5 key risks to retirement
For most people, their whole investment life has revolved around saving and growing their wealth. However, retirement is sort of like putting your car in reverse, it's a different way of investing in and a different way of thinking about your finances. To borrow from a climbing metaphor, it's often said that the most accidents in mountain climbing occur while descending the mountain, the same can be true of a person's retirement. Retirement is often viewed as a time of relaxation and leisure, but it can also be a time of uncertainty and financial risk. Planning for retirement is essential to ensure a comfortable and secure future, but it is equally important to be aware of the potential risks that can derail your plans. In this article we'll discuss some of the common risks to retirement and how to mitigate them.
1. Inflation risk: One of the biggest risks to retirement is inflation. Inflation refers to the increase in the price of goods and services overtime. This means that the value of money decreases which can impact your purchasing power in retirement. Inflation can be especially challenging for people in retirement as in healthcare costs typically inflate at a higher rate than that of ordinary inflation. A hard truth as a person gets older is the increased likelihood that they may need more medical care over the course of their retirement, so this can be an especially nefarious form of inflation.
To mitigate inflation risk it is important to invest in assets that provide a hedge against inflation. This may include investments such as stock, real estate and commodities to name a few. It is also advisable to have a diversified portfolio that includes a mix of assets that provide both growth and income.
2. Market Risk: Market risk refers to the potential for investment losses due to fluctuations in the stock market or other financial markets. This risk is particularly relevant for those who rely on their investments for income during retirement. A market downturn can significantly impact your retirement income in may force you to dip into other savings.
To mitigate market risk, it is essential to have a diversified portfolio that includes a mix of stocks, bonds and other assets. It is also advisable to work with the financial advisor who can help you create a retirement portfolio that aligns with your risk tolerance investment goals and overall retirement income needs. If possible, having a buffer of cash can also aid in potential market downturns.
3. Longevity Risk: Longevity risk is somewhat of an ironic risk where living a long life is a good thing but can have negative consequences on your overall retirement plan. longevity risk refers to the risk of outliving your retirement savings. With life expectancies increasing there's a greater chance that you will live longer than expected, which puts a strain on your retirement income. The longer you live the more money you will need to fund your retirement, which can be challenging if you have not planned accordingly.
To mitigate longevity risk it is essential to plan for retirement income that will last throughout your lifetime, many people seem to underestimate how long they might live and so using a few different types of life expectancy ages during the retirement process can help bring light to certain levels of risk depending on how long you might live. In addition we know that much of the health care costs during retirement is end of life care so if you end up living longer and the potential for more end of life care may increase. So consider running scenarios that also consider a change in your expenses during the final 3-5 years of your life, this may include long term care costs, or in home care costs.
4. Withdrawal Rate Risk: Similar to market risk, when you retire, most retirees use a portion of their retirement savings to live off of. This should be expected, but is a common source of anxiety and concern for those living in retirement. Many people like to work off of what is commonly called, The Safe Withdrawal Rate, which uses a starting portfolio withdrawal percentage of 4%. If when you retire, the market goes down substantially, that will drive your portfolio distribution rate higher, as your portfolio value decreases. Below is a chart of a one-million-dollar retirement portfolio and how well it would have faired under different withdrawal rates (4%,5%,6%,7%,8%).
Source: BlackRock
In order to mitigate withdrawal rate risk, it is important to understand your budget, and how much you may need to withdraw from your portfolio. This will help give you an accurate starting point of how much you may need to withdrawal from your portfolio to support your retirement. From there it Is important to make sure you have an appropriate retirement income portfolio designed to support your income needs throughout different market environments.
5. Tax Risk: Tax risk refers to the potential for taxes to impact your retirement income. Taxes can impact your retirement income in various ways, such as through required minimum distributions, Social Security taxes, Medicare premiums, and income and capital gains taxes. Since many people save for retirement in tax deferred accounts, this can decrease the amount they have saved on an after-tax basis.
To mitigate tax risk, it is important to have a tax efficient retirement plan. This may involve diversifying your retirement income sources, taking advantage of tax deferred retirement accounts, and working with a financial advisor who specializes in tax to optimize your retirement income.
To wrap it all up retirement planning is not just about saving money it is also about understanding and mitigating the potential risks that can impact your retirement income. By considering these key risks and taking steps to mitigate them you can help ensure a comfortable and secure retirement.
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