All the most careful plans and preparation for retirement can fall apart due to an unexpected death, illness, a stock market crash or a pension plan that goes bankrupt. In addition, it is not unusual for people to live more than 30 years in retirement, due to increased rates of early retirement and rising life expectancy, which in itself presents a major risk that retirees will outlive their assets. The longer the time spent in retirement, the harder it becomes to be certain about a retiree's financial outcome. In planning for retirement, or living it, you must understand the risks that lie ahead and how they could impact your financial security.
Types of Post-Retirement Risks
The Society of Actuaries (SOA) in the United States identified 15 post-retirement risks that can affect retirees and their financial security. Those preparing for retirement or already in retirement should consider these risks when making plans for the future:
- Personal and family risks - Changes in your life or the life of a loved one that could impact your retirement income stream
- Healthcare and housing risks - These include the risk that failing health will require moving to a facility with professional caregivers
- Financial risks - These risks revolve around inflation, investments and stock market activities
- Public policy risks - These risks involve government decisions that could affect retirees
Personal and Family Risks
Many retirees plan to supplement their income by working either part-time or full-time during retirement. In fact, some organizations prefer to hire older workers because of their stability and life experience, but success in the job market may also depend on technical skills that retirees cannot easily gain or maintain. Employment prospects among retirees will vary greatly because of demands for different skills and may change with health, family or economic conditions.
Choosing the point at which you want to retire is integral to retirement planning. Later retirement is an alternative to increased saving, but there is no certainty that appropriate employment will be available. Working part-time is an alternative to full-time employment, and part-time jobs may be easier to obtain. (Read more about working past retirement age in Stretch Your Savings By Working Into Your 70s.)
Running out of money before you die is one of the primary concerns of most retirees. This is an even larger concern today as life expectancies have risen. The life expectancy at retirement is just an average age, with about half of retirees living longer and a few living past age 100. Thus, planning to live to a specified age is risky, and planning to live only to your life expectancy will be inadequate for about half of retirees. The longer you live, the more exposure you will have to other risks that are listed below.
Those who are managing their own retirement funds over a lifetime have to perform a difficult balancing act. Being cautious and spending too little might needlessly restrict your lifestyle, and spending too much increases the danger of running out of money.
A pension or annuity can mitigate some of the risk because it provides an income stream for life. However, there are some disadvantages, including loss of control of assets, loss of ability to leave money to heirs and cost. Although people may not want to annuitize all their assets, annuities should be considered as an important part of retirement planning. (For more information on how annuities can provide steady income in retirement, read Inflation-Protected Annuities: Part Of A Solid Financial Plan and Personal Pensions: Repackaging The Annuity.)
Death of a Spouse
The grief over a spouse's death or terminal illness contributes to high rates of depression and suicide among the elderly. A spouse's death can lead to a reduction in pension benefits or bring additional financial burden. Also, the surviving spouse may not be able or willing to manage the finances if they were usually handled by the deceased spouse.
Financial vehicles are available to protect the income and needs of survivors after the death of a partner or spouse, such as life insurance, survivors' pensions and long-term care insurance. Estate planning is also an important aspect of providing for survivors. (For information about estate planning, see Top 7 Estate Planning Mistakes.)
Change in Marital Status
Divorce or the separation of a cohabiting couple can create major financial problems for both parties. It can affect benefit entitlement under public and private retirement plans as well as individuals' disposable income. (Read Getting A Divorce? Understand The Rules Of Dividing Plan Assets for more information.)
Splitting the marital assets will almost certainly lead to an overall loss in standard of living, especially if it was necessary to pool income and resources to maintain the standard of living to which both parties had become accustomed. Some experts believe that an individual may need about 60-75% of a cohabiting couple's income to maintain his or her standard of living. This is because some expenses, like rent and utilities remain the same, regardless of the number of people living in a household.
Although divorce rates among older couples are far lower than for younger couples, it is not uncommon for a retirement-age couple to get a divorce. Prenuptial agreements may be used to define each party's right to property prior to marriage. (Read more about prenuptial agreements in Marriage, Divorce And The Dotted Line. Or maybe a postnuptial agreement is for you - read Create A Pain-Free Postnuptial Agreement to find out.)
Unforeseen Needs of Family Members
Many retirees find themselves helping other family members, including parents, children, grandchildren and siblings. A change in the health, employment or marital status of any of the family members could require greater personal or financial support from the retiree for that individual. Examples of financial assistance include paying healthcare costs for an elderly parent, paying higher-education fees for children, or providing short-term financial assistance to adult children in the event of unemployment, divorce or other financial adversities. (Feel caught between your own parents and children? Healthy Survival Guide For Sandwiched Boomers can help you take control.)
Retirement planning should recognize the possibility of providing financial support for family members in the future, even if this does not seem likely at or before retirement.
