Retiring successfully is a common goal, and although the definition of retiring successfully varies from person to person, having financial well being does seem to be a common term and ultimate target. Since financial well being can be subjective, we are going to use running out of money as an indication that a person's financial well being is not well.
With this in mind, we have built a financial planning software tool that helps investors identify six areas of risk a retiree might have. The program provides a baseline using these six areas of risk, and gives the investor a “probability of success” based on running out of money. (For more, see: Common Risks That Can Ruin Your Retirement.)
Let’s go through each of the six areas of risk and summarize how an investor might manage them. The areas of risk are a market crash, tax hike, Social Security decrease, longevity, inflation and healthcare costs increase.
When evaluating each of the risks, RightCapital's program takes into account time and many other factors. Because of this, if someone is 20 or 30 years to the end of the plan (i.e. age of death is 90 on most plans), a market correction is not as high a risk as many investors might think. First Trust Advisors L.P., Morningstar returns from 1926 - 6/30/17 has a chart that shows bull markets since 1926 have lasted 2.5 to 15.1 years, while bear markets have lasted three months to 2.8 years. If an investor has 20 years plus left on the plan, this risk is mitigated to some degree because the market has rebounded - if the investor has the time and the ability to stay invested in the market.
If an investor has 90% to 100% of their investments in tax-deferred accounts (i.e. IRA, 401(k), 403 (b), etc.), increasing taxes present more risk than for investors who have funds diversified across different types of taxed accounts. Sometimes this cannot be avoided. If you are still a decade or more away from retiring, strive to be diversified across tax tree (Roth IRAs, HSAs), taxable (brokerage, CDs, checking) and tax-deferred (401(k), IRA) accounts.
Social Security Decrease
Decreasing Social Security might be a risk, but it is a small risk in my opinion. The risk with a recipient's Social Security is probably more on the amount of yearly increase one receives. As an example, if a person gets a 1% annual raise, yet inflation is growing at a 3% rate, the recipient is losing 2% a year in buying power. Inflation is a risk all by itself though, and adding it to minimum raises in a person's Social Security check can be an impactful risk to a person's retirement plan.
According to the CDC, life expectancy in 2015 for both sexes is 78.8 years old. If a person lives to age 65, his/her life expectancy is 84.4 years. If he/she lives to be 75, the person's life expectancy in 2015 is 87.3 years. You can see the longer you live, the more likely you are to live into your late 80s. When building and evaluating your retirement plan, longevity becomes more and more a risk, the older you get. I think we can all understand how that works. (For more, see: What Will Healthcare Cost After Retirement?)
Of these six risks, in my opinion, this is the biggest risk a retiree faces. It is the catalyst to causing taxes to be increased, Social Security checks to lose their buying power and healthcare costs to increase - and this does not even include housing, food and transportation costs going up. The long-term inflation rate has averaged 3.18% according to Inflationdata.com. Although that might not sound like a lot, based on this long-term inflation number, if an investor has $200,000 in a CD getting 1.18%, he/she is losing $4,000 a year in buying power. Think about the impact this would have on someone's retirement plan over a decade or two.
I regularly work with clients who are excited to get to 65 and be able to get on Medicare, thinking it is going to be less expensive than their current plan. Though in some cases it may be better coverage for less money, the overall costs are not always less expensive when you add the costs of paying for Part B, buying a supplement plan and adding a prescription drug plan. And, as many of you know, this is not likely to be one of those monthly expenses that goes down.
A good retirement strategy should help you be aware of and manage all six of these risks and this is not always going to be easy or as straightforward as we would like it to be. As an example, if you try to lower the risk of the market crashing, you may increase your inflation risk. I have found the best way to manage the six risks is to use an online tool like RightCapital that will take the combination of the market, Social Security, inflation and more, then provide a retiree or someone planning on retiring with reports that will identify what retirement strategies he/she might consider prioritizing. I also recommend finding an advisor you like - one you can collaborate with on all or even a few of them. Having an advisor with a fiduciary responsibility can be a valuable asset in managing these six risks. (For more from this author, see: Hiring An Advisor? Ask These 8 Questions First.)
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