Guided Retirement Income Planning- Chapter 10

The objective of retirement income planning is to make sure that retirement income is sustained throughout your life. In the planning process, there are a variety of risks that could crush your plan (see below). You should identify the risks you are susceptible to, based upon your unique circumstances. By doing so, you will have the ability to plan ahead and apply suitable tested strategies with ample time instead of waiting until years later when it might be too late to make meaningful changes.

1.     Longevity risk – Retirees are most concerned about outliving their money. People are living longer. Retirement can last for 30 years or more, often longer than time spent working. They do not want to outlive their assets late in life and be a financial burden to their family.

2.     Health and long-term care risk – As people live longer, they often become unhealthier later in life. They need medical care and attention, which costs money. Lots of money!  Currently, health and long-term care expenses exceed general inflation rates. Medicare or supplemental coverage does not cover all healthcare expenses. Being financially unprepared for chronic and acute illnesses can create severe cash flow concerns and irreversibly deplete needed assets for income in retirement.

3.     Inflation risk – Generally, inflation is a by product of monetary and fiscal policy. It reflects the increasing cost of living due to rising prices. Smaller inflationary increases will have a lower impact on a retirement plan while larger increases could have a devastating effect over the long-term. Some people may be inclined to be more conservative when investing in retirement. However, the effects of inflation can be a significant risk for a portfolio that is too conservative. Inflation is difficult to predict and out of any one person’s control. The best one can do is to be prepared and have a plan for it.

4.     Sequence of returns risk – This is the order that the market produces varying levels of positive and negative returns that have a dynamic effect on the success of a retirement income plan. Negative sequence of returns early in retirement can increase the probability of portfolio failure later in retirement. The problem is amplified when income withdrawals are taken early in retirement as the market is going down. It can be challenging to recover from such a steep decline.

5.     Dollar cost ravaging – This risk is closely related to sequence of return risk and is the opposite of a productive accumulation strategy referred to as dollar cost averaging. Both strategies have implications in volatile markets. Dollar cost averaging is a positive systematic approach, accumulating more investment shares, to build wealth over time. Whereas dollar cost ravaging is the negative outcome of distributing investment shares. In doing so, when the market is down, more shares are needed to meet income requirements. Over time it becomes detrimental to portfolio longevity with fewer investment shares working to recover in positive markets

6.     Market risk – This is intuitive for most people. They understand that investment assets are impacted by market volatility. Financial loss in the investment portfolio can fall into two categories in retirement:

·       Shallow risk – A temporary loss of assets that can be overcome in a relatively short period of time.

·       Deep risk – An acute or permanent loss of financial assets, a larger and long-term effect on a retirement income plan.

The unpredictability of stock market swings is part of the investor experience and it is necessary to plan for it.

7.     Excess withdrawal risk – Overspending can increase the risk of outliving assets. People don’t always differentiate between needs and desires. With overindulgence and unrealistic market expectations, a retirement income plan can fail. Of course, there are situations where spending will need to be revised due to extenuating lifestyle changes. Under these circumstances, it is important to modify the retirement income plan.

8.     Liquidity risk – This is a risk when real estate or other hard assets cannot be converted to cash to meet current needs. There are legitimate reasons to invest in illiquid assets but with prudence. Maintaining adequate emergency fund reserves can be helpful to offset this risk.

9.     Loss of spouse risk – The plan should be established for both spouses and prepared for one to predecease the other at a different point in time. Often, this risk is not given proper consideration. The loss of a spouse is such an emotional and personal experience and can be accompanied by a significant decline in social security and pension income. Additionally, federal income taxes can increase, as a widowed person must change their tax status from filing as married to individual.

10.  Public policy risk – A change in national, state, or local government tax law or entitlement programs such as Medicare and Social Security may have an impact on a retirement plan.

11.  Risk associated with work – Sometimes people are forced out of work earlier than planned, for any number of reasons, while other people may want or need to work part time in retirement but are unable to find suitable work. Further, there are some people who are unable to work due to personal health reasons or the responsibility of having to take care of loved ones.

12.  Interest rate risk – This is the risk that bondholders have from fluctuating interest rates. Some bond investments are more sensitive to interest rate risk than others.

13.  Spending shock risk –A one-time or series of unexpected ongoing expenses can include anything from a funeral, large home repairs, car expenses, weddings, or giving money to a loved one. Having an adequate emergency fund can act as a buffer to minimize the risk of one-time expenses. If an unanticipated expense arises that requires continuous spending, such as ongoing financial support to a loved one, the emergency reserve may not be enough to absorb the needed increase in spending. Under these circumstances, the asset allocation may need to be adjusted to balance greater current income needs and portfolio longevity.

14.  Risk associated with aging – These include cognitive impairment, elder abuse and frailty. Almost all retirees in their go-go years fail to account for any contingency plans that might occur during the no-go years. It is easy to understand why but important to consider the unintended consequences of aging. Although it is impossible to predict what will happen in the future, there are some protective safeguards available, such as making sure all estate planning is current and updated. Written instructions can also clarify certain issues regarding healthcare or financial matters. Additionally, it may make sense to purchase risk management, otherwise known as insurance.

15.   Cyber security Risk – The internet and consumption are at the center of our lives. With its focus on personal and sensitive data, cyber security is a threat to everyone. Younger and older people are vulnerable with computer and mobile device usage while hackers grow in sophistication. It is important for you to be well researched and to seek professional guidance over security. Following are a few tips to consider:

·       Make sure your passwords are well chosen, sophisticated, and stored safely

·       Change your passwords as needed

·       Setup multi-factor authentication where offered to protect sensitive data

·       Make sure your internet provider or a third-party firm sets up a firewall

·       Use antivirus software and keep it current

·       Browse the web safely

·       Do not open unusual links or anything that looks suspicious

Isolating potential pitfalls and risks in your retirement plan will allow you to monitor them and to determine corrective action before they unfold. If long-term care will be unaffordable in the future, some of the risk can be transferred to an insurance company. If outliving your assets may be a concern, annuities and other portfolio strategies may help overcome longevity risk. In the event the market and inflation are uncooperative, a well-balanced, personalized portfolio can help manage these risks. Working with a qualified financial advisor will help you keep your risks in check and prevent you from making poor financial and emotional decisions.

It is important to stay ahead of your unique risks. Doing so will have an enormous, positive, long-term impact on your plan’s success!