After working and planning for years, the sweet stuff of retirement is supposed to follow. However, even after long-term planning, there can still be some concerns about retirement.
You never know what the future may bring, especially when it comes to stagnant markets or even corrections. That doesn’t have to leave you uncertain about your retirement, though. Here are some common financial retirement concerns folks often have and strategies to address them. Realize that managing risks is more important for retirees than for those in accumulation because retirees don’t have time to wait for a recovery of the economy or the market after a down period. Plus, retirees may have additional goals and needs for their portfolio.
1. Investment Loss
One of the biggest financial fears retirees may have is investment loss. Because the markets move cyclically, there’s a good chance you’ll experience a market downturn during retirement. This can be doubly painful if you’re a retiree, because you have little choice but to sell at a loss for the capital you need. For retirees this is called “sequence of return risk,” because withdrawing investments in a down or declining market may cause you to liquidate too many shares, which then leaves fewer shares to grow when the market bounces back.
A flooring strategy can reduce this sequence of return risk if you start planning at least a year before retirement. You can also use this strategy at any time if you’re already retired. Just be sure you’re evaluating your investment liquidation strategy if you do want to implement a “floor” of income.
Here’s how the flooring strategy works.
Flooring Strategy: Cover Essential Expenses with Fixed-Income Streams
- Calculate your total expenses for all your out-of-pocket essentials like housing, food, utilities, medical premiums, and prescription drugs.
- Add up all your guaranteed lifetime income sources such as Social Security, pensions, and annuities/longevity insurance.
- If your guaranteed income already covers all your essential expenses, congratulations! You’ve already limited the need to sell off your market investments to cover essentials. Because you’ve met your essential expenses with lifetime income, you can delay selling investments in a declining market and potentially wait it out until the market stabilizes. You still might need extra income in a year for nonessential expenses or an emergency, so make sure you have an emergency fund that you can tap first, then look to liquidate investments last.
- On the other hand, you may not have enough lifetime income to cover your essential expenses. This means you’d have to sell some of your investments just to meet your basic/essential needs. To reduce this sequence of return risk, you need to complete your “floor” of income. Consider using some of your invested assets to purchase guaranteed lifetime income (like an annuity) to supplement your income and fill the gap between the essential expenses you must cover and the amount you already are able to cover with the income you identified in step 2.
With this strategy in place, the rest of your assets remain invested in the market while your basic needs are covered, and you can limit selling too many shares by withdrawing into a declining market. Remember that it’s still important to diversify. Consider investments that aren’t correlated to the stock market, as a little extra diversity in your portfolio may help you weather market downturns.
A flooring strategy like this can potentially provide some reassurance that your basic needs are covered and your market investments aren’t being depleted by regular withdrawals.
2. Running Out of Money
When you’re younger, a market decline can be weathered in multiple ways: perhaps by saving more, working longer, getting a second job, or just waiting it out because you won’t need to use your savings for years. But once you’re close to or in retirement, running out of money becomes a serious concern. Few people would want to go back to work at age 95 because they ran out of money. Fortunately, the flooring strategy helps here too. Lifetime income means just that: an income stream that’ll last no matter how long you live. By deploying annuities and other lifetime income strategically—just to meet your essential expenses—you can cover basic needs and avoid becoming a burden to your kids or others.
Tap investable assets only to cover discretionary expenses. These discretionary expenses can be postponed until you can determine which assets make sense to liquidate. You can even employ tax-loss strategies by selling some losers with some winners to keep your tax bill lower. Keep in mind investors sell securities for investment reasons, not primarily for tax reasons, but if an investor is considering a sale then tax considerations are often considered. Be sure to consult your tax advisor before pursuing a tax strategy.
If you have substantial discretionary expenses like vacations, gifts, car purchases, home renovations, and so on, another strategy to add to your floor is a “time segmentation” strategy. Here’s how time segmentation works.
Time Segmentation Strategy: Building Income Ladders
- Determine your discretionary income wishes for the next five years. (Remember that essentials are covered by your floor.)
