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We often look forward to retirement as a time to kick back, travel more or otherwise revel in our golden years.
But smooth sailing is no guarantee in retirement, especially if you don’t understand where the risks lie and make plans to avoid them.
Here are seven risks that could sink, or at least heavily damage, your retirement, along with strategies to avoid them.
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1. Longevity risk
Longevity would, in most instances, seem like a positive thing. But the longer you live, the more likely you are to run out of money. When planning, consider the possibility that your retirement could last two or three decades — or longer.
This means you need a guaranteed monthly income that will cover all of your expenses and last for the rest of your life. That income could include Social Security, a pension or other income sources that you can’t outlive.
One strategy that can increase your monthly income stream is to purchase a deferred annuity, such as a fixed-index annuity, and add a lifetime income rider to it. A deferred annuity allows your money to grow tax-deferred until you start withdrawing from it.
When you are ready to begin withdrawing money from the annuity, you activate the income rider, and you will receive a monthly payment for life, even if your account value drops to zero.
2. Market risk
When you’re young, a market downturn usually isn’t necessarily worrisome because you have years to recover.
Historically, the market has always rebounded, so you can wait it out. As you near or reach retirement, though, that’s no longer the case.
The worst scenario is a market drop occurring at the same time as you withdraw money from your investments to live on. Your portfolio balance can plummet quickly.
People often try to combat this risk by moving a percentage of their money from the stock market into less aggressive investments.
But that comes with its own risks. If you become too conservative, your investment’s growth may not keep up with inflation.
Again, this is where a carefully planned income stream can help.
3. Sequence of returns risk
It may surprise you to learn that retirements can be unequal even if retirees have the same amount of retirement savings and the same return on their investment over time.
The reason for that is sequence of returns risk. Put simply, people who experience a down market early in retirement and a positive market later fare worse than those who experience the opposite.
A hypothetical scenario illustrates why. Two men, John and Bob, both retire with $100,000 in personal savings. Both retirees will withdraw $5,000 a year to supplement their other retirement income, and both will live another 25 years. Both men enjoy a 6.8% average annual rate of return on their investments.
However, while Bob sees his $100,000 grow over the 25 years, John sees a significantly different result. He runs out of money in year 19.
The difference is that John’s worst years came at the beginning of retirement. His portfolio suffered losses that, ultimately, he could not recover from. Bob’s best years were during the early years of his retirement, helping his portfolio grow and giving him more of a cushion for when the down years arrived.
One way to manage sequence of returns risk is to hold your personal investments in a diversified portfolio with a broad range of asset types and classes. Another strategy is to maximize your guaranteed income sources, which allows you to reduce your reliance on personal savings and investments.
4. Tax risk
Many retirees saved for retirement by contributing to tax-deferred accounts, such as traditional IRAs or 401(k) accounts. A downside of these accounts is that when you retire and begin withdrawing the money to live on, your withdrawals are taxed as ordinary income.
In addition, once you reach the age of 73 (75 for those born in 1960 or later), required minimum distributions (RMDs) kick in. Those RMDs force you to withdraw a certain percentage from your tax-deferred accounts each year.
A popular strategy for reducing some of your tax risk is to convert tax-deferred accounts to Roth accounts. You pay taxes when you make the conversion, but the money in the Roth account grows tax-free, and you don’t pay taxes when you make withdrawals.
5. Interest rate risk
Although debt is an obvious way in which people are affected by interest rates, a retiree doesn’t need to be in debt for interest rates to be problematic.
Many retirees have money in bonds, and interest rates directly affect these, sometimes for the better and sometimes for the worse. When interest rates rise, bond values fall. When interest rates fall, bond values rise.
Diversifying your investments with a mix of stocks, bonds and other assets is one way to mitigate interest rate risk.
6. Inflation risk
Inflation can be catastrophic to retirees on a fixed income.
Although Social Security has an annual cost-of-living increase, this can be canceled out by increases in health insurance costs, including Medicare.
To combat inflation, retirees might want to revisit how their money is invested. Stocks have the potential to provide greater investment returns that could outpace inflation, but they are also riskier than some other investments, so you still want to carefully weigh what percentage of your portfolio goes to stocks.
You might also be able to grow your income with a fixed-index annuity with an increasing income rider or ladder multiple income annuity products.
7. Long-term care risk
Few people nearing retirement want to focus on the fact that they may eventually need expensive long-term care, but that’s the reality.
Someone who turns 65 today has about a 70% chance of requiring some type of long-term care during their remaining years. Such care is not cheap.
The projected monthly cost of a semiprivate room in a nursing home in 2026 is $9,842, according to the annual CareScout and Genworth Cost of Care Survey. An assisted living facility is $6,259 a month.
Several options exist for handling this risk, including having a traditional long-term care insurance policy, a life insurance policy with a long-term care rider or personal savings.
Putting a plan in place
Preparing for these retirement risks can be the difference between a relaxing and enjoyable retirement and one that causes constant anxiety. While there is no guarantee these risks will be eliminated, you can take steps to mitigate some of the pain they cause.
As you can see, there’s a lot to digest here. A financial professional can help you understand how much each risk might affect your retirement and help you create a game plan to prepare for them.
That way, once your working years are behind you, you can focus on more of the things that make retirement worthwhile.
Ronnie Blair contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
