When planning for retirement, it's important to expect the unexpected. Any number of post-retirement risks—such as the earlier-than-anticipated death of a spouse, a lengthy illness, stock market volatility, a bankrupt pension plan, even unplanned-for longevity—can upend the most carefully-laid retirement plans. As people live longer and in some cases are given incentives or forced to retire earlier, the risk of outliving your savings grows. And the more the retirement period grows, the harder it may be to be certain about the adequacy of your assets. Here are some of the risks ahead and their potential impact on your financial security.
- Personal and family risks include employment issues, longevity, a change in marital status, and the needs of other family members.
- Healthcare and housing risks include unforeseen medical bills, the need to change living situations, and the cost or lack of available caregivers and care facilities.
- Financial risks include rising inflation, fluctuating interest rates, stock market volatility, and poorly performing retirement plans.
- Public policy risks include the possibility of higher taxes and reduced benefits from Medicare and Social Security.
Types of Post-Retirement Risks
The Society of Actuaries (SOA) in the United States has identified a number of post-retirement risks that can affect income. People preparing for (or already in) retirement should consider these risks carefully. They generally fall into these categories:
- Personal and family: Unexpected personal events (including longevity) or changes to your family (such as early death of a spouse or family members who need financial support)
- Healthcare and housing: The rising costs of healthcare including premiums, the need for long-term or nursing care, and other medical-related costs
- Financial: Inflation, variable investment returns, and a volatile stock market
- Public policy: Changes to programs like Medicare and Social Security
“There are many unexpected demands for a retiree’s funds," says Peter J. Creedon, CFP®, ChFC, CLU, chief executive officer at Crystal Brook Advisors in New York, N.Y. "For that exact reason, everyone needs a realistic emergency fund." These demands have the potential to be especially harmful if they occur early in retirement, he says, since it not only decreases the amount of money available but also that money's potential to earn a return, he adds.
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 may prefer to hire older workers because of their stability and life experience. However, 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. Retiring later is an alternative to increasing saving, but there is no certainty that appropriate employment will remain available. Working part-time is an alternative to full-time employment, and part-time jobs may be easier to obtain.
“Not having employment at any point can reduce your retirement income from Social Security, as well as if you have a pension from your employer," says Allan Katz, CFP®, president, Comprehensive Wealth Management Group, LLC in Staten Island, N.Y. "It may also take longer to collect your pension if there is a stipulation regarding years of service."
Running out of money is one of the primary concerns of most retirees. Longevity risk is an even larger concern today, as life expectancy has risen. One's life expectancy at retirement is just an estimate, and many will live longer.
Not dying soon enough sounds an odd thing to worry about, but planning for just enough income to live to your predicted life expectancy will be adequate for only about half of retirees. The longer you live, the more exposure you may 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—especially in early retirement when you are the healthiest and most mobile—but spending too much increases the danger of running out of money.
A pension or an annuity can mitigate some of the risk because they can provide an income stream for life, depending on the type. However, there are some disadvantages, including loss of control of assets, loss of ability to leave money to heirs, and cost.
Although it’s unwise for people annuitize all their assets, annuities should be considered in retirement planning. Nevertheless, also carefully investigate any company where you’d place an annuity, consider interest rates, be cautious of fees, and consider other options, such as laddering bonds.
Death of a spouse
Grief over a spouse’s death or terminal illness contributes to depression and even suicide among the elderly. Then there’s the financial impact: A spouse’s death can lead to a reduction in pension benefits or bring additional financial burdens, including lingering medical bills and debts. Also, the surviving spouse may not be able or willing to manage the finances if they were usually handled by the deceased.
Financial vehicles are available to protect the income and needs of survivors after the death or illness 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.
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.
Splitting the marital assets will almost certainly lead to an overall loss in standard of living for both parties, especially if their lifestyle had been maintained by pooling income and resources. Two individuals in their own homes will need about 20 percent more income to maintain their standard of living, compared to those individuals remaining in the same home. This is because some expenses, such as 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. Postnuptial agreements are similar, but signed after marriage.
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 them could require greater personal or financial support from the retiree. 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.
“Bailing your adult kids out of their repeated financial mistakes can derail your retirement," says Kristi Sullivan, CFP® of Sullivan Financial Planning, LLC in Denver. "For some people it’s like taking an unexpected cruise every year with all of the expense and none of the fun."
It’s important to set boundaries on excessive gifts or emergency checks when you leave your steady paycheck behind. Or if you think this may be an issue, tell your financial advisor about it, so you can work those expenses into your retirement income plan.
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.
Uncertainty about the future is no excuse to avoid retirement planning; you can't plan for everything, but without a plan, you may end up with nothing.
Healthcare and Housing Risks
Unexpected medical bills
These are a big concern for many retirees. Prescription drugs are a major issue, especially for the chronically ill. Older people usually have greater healthcare needs and may require frequent treatment for a number of different health-related issues. Medicare is the primary source of coverage for health care services for many retirees. Private health insurance is also available, but it can be costly.
Change in housing needs
Retirees may need to change from living on their own to other forms of housing, such as assisted living or independent living in a retirement community, which combines some assistance with housing. These residences can be quite costly, though not as expensive as nursing homes. Many people mistakenly believe that Medicare helps to pay for assisted living.
The likelihood of requiring day-to-day assistance or care rises with age. When this will need to happen is often hard to predict, because it depends on 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.
Lack of 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. In general, long-term care costs are an important reason that retirees run out of money, reports the SOA.
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.
According to the SOA, retirees and would-be retirees should consider investing in assets that have historically grown in value during periods of inflation, or those that incorporate inflation protection, such as Treasury Inflation-Protected Securities (TIPS). In addition, would-be retirees can choose to continue working, even if it is only on a part-time basis.
Lower interest rates reduce retirement income by lowering growth rates for 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 to 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. All the same, because of their effect on savings income, high real interest rates, over and above rates of inflation, can make retirement more affordable.
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. A retiree who experiences poor market returns in the first couple of years in retirement, for example, 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 an individual may have a much shorter period over which the assets need to last.
Loss of pension plan funds can occur if the employer that sponsors the pension plan goes bankrupt or the insurer that is providing annuities becomes insolvent. There are guarantees for private pension plans under the Pension Benefit Guarantee Corporation (PBGC) that may protect some of your pension income, but might not cover all of it.
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 matching contributions and in cases where plan balances include company stock.
Public Policy Risks
Government policies affect many aspects of our lives, including the financial position of retirees, and these policies often change over time. 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 be aware of your entitlement to state and local authority benefits.
The Bottom Line
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 that they are mitigated and properly managed. Try to have a Plan B—or even a Plan C—at the ready for each of these risks, just in case you need it.
Don’t use uncertainty about the future as an excuse to do nothing. “The number-one risk is the lack of a plan for the course of retirement,” says Kimberly J. Howard, CFP®, founder of KJH Financial Services, Newton, Mass. You can't foresee every bump in the road, but it's still important to have a plan.