- Create a bond ladder or single premium immediate annuity (SPIA) ladder to cover just these expenses. You may need to liquidate some of your investable assets to purchase the bonds or SPIAs.
- Each bond or SPIA provides income. Plus, the principal that comes due during the five-year period will be used to cover your discretionary expenses.
- Invest the rest of your market-based investment assets in five-year incremental portfolios. So portfolio two is invested for five years, portfolio three for 10 years, portfolio four for 15 years, portfolio five for 20 years, and so on.
- As you get close to the expiration of the first five-year period for your bond/SPIA ladder, you can create another ladder for years six through 10 using the market assets you have in portfolio two. All your other portfolios stay fully invested.
- Time segmentation can get even more advanced. Using what we’ve discussed so far can help you understand the nature of retirement risks and some of your choices to reduce risk.
Another way to reduce the chances of running out of money is to carefully manage when you take your Social Security. A retirement professional can help you structure your portfolio and coordinate your distributions with your Social Security benefits in a way that allows you to lengthen the life of your money. If you can wait a little longer to draw benefits, your monthly Social Security payments will be higher, which can be a comfort later in life. Each year you wait to take Social Security past normal retirement age adds another 8% in return to your payment. And that payment continues to increase via cost-of-living adjustments (COLAs) too. Women in particular need to maximize Social Security payments because of longer expected life spans. Remember that your Social Security payment will be reduced by your Medicare Part B premium, so you won’t have all of your Social Security payment available to spend.
You can also consider investing in income-producing assets during retirement. Rental properties and other real estate projects, certain business investments, and other assets can continue to create income, which might provide you with a way to avoid reliance on stock market performance during your retirement.
3. Major Health Event
As we get older, it’s common to see an increased need for health care. It’s natural, as a retiree, to worry about a major health event that can set you back financially. But it’s possible to prepare to some degree for such events.
If you aren’t yet retired, consider contributing to an HSA to build up your tax-advantaged portfolio. If you qualify, consider contributing to a Health Savings Account (HSA). An HSA has the advantage of providing a tax deduction when you contribute, as well as growing tax-free as long as the money is used for qualified health care expenses.
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You might also look into long-term care insurance in case you ever need to be in a long-term facility that might not be covered by Medicare or Medicaid. Medicare covers only shorter-term medical needs. And with Medicaid, you’d need to deplete all your assets to qualify.
If you’re concerned about paying premiums for a long-term care policy that you might never need, another option is to purchase longevity insurance. Longevity insurance starts paying you once you reach 80 to 85 years old, which may coincide with a need for extra care or higher medical bills. So although the payment isn’t tied to your medical bills, you can use this insurance to cover possible costs. If you stay healthy and don’t need the extra money, you can invest it for the future, bulk up your emergency fund, or use it for discretionary expenses like purchasing a new car or taking a dream vacation.
4. Inflationary Effects
Inflation is sometimes considered the “quiet killer” of retirement. Over time, prices rise, making your money less valuable. A dollar today is worth more than a dollar tomorrow. Keeping up with inflation is an important part of retirement planning.
If you haven’t already retired, one possible way to offset inflation is to save more than you had planned. Consider increasing your retirement portfolio contributions so you have more money saved. You can also look to invest in annuities or other products that offer COLAs. Social Security offers this adjustment, although medical care tends to rise faster than the Social Security COLA.
Another strategy is to look for diversified growth investments that can potentially provide an inflation-beating rate of return. That way, your money grows faster than inflation and might insulate you from some of its effects. The flooring strategy and/or time segmentation may also help. All these strategies can potentially help reduce the risk of running out of money, and they keep part of your portfolio fully invested in long-term growth assets that have the potential to overcome inflation.
Bottom Line: Planning Matters
One of the best things you can do for yourself is to plan ahead. Meet with a retirement specialist to create a plan that might help you avoid unpleasant surprises in the future. The earlier you start, the more likely you are to avoid the common fears faced by retirees. Having a plan in place and making consistent contributions to a retirement portfolio can go a long way.