The classic images of retirement include attractive couples walking hand-in-hand on the beach, or lounging in Adirondack chairs as they gaze across the water.
Of course, in reality, retirement means many different things. Some people enjoy visiting new places, others take up new hobbies or even start businesses. Some throw themselves into a full schedule of volunteer work and advocacy.
But there are plenty of potential pitfalls along the road to that dream retirement. Sadly, people often fail acknowledge the risks — or they’re simply unaware of the obstacles that could derail their best-laid plans.
It’s not that these challenges inevitably damage one’s retirement dreams. By remaining cognizant of the pitfalls, pre-retirees are better equipped to deal with them.
Here are 12 specific retirement risks:
Longevity risk: The risk of outliving sustainable income. People often underestimate the amount of money they will need to cover living expenses over a long life span. In most cases, it’s worth a review of one’s financial resources before making the decision to retire on a specific date.
Entitlement risk: Not that you feel entitled to certain income in retirement, but that government entitlement programs, such as Social Security and Medicare, will not provide sufficient retirement income.
Market risk: The risk of losing retirement assets temporarily or permanently because of a market downturn or poor investment performance. In many cases, investors make the mistakes of trying to pick stocks and time the market. Rather than lowering risk, attempts to outsmart the market generally worsen performance.
Excess withdrawal risk: The risk of drawing down assets too quickly. Our firm routinely sees people who are spending money at a rapid rate and are on track to run out of money in the foreseeable future. This can be addressed by doing a financial plan — and sticking to it!
Lifestyle risk: This is related to excess withdrawal risk. It happens when a the available resources are insufficient to cover the current or expected standard of living.
Asset allocation risk: The risk of investing either too conservatively or too aggressively, relative to your objectives and time horizon. Often, we see portfolios that have no cohesive strategy; instead, the investments are a seemingly random collection of stocks, bonds and mutual funds. That lack of thoughtful, diversified allocation often leads to a portfolio that doesn’t generate enough income to meet one’s goals, or takes too much risk for a given situation.
Sequence-of-returns risk: The risk of getting low or even negative returns in the early years of retirement. This can have long-term devastating effects. The good news is, sequence-of-returns risk can be mitigated by separating portfolio assets into “buckets.” For example, money you need in the next few years can be invested in a more conservative way than money that will cover your expenses a decade from now.
Inflation risk: The risk that rising costs will undermine your portfolio’s purchasing power. Here’s where we see this most often: People park vast amounts of money in cash, believing it’s “safe.” By doing that, however, people actually lose money, because cash does not keep up with inflation. Inflation risk is often a silent retirement killer, since the downside of cash doesn’t make the news. Cash masquerades as a safe, prudent choice, but it’s often a big mistake.
Medical expense risk: The risk of paying for the growing costs of health care services in retirement. This risk is amplified by ever-lengthening life expectancies in the U.S.
Tax risk: This is another retirement expense that often goes unrecognized. In fact, for many years, it was assumed that Americans’ tax burden automatically declined in retirement. However, required minimum distributions from individual retirement accounts, along with Social Security income, often result in a higher-than-expected tax bill. In addition, retirees no longer have deductions for dependents and often have no mortgage deduction. In other words, your post-retirement taxes might be higher than you expect.
Personal or event risk: These are the risks unique to your situation. For example, at our firm, we often meet people whose spouses have generous pensions. Those are great for sustaining the couple’s lifestyle. However, if the pension goes away upon the death of the account owner, the surviving spouse might struggle to make ends meet. That’s just one example. In other cases, the need to support an adult child could arise, throwing a wrench into retirement plans. Fortunately, these situations can often be mitigated with advance planning that anticipates various scenarios.
Incapacity risk: The risk that deteriorating health will result in the inability to make sound judgments about one’s financial affairs. Sadly, we are meeting with a growing number of baby boomers whose elderly parents are no longer able to make good financial decisions, and it’s often problematic. Again, advance planning can address some of these issues, but often, that process involves some difficult family conversations.
While it’s easier and more fun to imagine sitting in those beach chairs, remember: It will be easier to enjoy those relaxing moments if you first shore up your financial situation. Not every risk will disappear, but it helps to plan ahead and mitigate the ones you can.
