6 Retirement Income Risks We Shouldn’t Ignore
Achieving financial security isn’t an easy task. The dynamics of retirement income planning have evolved. It used to be that retired households could rely upon Social Security and personal pensions for the income they needed.
But that has changed. Now Americans shoulder more individual responsibility for their future income security. Also, life expectancies are on the rise. The challenge becomes ensuring our money will last for a retirement lifetime.
As you create your own retirement income plan – or consider potential changes to your current plan – here are six risks to retirement income to consider. Keep these potential pitfalls in mind as you formulate your own strategy.
Potential Risks to Retirement Income Security
So, what are the risks that can put retirement income at jeopardy?
1. Uncertain longevity. Life expectancies are increasing. According to the Social Security Administration, a 65-year-old man today can expect, on average, to live until age 84.3. For a 65-year-old woman, the average life expectancy is until age 86.6. Contrast that with 1929, when the U.S. life expectancy was living to be 57.1 years old.
And as the SSA data crunchers point out, those are just averages. Roughly one out of four 65-year-olds today will live beyond age 90, while one in 10 will live to be older than 95. As healthcare and technology advance, lifespans may lengthen even more.
This raises a core uncertainty for people in retirement: How long will their financial plan need to manage and provide income for? Sure, enjoying a long life is great, but it might entail years-more of income needs. That puts more strain on retiree financial resources.
To guard against this uncertainty, an income plan should provide for as much as 30 or more years of retirement life. Retirees should also include strategies that counter risks magnified by a long lifespan.
2. Retirement plan isn’t tax-efficient. Several retirement plans don’t include the most effective tax mitigation and income strategies. For instance, many Americans save money in 401(k)s, IRAs, and other tax-deferred accounts during their working years. While that keeps taxes low then, it’s on the backend that retirement money can take a huge hit. Account withdrawals are taxed as ordinary income. And if someone intends to cover a majority of their lifestyle needs with money from tax-deferred accounts, income taxes can take a big bite into those funds.
Retirement is when new income sources will come into the mix — like Social Security benefits, which also have their own tax requirements. So, it’s worthwhile to evaluate the tax implications of your current plan, then to explore ways it can generate tax-free income.
If your plan already includes tax-free money strategies, but you still worry about your tax-deferred accounts, you may consider enhancing those strategies. The Congressional Budget Office projects that by 2046, spending on Social Security, Medicare, and other major healthcare programs, for individuals aged 65 and over, will account for half of federal non-interest spending.
3. Holding too much investment risk. Everything changes when people transition from their working years to retirement years. It’s when you reach the preservation and distribution phases of life. Now it’s time to focus on keeping the money people have and, in retirement, using it for income.
Every investment carries different kinds of risk — to name a few, market risk, inflation risk, even behavorial risk. After all, investment losses can influence personal emotions and push investors toward inferior decisions about their investments. So, ask yourself: Do you fret over the next market correction? Are you anxious about investment losses and how it might affect your retirement life and goals? If so, it’s prudent to reassess your risk tolerance and its place in your current retirement plan.
On the other hand, low interest rates may prompt retirees toward more aggressive portfolio allocations. For example, the 10-year treasury has been floating around 2%, and at times slightly above there, for some years now. Facing more pressure to generate income, retired investors may take on more investment risk or withdraw more money from their retirement accounts.
But withdrawals can bring more sequence of returns risk. Likewise, more aggressive investing means greater risk of portfolio values dropping when markets fall. This may also be a time to revisit your plan and see if your strategies make sense for your age, goals, and situation.
4. Setbacks from unplanned expenses and emergencies. Spending patterns change over time, and retirement is no exception. In fact, retirees might encounter many unexpected expenses, often tied to personal care and healthcare needs. It’s important to prepare for these situations as much as we can. Otherwise financial emergencies might wipe outsavings, and even eat into the money you will use for retirement lifestyle spending.
Nothing is foolproof, but planning ahead can help you build reserves for emergency expenses and have other funds for your retirement goals. A good starting point is anticipating what your retirement expenses will be. Samantha Stein of the Association for Long Term Care Planning shares five major areas of retirement expenses to look out for. This article takes note of many things, from annual household expenditures to the “one-time” expenses you will definitely want to include in your income plan.
According to surveys, many Americans aren’t prepared for emergency expenses. In a survey by BankRate, 59% of polled Americans couldn’t pay for emergency expenses from savings. This underscores the importance of mapping out retirement expenses, including less frequent costs (like a roof replacement, car repairs, appliance maintenance costs, and so on) in your plan, and allocating financial resources to cover them.
5. Rate of lifestyle spending. After years of hard work, most people look forward to enjoying life on their terms. Retirement offers time for you to pursue the activities and causes that matter to you. Your income plan should let you enjoy the life you want and equip you to maintain your lifestyle preferences over the long run.
With that said, the cost of living doesn’t stay the same. Inflation has real effects on your money’s purchasing power, even over just a few years. It’s even been called the “silent retirement killer” because of how its impact adds up over time. So, an income plan should specify how you will keep up with the compounding effects of inflation throughout retirement.
Yet many households haven’t mapped out how they will deal with inflation. In a recent survey by Allianz Life, 64% of polled households didn’t have a plan for inflation.
6. Changes in capacity to manage finances. Yes, longevity does bring up the challenge of making sure that our money lasts for an entire retirement lifetime. But it also gives rise to another risk: declining cognitive abilities with aging. As they move into advanced ages, many people will find it increasingly hard to make effective decisions about retirement, investing, and income management. An income plan should account for this possibility.
Many households vary in their financial mangement practices. It’s not unusual for one partner to handle household money matters. However, should the spouse managing the finances pass away, it could lead to serious issues for their partner if they don’t have a plan ready. An income plan should be prepared to help the surviving spouse through a smooth financial transition and to equip them to live comfortably.
Creating Income Strategies for Your Future
While these risks can be income pitfalls, they can be managed with proper planning. The next step is working with a financial professional to create risk management strategies for your income needs and goals. Here at SafeMoney.com, financial professionals stand ready to help you build a plan you can be confident in.