Ah, retirement! The time of your life! Or maybe not.
For many, the homestretch of life may not be the golf and travel bonanza advertised in the media.
Will your retirement destiny be a scene from an absurdist play, or ripped from the pages of “Dream Retirement Weekly”? While you can’t know the outcome in advance, you can at least be forewarned of the risks that can wreak havoc on the best-laid retirement plans.
Play “Wheel of Worry” and find out what retirement risks lie ahead and how you can best prepare for them.
- Market Risk
- Sequence of Returns Risk
- Loss of Spouse
- Health Expenses
- Forced Retirement
- Unplanned Expenses
Like death and taxes, market risk is virtually inescapable. Unlike the former, you can opt out of the stock market, but you do so at your peril. Investors load up on this type of risk when they put their entire portfolio into the stock market. Then when the market plunges, stress levels shoot up.
But owning stocks may be a necessary evil for most retirees, who have to figure out how to fund more than 30 years of life. Â Â
"In practice, avoiding market risk entirely means taking on an extraordinary amount of inflation risk, because you're going to end up in fixed-income vehicles that leave you highly exposed to inflation," says Certified Financial Planner professional Michael Kitces, partner and director of research at the Pinnacle Advisory Group in Columbia, Maryland, and publisher of the Kitces Report and Nerd's Eye View.
How to prepare
So escaping market risk is all but impossible for most people, but it can be mitigated by smart asset allocation, or the way you spread out investing dollars across different types of investments.
"The best way is to diversify into different markets -- all these markets don't move in tandem," says Phillip Christenson, CFA, financial planner and portfolio manager at Phillip James Financial in Plymouth, Minnesota. "They aren't 100 percent correlated. So one market may be up and one may be down."
Diversifying across countries, industries and company sizes are all good ways to get investments that respond differently to varying market forces.
Sequence of returns risk
If a market downturn hits in the first few years of retirement and withdrawals must be taken from a retirement portfolio, it can have lifetime ramifications. The retiree may even run out of money early. On the other hand, a few awesome years at the beginning of retirement can put some serious cushion under savings and increase the probability of dying with money in the bank.
For someone with a $1 million portfolio, "If you have five bad years in the market, you might have $800,000. If you have five great years in the market, you may have $2.5 million," says Certified Financial Planner professional and lawyer David Littell, co-director of the New York Life Center for Retirement Income and a lawyer and professor of taxation at the American College.
Similarly, if the market takes a dive right before or after withdrawals begin, your portfolio may never be able to recover.
How to prepare
Planners mitigate the risk by advocating guaranteed income products or by using asset allocation and spending plans that take into account worst-case scenarios. Consider these strategies to curb risk and ensure a successful retirement plan.
Dial down the risk in your portfolio
"We see more balanced portfolios as a way to manage the sequence risk. So technically on average I will have less money by owning a balanced portfolio, but I'm less exposed to these sequence risk issues because I just don't have as much risk on the table," says Certified Financial Planner professional Michael Kitces, partner and director of research at the Pinnacle Advisory Group in Columbia, Maryland, and publisher of the Kitces Report and Nerd's Eye View.
Spend less when the market dips
"If you are able to tighten your belt a little and spend less in the bad years, it leaves a little bit more money invested so that you can recover. Then you can spend more in the good years," Kitces says.
Spend less no matter what the market does
"That is the origin of what is often called the safe withdrawal rate research. I'm going to pick a number that is just conservative enough that if I get a bad sequence (of returns), I'll be OK, but there will probably not be a lot left over. If I get a good sequence, I'll just have more money than I was expecting," Kitces says.
Substitute bonds with annuities
"We have this new product, a deferred income annuity, that allows you to buy specified income that will begin at some future date before you get to retirement," says American College's Littell.
"At 55, I could buy income that is going to start at 65. I can reduce my risk by starting to lock into some income and have my own kind of personal pension plan by buying a specified income that starts at 65," he says.
