Plan Carefully, Avoid Biggest Risks To Your Client’s Retirement Fund

By Russ Wiles

Planning for retirement can be tricky. It requires sacrifice in terms of saving money over many years, shrewdness in investing it and discipline in withdrawing it cautiously.

In addition, you must deal with uncertainties such as how long you might live, future inflation rates and how much you could incur in medical expenses.

No wonder many people fail to minimize the following five key risks of retirement. From withdrawing too much early in retirement to underestimating health costs and failing to plan for taxes, there are a lot of potential pitfalls. And don't forget about inflation and planning a buffer in case you live to be 115.

Here are the biggest risks:

1. Withdrawing big early

There's a natural tendency to want to spend liberally early in retirement, when your health is better and your interests and hobbies more varied. But taking a large withdrawal from stock-focused investment accounts can be hazardous if the market plunges soon thereafter.

"You have less time to make a comeback, especially when you are starting to withdraw from those accounts," said Jim Braun, president of Tri-State Retirement in a commentary.

Visualize the damage wrought in a tough year like 2008, when large stocks tumbled 37% on average. To recover from a plunge of that size, your portfolio would need to rebound by 60%. If you also had withdrawn, say, another 10% to splurge on vacations or a new car, it would have been harder to make up the lost ground.

One way to lessen this risk would be to start with a relatively low withdrawal rate and increase it gradually over time. Another option would be to shift into more conservative assets, though few retirees have all of their assets in the stock market anyway.

A 4% annual withdrawal rate is a common suggestion to maintain a portfolio's size without depleting it too quickly.

2. Not recognizing inflation risk

General price levels have risen only modestly over the past four decades, but that could change. While many powerful disinflationary forces are still at play, from technological innovation to the graying demographic trend, inflation has spiked recently. Just think how much home prices, rents, gasoline prices and restaurant meals have risen lately.

Medical inflation is another worry for retirees. According to Fidelity Investments, a 65-year-old, opposite-gender couple retiring this year can expect to spend $300,000 combined in health and medical expenses throughout retirement. That's up from a $230,000 estimate 10 years ago. Fidelity's estimate assumes individuals don't have employer-provided medical coverage in retirement but do qualify for Medicare.

Suppose you plan to take 4%, or $40,000, from a $1 million portfolio each year. "That $40,000 won't have the same spending power in year 10 of retirement as it did in year one," Braun said. As noted earlier, one way to offset this risk is by starting with a lower withdrawal rate and gradually increasing it. Also, try to hold some cash elsewhere so you can slow or halt withdrawals during down-market years.

3. Underestimating health costs

Medical expenses are an important inflationary component that retirees must heed. In addition to inflation itself, many people don't prepare for unexpected medical outlays.

For example, "At some point, you could require long-term care, which comes with a staggering price tag," Braun said. Seven in 10 people will require such assistance at some point in their lives, though it won't necessarily extend for years at a time. At any rate, few people prepare for this contingency, he said.

Medical expenses are a wild card. "Covering health-care costs is one of the most significant, yet unpredictable, aspects of retirement planning," said Hope Manion, a senior vice president in Fidelity's workplace consulting unit.

Health savings accounts are a great way to prepare. These accounts combine tax-free contributions, tax-sheltered investment growth and tax-free withdrawals if used to meet a broad list of medical expenses. Yet HSAs are also widely underutilized, Fidelity reported, with many people not contributing the maximum yearly dollar amount or investing their funds too cautiously.

4. Outliving your assets

Rising life expectancy increases the chances that you could deplete your savings sooner than expected.

"If you are calculating that you just need enough money for a 10- or 20-year retirement, you could be in for a surprise," said Braun, noting that 1 in 5 men who reach age 65 will live to 90. Among women, it's 1 in 3. This is another reason to retain stock-market or other growth investments in a balanced portfolio.

Russ Wiles

Columnist

USA TODAY