies suddenly and you must make do with only one Social Security check instead of two?
The sad fact is that simply saving for retirement isn’t enough. You have to take steps to protect yourself against risk, so here are some of the more common risks associated with retirement and what you can do to mitigate those risks.
Longevity Retirement Risk
Longevity retirement risk refers to the possibility that you might outlive your money. People are living longer than ever, and healthcare professionals estimate that the 120-year lifespan could soon become a reality, so even if you’re planning to live into your 80s or 90s, you still might end up running out of money. For most people, accounting for this fact means needing to save more for retirement, waiting longer before completely retiring, or both.
Inflation Retirement Risk
Have you ever asked your parents (or grandparents) what something cost when they were a kid? The answer probably surprised you. So, take the difference between the cost of that item several decades ago and what that same item costs now, and you’ll get an idea of how much inflation has impacted them. How much will it affect your retirement? So, make sure you account for having enough to pay for the things you’ll need at the prices they’ll cost when you retire (rather than what they cost now).
Market Volatility Risk
If you’re like many, you will rely on taking money periodically from a 401(k) or IRA invested in mutual funds for at least a portion of your retirement income. Because of longevity risk and inflation risk, your money needs will likely continue to grow during your retirement years. The principal and how much income it can generate will be impacted by the fluctuations of the stock and bond markets.
Many people expect and plan on getting average returns or only “The Best” returns. Unfortunately, no matter your risk tolerance, investing is not that controllable. In many cases, the return could end up being lower than desired. You might even see your balance go down if the market takes an unexpected turn or some of the stocks of the companies held inside your mutual fund don’t pan out. If you’re already retired and taking money out of your accounts, downward fluctuations can be unsettling and hazardous to your payments. If you withdraw money when the market is down, it takes much more return to overcome the effects of the market downturn.
Tax Rate Risk
Not everyone realizes the money they have in their 401(k) or standard IRA will be taxed as soon as they start withdrawing money from that account, which means they don’t have as much money to spend in retirement as they thought they did. Calculating how much you need to set aside for taxes is tricky because the marginal tax rate is not static. To give you an idea of the potential for the marginal tax rate to fluctuate, it has been as high as 90% in the past, while today’s highest marginal tax rate is a mere 37%. It’s impossible to say what the tax rate for your income bracket will be throughout your retirement years, but it’s safe to say you’ll need to consider taxes. That may mean saving in Roth or Health Savings Accounts (if used for healthcare) where there is no tax on the money withdrawn from those accounts. You may also consider either paying the taxes out of your 401(k)/IRA or paying from a separate account.
Declining Cognitive Abilities Risk
No one likes to think about it, but everyone runs the risk of losing at least some of their cognitive abilities as they age. According to Alzheimers.net, 1/3 of senior citizens get some form of dementia. So, while there’s nothing wrong with hoping for the best, you should also plan for the worst just in case you do end up falling into the 1/3 of seniors who get some form of dementia, and have a plan in place to account for it. Due to this risk, consider simplifying your retirement income strategy. Things like pensions and Social Security are simple once claimed: you just receive the check. If you don’t want to “pensionize” your retirement accounts in the form of some sort of life annuity, consider whether your strategy might be put on autopilot. You may find you need to find someone you can trust who is both intellectually and emotionally capable of executing your strategy.
These are just some of the more common risks associated with retiring and no longer replenishing your checking account with income. There are several options for moderating these risks. Some of those include saving more, achieving higher rates of return on your savings, working longer or using strategies that offer inflation protection, such as a fixed annuity with a cost of living adjustment.
Many retirement decisions offer no do-overs. Consider talking to a certified financial planner, chartered retirement planning counselor, retirement income certified professional, or financial professional with specific designations in retirement to make sure there are no gaps in your retirement plan that leave you unnecessarily exposed to retirement risk.