Risks To Securing Incomes That Last A Lifetime

 

“You only retire once .. that is if you do it right.” Anonymous

Aging America

Time is running out for many Americans to take the necessary steps to secure their financial futures. Thirty-five million Americans, one in eight, are over age 65 right now and by 2040, more than 77 million Americans will be over 65—over 20 percent of the whole population. In fact, boomers are turning age 50 at the rate of more than 12,000 a day, or one person every eight seconds.

But, as the population changes, the core principles for building lifetime wealth through financial assets remain constant. Begin investing as early in life as possible; keep investing regularly; and build a well-diversified portfolio strongly weighted towards equities. Moreover, avoid the twin risks of excessive caution early in life and excessive risk-taking close to and in retirement.

Income Risks

But at the point where individuals transition from building assets to drawing down their life savings, their situation becomes more complex—and the stakes of making correct choices rise.
The five key risks that everyone should address as they plan for retirement include: longevity risk, or the likelihood of living well beyond their theoretical life expectancy; withdrawal risk, or the potential of drawing down their savings too rapidly; inflation risk; asset allocation risk, specifically being too conservative or too aggressive; and the risk of not having set aside enough money to cover future health care expenses.

Longevity Risk

Longevity risk is probably the least-understood variable in retirement income planning.

As medical research and technology continue to push the life span envelope, more and more healthy individuals just entering retirement will have to make plans for the very real possibility of needing 30 to 40 years of post-retirement income.

For instance, an American man who has reached age 65 in good health, has a 50 percent chance of making it to age 85, and one chance in four of living to 92. And, the odds that at least one member of a 65-year-old couple will live to 92 are 50 percent.

Inflation Risk

Inflation, the long-term tendency of money to lose purchasing power, impacts retirement income planning in two ways: by increasing the future costs of goods and services and by potentially eroding the value of assets set aside to meet those costs.

Even a relatively low inflation rate of 2 percent can have a significant impact on a retiree’s purchasing power. For instance, $50,000 of income today would only be worth $30,477 in 25 years.

What’s more, general inflation may not capture the impact of rising medical expenses on retirees. Studies show that the majority of lifetime medical costs are incurred in the last few years of life, posing additional high costs in the very last stage of retirement.

The high likelihood of continued inflation makes investments (equities) that have the potential to beat inflation imperative.

Asset Allocation Risk

There is a real danger that many anxious retirees may overreact to a down cycle by selling most or all of their equity holdings and aiming to meet lifetime income needs solely with cash and fixed-income instruments. Adopting such an ultraconservative strategy can actually be quite dangerous to their financial health.

It can, in fact, seriously raise the risk that they will outlive their assets, because it eliminates the long-term upside potential and inflation hedge that diversified stock investments offer.

Being too conservative may not allow a portfolio to grow enough to last for a lifetime. Under average market conditions and a 5 percent withdrawal rate, a conservative portfolio might only last 28 years, versus a projected 35 years for an aggressive portfolio.

Withdrawal Risk

Changing the annual rate of planned withdrawals can, of course, dramatically raise or lower that portfolio’s prospects of lasting for a longer period of time. This is a variable largely in the control of a retiree. So withdrawal rates can be adjusted to take account of a person’s age, health, their desire to leave a legacy, and other variables.

The risk of being put on a path to depletion rises steeply at withdrawal rates over 4 percent. This risk can be magnified even further if a sustained market correction—similar to the 2000-2002 correction—occurs early in retirement. Consequently, retirees should consider using conservative withdrawal rate assumptions in the early years of their retirement.

Those who have planned wisely and preserved their investments may have the ability to sustain reasonably higher withdrawal rates later in retirement, with less risk of depleting assets in their lifetimes.

Health Care Risk

Longer life spans, retiree medial costs rising faster than general inflation, declining retiree medical coverage by private employers, and possible shortfalls ahead for Medicare and Medicaid all add up to make health care costs a critical challenge for retirees and pre-retirees alike.

A recent study estimates that a couple retiring today at age 65 will need current savings of a
least $200,000 to supplement Medicare and cover their out-of-pocket health care costs in retirement, unless they have an employer-funded retirement health plan.

So substantial is the risk posed by health care expenses, health insurance itself has become one of the core elements of current retirement security along with pensions, personal savings, and Social Security.

Funding such insurance, then, should be considered an essential expense in the lifetime income planning process.

Conclusion

One way to define financial success in retirement is the ability to successfully manage available resources to navigate around the risks we’ve discussed. I’ll discuss strategies to do so in future newsletters.

Invitation

If you’re not a client yet, and you’d like to explore the option of developing a professionally managed investment portfolio comprised of no-load mutual funds, please give me a call.

I’d be happy to sit down with you and explain how as a fee-only investment advisor I can assist you in meeting your financial goals.

Marshall Sitarik - CFP
Ph. 407-977-3800