Loss of spouse
Statistics show that it's common for one spouse to outlive the other one by many years. Failing to plan for this likely eventuality can compound the woes of the surviving spouse, due to the loss of income.
"First off, you will want to make sure you will have sufficient income. You are getting two Social Security benefits. If you are a married couple, and one person dies, you are going to lose one of those benefits," says Certified Financial Planner professional and lawyer David Littell, co-director of the New York Life Center for Retirement Income and a lawyer and professor of taxation at the American College.
How to prepare
Wise Social Security claiming decisions can help maximize income.
One strategy: "Making sure that we have the person with the larger benefit deferring that as long as possible so that we can minimize that loss after the first death," Littell says.
If the higher-earning spouse waits until age 70 to claim, he or she will get the largest possible benefit. Then the survivor of the couple will be able to keep collecting the higher benefit for life.
That's just the tip of the iceberg, though. There are hundreds of strategies for making the most of Social Security benefits.
Medical and long-term care expenses are the monsters lurking under the bed in old age -- not to mention the attendant suffering that incurred the expenses in the first place.
"Many times people don't plan for it as much because they're already paying it," says Phillip Christenson, CFA, financial planner and portfolio manager at Phillip James Financial in Plymouth, Minnesota. "But it's going to cost a lot more when you're 85 or 90."
How to prepare
The most basic way to guard against long-term care costs or escalating medical expenses is by purchasing insurance.
"Insurance is not an investment; it's a protection vehicle," Christenson says. "You don't buy insurance because you're going to need it. You buy it just in case. You could be paying premiums and the odds of you needing it are low. Or maybe you don't need a Cadillac plan. Just a simple plan would do to help with those costs."
Understanding how much money your portfolio will provide and the extent to which your portfolio would be able to bear additional health care costs will show you how much insurance may be needed to fill the gap.
You may have planned to work until age 70, but life may have had other plans for you. Anything from health issues to economic downturns imperil employment.
Over-planning is the best way to counteract any unforeseen calamities life throws at you.
"If you want to retire at 65 and have to save X amount of dollars for that, you may want to save additional money, just in case," says Phillip Christenson, CFA, financial planner and portfolio manager at Phillip James Financial in Plymouth, Minnesota. "It's easy to say 'save more,' but be sure that your plan is flexible."
If you had projected living on $5,000 per month, run the numbers at a lower level. What will happen if you can only spend $4,000 per month?
"Run those other plans, the what-if scenarios," Christenson says.
How to prepare
Workers nearing retirement may be banking on income earned in their final years of work to pad retirement portfolios. Investing in yourself to ensure that you're up to speed with current technology and workplace trends could be invaluable. Keeping up job skills and making sure your resume is up to date and competitive are two ways to protect yourself.
"Working a couple of years longer is such an important part of improving a retirement plan," says Certified Financial Planner professional and lawyer David Littell, co-director of the New York Life Center for Retirement Income and a lawyer and professor of taxation at the American College.
"It leads you to the conclusion that people should also be spending a lot of time at older age just paying attention to staying employable," he says.
It's one thing to prepare for your own financial emergencies. But too often, people who are close to retirement or in retirement end up bailing adult children out of their financial mistakes. More than 6 in 10 people over age 50 had given financial support to a family member during the past five years, according to a recent survey by Age Wave and Merrill Lynch.
How to prepare
For able-bodied adult children, the best thing may be to exhibit a little tough love, particularly when your retirement is on the line.
"I see it all the time. I try to get retirees to focus on controlling the amount they are going to pay, says Certified Financial Planner professional Leon LaBrecque, CPA, CFA, managing partner at LJPR LLC in Troy, Michigan.
The more difficult situation is caring for elderly parents. "These are the people who raised you and most people feel the obligation to take care of them," LaBrecque says.
LaBrecque recommends figuring out the monthly amount required to help parents.
"Then see if we can get other siblings to help cover it," he says.