Be Wary Of These Underestimated Retirement Risks

Like any other phase of life, retirement is not risk-free. While it is seen as our reward for many years of hard work, it still carries exposure to what is happening out in the world.

Our concerns tend to center around the stock market falling or interest rates rising. We worry that inflation will reduce the value of what we've saved or that declining real estate market values could decrease the worth of essential assets. And the older we get, the greater the risk to our health.

Despite all this concern, there are three areas where retirees often underestimate the risk. Let's look at all three.

The risk of your portfolio failing

Running out of money is a common fear. Despite how much you might have in investments and savings, the fear usually results from having only a superficial understanding of your holdings and a lack of detailed withdrawal and spending plans.

Once the paychecks stop rolling in, you shift from the "accumulation" to the "decumulation" phase – you start subtracting from your nest egg instead of adding to it. You may still have some streams of income, but your basic nest egg is defined.

The typical portfolio considerations are market fluctuations and how your assets are allocated to generate ongoing profits and income. But you have two other factors to consider: (1) what formula you will use to withdraw funds, and (2) where the market is in terms of sequence-of-risk.

Withdrawal rate – The "4% Rule" is a popular rule of thumb for withdrawing spending money. It was designed nearly 30 years ago as a sustainable spending rate – the percentage of your assets you can withdraw each year, with the balance adjusted for inflation going forward. But because the rule was created in the 1990s when interest rates were higher, it is not foolproof today.

Some people feel the percentage should be lower, such as 3%, and others think more dynamic measures should be used. (By working with a qualified financial advisor, you can develop a formula that works with your specific nest egg and your projected financial needs.)

Sequence-of-risk – Markets go up and down. "Sequence-of-risk" refers to financial market returns when you start your spending. If your portfolio has negative returns when you begin withdrawals, it can leave you with too little to take advantage of any future market recovery and derail your retirement plans.

However, being aware of the importance of sequence-of-risk offers options: It may lead you to delay retirement until the market rebounds. Or you may leave your portfolio untouched and spend from non-market funds. Barring that, you might adjust your spending in the early years to minimize the damage.

The risk of facing unplanned financial responsibility

Many contingencies are considered when retirement plans are developed, but not all. Here are some that are often overlooked – or at least underestimated.

Thanks to the COVID pandemic, more people than usual are caught in what is called a "sandwich generation." You may have parents who need more care and children (even adult children) who lost their jobs or moved home. And they may rely on you for financial and other support.

Divorce, while not typical, is not unheard of among retirement-age couples. And it results in splitting up material assets, everything from housing to savings and investments.

Last is the loss of a spouse to death. While more predictable, what is unknown is the timing and which spouse will die first. But, still, the risk is usually factored into thorough financial planning. The economic impact can include the loss of pension benefits, Social Security, and other income streams. At the same time, tax brackets will shrink from filing as single instead of married, and taxes will take even more of your reduced income. An estate plan, if prepared well, can soften the financial impact of a painful loss.

The risk of unexpected health-related costs

Many people look forward to turning 65 to get onto Medicare and off costly health insurance policies. But Medicare is not free and, unless other steps are taken, your care can become expensive as your health declines with age. We offer an "Understanding Medicare" on the Resources page of our website.

Your choice between Original Medicare and Medicare Advantage is one determining factor – both of which can leave you exposed to certain out-of-pocket expenses, including prescription drugs. But Medicare Advantage and prescription drug plans do have out-of-pocket maximums. And Original Medicare can be combined with a supplement insurance (or Medigap) policy to limit what would otherwise be open-ended exposure.

However, you will have to factor those out-of-pocket maximums and ongoing Medigap premiums into your retirement planning. The alternative is to risk having unexpected medical bills alter your retirement plans.

Another health-related risk factor is the need for increased care from caregivers – and the eventual need for different housing, such as independent living in a retirement community or assisted living. Many believe Medicare helps pay for assisted living, but it does not. Hopefully, your planning will have included long-term care or hybrid insurance policies that will help cover what can be the highest cost in retirement.

Last thoughts

You may not be able to plan for everything. But you can take steps to minimize the risk of your portfolio failing because you used the wrong withdrawal rate or ignored sequence-of-risk. You can prioritize funding your retirement by creating boundaries to the help you can offer to others – and avoid putting yourself at risk of becoming a burden to them in the future. And there are ways to protect against devastating health-related costs as you age.

But there is one more risk that all retirees face: underestimating how long they will live in retirement. In 2020, "How Accurate Are Retirees' Assessments of Their Retirement Risk?" – a study by the Center for Retirement Research at Boston College – showed that both men and women at age 65 underestimate the probability that they will reach age 80. And their retirement can last up to six or more years longer than they anticipate.

With retirement planning, underestimating your longevity can skew many critical calculations. So rather than count on personal estimates, examine formal life expectancy tables and add a few years to the probabilities. Nothing could be more devastating than running out of money because you lived too long. And no one will complain if you have money left over.

Bill Harris is a Retirement Management Advisor (RMA), a CERTIFIED FINANCIAL PLANNER practitioner (CFP), a Master Elite Ed Slott Advisor, and author of "Inheriting Your Spouse's IRA." He is president of WH Cornerstone Investments, a financial advisory firm located in Kingston, Massachusetts. Learn more at https://whcornerstone.com.

Investors, Plans & Money

Bill Harris