Today’s retirees are faced with unprecedented risks. Pensions, the foundation of the previous generation’s retirement plans, have all but disappeared for the majority of Americans. The 2008 market crash decimated many people’s portfolios, right as they were approaching the critical period leading up to retirement. Market volatility is a constant concern, as well as rising inflation. On top of everything, many retirees are unsure of who they can trust for advice, yet fearful of making investment mistakes on their own.
These risks have turned retirement into the ultimate obstacle course and it’s up to you to help your clients navigate it successfully. Recently, I created a report for advisers that details 18 key risks that clients need to address. However, here I will highlight what I consider five critical risks faced by retirees, which require particular attention.
Also see: “10 ways to make the years before retirement count.”
1) Longevity risk
Longevity risk is a risk multiplier. Here, retirees face the risk of outliving their money. It is one of the critical risks in retirement because the longer a person lives, the greater chance they will be impacted by other risks in retirement such as healthcare costs, inflation, market changes and more. Today, if you take a 65-year-old couple, there is a 50% chance that one spouse will live to age 93, and a 25% chance that one will live to 98. In fact, according to the U.S. Census Bureau, the number of people living to age 90 tripled from 1980 to 2010.
Retirees need a guaranteed lifetime income floor more than ever in order to reduce or eliminate longevity risk, a base they cannot destroy or outlive and with proper provision principle you cannot lose. Social Security is one source that can provide guaranteed lifetime income. Advisers should consider strategies that allow clients to maximize their monthly Social Security benefits. Pensions can be a secondary source of guaranteed lifetime income, but as mentioned before, are no longer available to most retirees. For these retirees, income annuities can allow them to create their own pension-like stream of guaranteed income for life.
2) Inflation risk
Inflation is the silent thief in retirement. An item that cost $100 in 1996 would now cost $153, which is a 53% cumulative rate of inflation. Another way to look at this is that $100 in purchasing power in 1996 is equal to $65 in purchasing power today. When applying the impact of inflation to a person’s entire retirement portfolio it can become extremely problematic. This is especially true as many retirees live on a fixed income and are not receiving the pay increases they received during their working years that helped offset inflation.
Every secure retirement plan needs to address the risk of inflation. This can be done by having a portion of the retirement portfolio in inflation-sensitive investments. There are also inflation riders available that can be used with income annuities so that the income payments increase over time. Additionally, Social Security receives an annual cost of living adjustment. This can offer a natural hedge against inflation. By maximizing a retiree’s Social Security benefit, they can maximize the real dollar impact that COLAs provide.
3) Healthcare risk
Healthcare and medical costs have become major concerns as well. While Medicare offers some coverage, retirees are often left paying huge sums of money for medical treatment. A 2012 New York Times article reported that, “for a 65-year-old couple retiring [in 2012], the cost of healthcare in retirement will be $240,000, 6% more than that same couple retiring in 2011 would pay.” These costs are continuing to rise. The expenses for ongoing care, including long-term care or nursing home costs, can quickly decimate a lifetime of savings for retirees who may require them. Clients need to be aware that Medicare does not cover many of these expenses and have a plan to deal with healthcare risk during retirement.
4) Sequence of returns
While most people saving for retirement are concerned with average returns, in retirement it’s sequence of returns, also called order of returns, which deserve the focus. Celebrated financial author and professor Moshe Milevsky put forth an example comparing two retirement portfolios each starting at $1 million. They were both subject to a $3,800 monthly withdrawal with a 3% rate of annual inflation. Both portfolios averaged an 8% rate of return.
The only difference with each portfolio was the sequence of returns: the first had a 17%, 27% and -20% rate of return that repeated every three years. The second portfolio had a 17%, -20% and 27% rate of return that repeated every three years. The first portfolio took 30 years to deplete while the second portfolio took only 25 years. In retirement, the sequence of returns becomes incredibly important.
5) Market risk
With the financial crash of 2008 still fresh in people’s minds, market risk is a major concern for many retirees. It is especially important not to lose money in the five years leading up to retirement and the first five years in retirement when these losses can have the biggest impact. Advisers need to help their clients create a plan to reduce market risk in retirement. Guaranteed, stable sources of lifetime income can reduce the risk of a retiree being forced to withdraw from their investments during a down market period.
Also see: “The politics of rising ACA premiums.”
While all these risks can be worrisome, proper financial planning can help reduce, manage or even eliminate them. This is an incredible service that financial professionals can provide to their clients. However, when you sit down with your prospects or clients, always remember they do not want to be sold a product. They want you to ask questions, listen and learn about their retirement goals and desires. They want to have a discussion about their financial fears and learn what they can do to create a successful plan. By educating your clients on these risks, you will find that the conversation naturally turns to the tools you have that can help guard against these five critical retirement risks.
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