Healthcare and Housing Risks
Unexpected Healthcare Needs and Costs
Unexpected healthcare needs and costs are a major concern for many retirees. Prescription drugs are a major issue, especially for the chronically ill. Older people usually have greater healthcare needs and may need frequent treatment for a number of different health-related issues. Medicare is the primary source of coverage for healthcare services for many retirees. Private medical insurance is also available, but it can be costly. (Read Getting Through The Medicare Part D Maze and 20 Ways To Save On Medical Bills for tips on managing prescriptions and other healthcare costs.)
The Society of Actuaries (SOA) says that healthcare costs can be mitigated to some extent by committing to a healthy lifestyle that includes eating right, exercising on a regular basis and using preventive care. In addition, long-term care insurance can pay for the cost of caring for disabled seniors.
Change in Housing Needs
Retirees may need to change from living on their own to other forms of housing, such as assisted living, which combines care with housing, and independent living, which combines some assistance with housing. Housing that includes care can be quite costly, and the most appropriate form of housing for an individual in a given situation may not be available in the chosen geographic area or may have a long wait for entrance.
The likelihood of requiring day-to-day assistance or care rises substantially with age, but changes in individual cases are often hard to predict, because they vary with one's physical and mental capabilities, which themselves change with age. Changes can occur suddenly, due to an illness or accident, or gradually, perhaps as a result of a chronic disease. (Read more about your options in Long-Term Care: More Than Just A Nursing Home.)
Lack of Available Facilities or Caregivers
Facilities or caregivers are sometimes not available for acute or long-term care, even for individuals who can pay for it. Couples may be unable to live together when one of them needs a higher level of care. For people who have lived together for decades, this can result not only in increased costs, but in emotional stress as well.
In general, little advice is available from the state or the financial-services industry on planning for long-term care costs. This may lead consumers to make uninformed decisions or to defer them and hope for the best.
Inflation should be an ongoing concern for anyone living on a fixed income. Even low rates of inflation can seriously erode the well-being of retirees who live for many years. A period of unexpectedly high inflation can be devastating for those living on a fixed income.
According to the SOA, retirees and would-be retirees should consider investing in equities, a home and other assets, such as Treasury inflation-protected securities (TIPS) and annuity products with a cost-of-living adjustment feature. These types of products help offset inflation. In addition, would-be retirees can choose to continue working - even if it is only on a part-time basis. (Learn how inflation-protected securities can help in Curbing The Effects Of Inflation.)
Interest Rate Risk
Lower interest rates reduce retirement income by lowering growth rates for the retirement savings accounts and assets. As a result, individuals may need to save more in order to accumulate adequate retirement funds. Annuities yield less income when long-term interest rates at the time of purchase are low. Low real interest rates will also cause purchasing power erode more quickly.
Lower interest rates can reduce retirement income, and can be particularly risky when people are depending on drawdown from savings to finance their retirement. On the other hand, a problem also exists if interest rates rise as the market value of bonds drops. Increases in interest rates can also negatively impact the stock market and the housing market, thereby affecting the retiree's disposable income. As such, high real interest rates, over and above rates of inflation, make retirement more affordable. (See Why do interest rates tend to have an inverse relationship with bond prices?for related reading.)
Stock Market Risk
Stock market losses can seriously reduce retirement savings. Common stocks have substantially outperformed other investments over time, and thus are usually recommended for retirees as part of a balanced asset allocation strategy. However, the rate of return that you earn from your stock portfolio can be significantly lower than the long-term trends. Stock market losses can seriously reduce one's retirement savings if the market value of your portfolio falls.
The sequence of good and poor stock market returns can also impact your retirement savings amount, regardless of long-term rates of return. For instance, a retiree who experiences poor market returns in the first couple of years in retirement will have a different outcome than a retiree who experiences good market returns in the first couple of years of retirement, even though the long-term rates of return might be similar. Early losses can mean less income during retirement. Later losses can have a less-negative impact, as the individual may have a much shorter period over which the assets need to last.
Loss of pension funds can occur if the employer that sponsors the pension plan goes bankrupt or the insurer that is providing annuities becomes insolvent.
Defined-contribution plan accounts are not guaranteed, and plan participants bear losses directly. However, unlike pension plans, the balances in these accounts usually do not depend on the financial security of the employer, except for the employer's ability to make future contributions and in cases where plan balances include employer stocks. Depending on an individual's allocation, the risk of such losses is based on the market performance of the investments or on possible failure of the employer's business if the account is concentrated in employer stock. Ultimately, most investments will always be subject to business risk.
Public Policy Risk
Government policies affect many aspects of our lives, including the financial position of retirees. These policies often change over time along with government policy. Policy risks include possible increases in taxes or reductions in entitlement benefits from Medicare or Social Security.
Retirement planning should not be based on the assumption that government policy will remain unchanged forever. It is also important to know your rights and to be aware of your entitlements to state and local authority benefits.
Even the best-laid retirement plans can fail as a result of unexpected events. Although some risks can be minimized through careful planning, many potential risks are completely out of our control. However, understanding what the potential post-retirement risks are and considering them in the retirement planning stage can help to ensure they are mitigated and properly managed.