If you are planning to retire soon or have retired in the recent past, you probably have many short-term questions on your mind. “Should I take up golf?” “Where would I like to travel?” “Should I fish today or tomorrow?” “Should we pretend we’re not here when the kids call?” These are all perfectly normal in the short run. But, what about the long run? For the vast majority of people, the most important long-term question is, “Will I be okay?”
To answer the question, you must identify the possible things that could make you “not okay” – the things that could seriously disrupt your plans. This can be difficult, because it’s not the snake you see that bites you; it’s the one you don’t see. Based on my experience and the research of a multitude of academic and financial institutions, there are five key risks we will all face in a long retirement. Before I describe them, let me offer you an analogy:
If you learned that you and your family faced a risk of serious disease from five new viruses, and medical researchers indicated there was a better than even chance you would be exposed to those viruses in the next few years, what would you do? If you’re like most of us, you would head straight to your physician and get vaccinated against all five threats, correct? Well, your financial health in retirement is no different. If you can focus your efforts on immunizing yourself and your family against these five threats, you can spend your retirement years enjoying the fruits of your efforts.
Risk #1: Outliving Your Assets
Let me clarify something. It would be virtually impossible to truly outlive all your assets. If you receive a pension from your previous employer (and elect a life or life with survivor option for payment), you theoretically cannot outlive it assuming the company or government entity that owes you the pension remains solvent. If you receive Social Security benefits, you theoretically cannot outlive your benefit, assuming the Social Security Administration can continue to pay them. What we find more often is that the risk is not actually outliving every penny you have, it is the loss of dignity and independence that comes from making hard decisions about your lifestyle due to a lack of resources.
41% of Americans are worried they won’t be able to maintain their standard of living in retirement, yet only 42% of Americans have even tried to calculate how much income they will need in retirement (US Dept of Labor).
Many of us will live longer than we think, and you would be wise to plan for a much longer life than you may expect. If you’re wrong and you die earlier, you won’t know it. If you’re right, at least you’ll be prepared.
Risk #2: Inflation
If inflation was a disease, it would be called the silent killer. Inflation is insidious and creeps into every aspect of your lifestyle. Inflation is nothing more than a rise in the prices of goods and services. The effect of inflation, however, is a loss of your purchasing power.
When you retired at age 65 and died at 72, three percent inflation probably wasn’t meaningful to you. But with many retirements now lasting 30 years or more, three percent annual inflation means you will need more than twice your current income just to maintain your current lifestyle.
And don’t expect Cost of Living Adjustments (aka COLA) in your pension or Social Security benefits to keep pace with the rising costs of healthcare, energy, and food.
Risk #3: Low Returns and Poor Withdrawal Planning
Imagine a mountain. Climbing the mountain is the wealth accumulation phase, while using the wealth, or distribution, is the downhill portion of the climb. The strategies you use to accumulate wealth don’t work on the other side of life’s mountain – the distribution phase. A stumble here can be disastrous.
Often, I note that people preparing for retirement in a year or two have moved their assets into either money market type instruments or bonds. When I ask why, they explain that are getting ready to retire and are concerned about risk. Often, the difference between gross returns and net returns on these products can be staggering – net returns after taxes and inflation. Traditionally “safe” investments are anything but when it comes to protecting your purchasing power and producing a growing stream of retirement income.
For most of us, our investing efforts to date have been focused on accumulating assets. Now, the conversation is shifting. The newest frontier in retirement planning focuses on “distribution” or withdrawal planning. In short, how do we make sure that all we have accumulated lasts us as long as we need it to? Once again, we will see that conventional wisdom fails us here, as the strategies we have used for wealth accumulation do not work on the other side of the mountain.
Risk #4: The Tax Man Cometh…Again and Again
Another bit of conventional wisdom is that your taxes will be lower when you retire. This was likely true for your grandparents and possibly your parents, but not for you. The good news? The government has decided to adjust the tax rates to more heavily tax the rich.
The bad news? You’re rich.
Taxes will be particularly meaningful in retirement for those who have uncontrollable sources of income such as pensions, Social Security, and mandatory IRA distributions. The risk, simply stated, is that your net retirement income after taxes may be less than you expect. Tax planning both prior to and in retirement will be an essential element for all of us.
Managing when and how much tax you pay in your retired years by using every legal means at your disposal will have meaningful consequences on your lifestyle and your potential legacy to your heirs.
Risk #5: Healthcare Costs
Medical advances have truly been amazing over the past century. Many of the illnesses that would kill us before our time have either been eradicated or are at least under control. The Center for Retirement Research has conducted extensive studies on the financial challenges that healthcare presents to an aging nation. In a recent survey, 39 percent of terminally ill patients reported that healthcare costs caused moderate or severe financial problems.
The spiraling cost of healthcare related expenses shows no signs of abating. Unfortunately, the cost-of-living increases built into Social Security, pensions, and other retirement benefits are generally based on the Consumer Price Index, a broad indicator of inflation. But the rapid rise in healthcare expenses is greatly outdistancing those increases.
Contrary to popular belief, long-term care is not covered by Medicare or typical employer-based retiree healthcare plans. Costs for one year of care can range from $33,000 in Louisiana to over $91,000 in Connecticut. Roughly 60% of Americans now turning 65 will be admitted to a nursing home at some point in their lives. Half of them will stay six months or less, but about 1 in 10 will stay three years or more. In 2004, the average daily rate for a semi-private room was $169, or about $61,000 per year. Today, the average rate for a private room is $206 per day, or $75,190 annually.
Unless you have made arrangements to cover these costs through some other means they will be borne by you or your family.
So it’s time to give yourself that shot in the arm and immunize yourself against these risks. Work with your financial advisor, CPA, family attorney and other professional providers to educate yourself on these risks and develop a strategy for immunizing your retirement plan from them.