“Understanding and mitigating the risks that cause plan failures is critical if you want to maintain your lifestyle when you retire.” Joe Uppleger
Seniors who want sustainable, inflation-protected income when they no longer work face some significant risks, including inflation risk, sequence of returns risk, and longevity risk. To avoid the possibility of retirement portfolio failure, you must address all of these erosive factors pro-actively, using tools and techniques specific to the spend-down phase of life.
Despite historically low inflation levels over the past few years, inflation continues to be an issue for retirement savers and those using their savings to finance retirement. Inflation in the United States has officially averaged about 1.8% per year since 2009 and about 3.2% annually over the last 50 years. Post-COVID economic worries and wasteful government spending mean increased inflation is inevitable for at least a few more years. Although the Fed’s goal is to keep inflation at 2% or less, even that seemingly small percentage has severe cumulative effects on retirement plans. For example, some retirees receive retirement streams from pensions that may not provide cost-of-living adjustments. Even slight upticks in inflation can become a severe issue if you mainly have a fixed income. For this reason, your retirement planner may find it necessary to put more of your savings in investments that have a chance of keeping pace with inflation, such as real estate or particular types of bonds known as treasury inflation-protected securities (TIPS).
The sequence of returns risk:
The sequence of returns risk is the potential for the market to decline in the early years of your retirement. If the market bottoms out just as you are entering retirement, you may have to delay withdrawing your funds or reallocate your savings into other vehicles. Early market declines in tandem with rising inflation can significantly impact how long your money lasts. Withdrawing cash in a market downturn is never a great idea, as doing so cements your losses in place. When you remove money from your original investment because returns are down, you shrink the principal and thus compromise any future returns. To avoid making panic-based decisions you’ll later regret, be sure to sit down with your advisor and objectively evaluate your risk tolerance. You’ll also want to understand how much time you have until you’ll need to tap into retirement investments. This period is known as your “investment horizon.” The investment horizon determines how long it would take you to recover in the event of a market loss.
Living too long is perhaps the most significant factor that erodes retiree wealth. Living too long not only carries its own set of problems, but it also increases the impact of inflation, sequence of return, and other wealth-destroying circumstances. When it comes to running out of money in retirement, the most relevant statistic may not be your life expectancy at birth but your life expectancy after you retire. The average 65-year-old man currently has a 13% chance of living more than 30 years in retirement. A female the same age has a 21% chance of retiring for over 30 years, and married couples have a 31% probability of outliving a 30-year retirement plan.
Such increased longevity means that traditional financial planning’s 4% rule, based on a 30-year retirement, may fall short for many people. If you adopt this rule and systematically withdraw 4% of your inflation-adjusted annual portfolio, you increase the potential of portfolio failure.
You have no way to know precisely how long you’ll live. The greater your longevity, the more likely the 4% rule will fail you. Fortunately, modern retirement income specialists have an array of safe money products and tools that can help offset longevity risk, including certain types of insurance and annuity products.
Bottom line: Designing your best post-work life is a balancing act that requires you to be realistic about things that can upend even the best plans. It’s crucial to locate a retirement income specialist who cares about your risk tolerance, long-term goals, and financial philosophy.
Partnering with your advisor ensures that as risks to your wealth increase, you will be able to mitigate those risks and shield your retirement savings.