The Six Retirement Risks

Retirement planning isn't just about saving enough money and figuring out how to spend it. Good planning focuses on managing the risks that can threaten your financial security after you stop working. Whether retirement is decades away or just around the corner, understanding these six risks can help you build a plan that prepares you for life's uncertainties.

Withdrawal Rate

The transition at retirement from the accumulation phase of life (building your savings) into the distribution phase (spending your savings) can be difficult to navigate without proper planning. Unlike many retirees decades ago who could depend on consistent pension income, the majority of retirement income today is generated through withdrawals from investment portfolios like 401(k)s, 403(b)s, IRAs, or taxable brokerage accounts.  While pensions remain available for some workers, especially in the public sector, most retirees today rely primarily on their personal savings and Social Security.

 Creating a withdrawal strategy that provides reliable after-tax income throughout retirement is one of the most important parts of a financial plan.  Many factors need to be considered, including pace of spending, inflation and cost increases, portfolio volatility, proportion of guaranteed income, and types of expenses or debt.  No one situation will necessarily be the same as another. 

Large market declines early in retirement can have a disproportionate impact on a portfolio because withdrawals continue while investment values are down. This "sequence of returns risk" means two retirees earning the same average return over retirement can experience very different outcomes depending on the order that market gains and losses occur.

 You (hopefully!) only plan to retire once, so it is essential that you prepare to get it right the first time. 

Asset Allocation

Asset allocation is the process of dividing your investment portfolio between different asset classes, most commonly stocks, bonds, and cash, to manage investment risk within your portfolio.  Many retirees, due to concern about market volatility and income withdrawals, struggle to find the right balance of growth and protection as they transition from building wealth to generating retirement income. 

 As investors approach retirement, reducing their asset allocation from an aggressive (stock-heavy) portfolio to one that is more evenly balanced with bonds and cash can be hard.  Managing the ongoing transition towards an income-focused investment strategy takes thoughtful planning and careful rebalancing throughout retirement as the market ebbs and flows.  It is natural for a portfolio to shrink through planned distributions over the course of retirement. The size of the portfolio matters less than the ability for that portfolio to generate the required income and security to meet a retiree’s needs. 

Longevity

Many soon-to-be retirees are focused on how soon they can take the plunge, but there is another factor that is as important, if not more important: length of retirement.  The average length of retirement and the number of high-activity years in retirement have grown over the past few decades as life expectancy and healthspan have improved. This fact requires proper planning and income projections so that late in life, retirement funds are not depleted. 

Many couples have a meaningful chance that at least one spouse will live into their 90s, making retirement a 30-year or longer financial plan. Considerations should be made for how a plan will be impacted by the death of a single spouse. 

 Considerations such as large expenses, gifting and legacy planning, guaranteed income, and long-term care planning are all relevant for how the latter years of retirement can be mapped out.  Retirement planning is an ongoing process. As your health, spending, family, and financial markets change, your plan should evolve with them. 

Medical Costs

Despite many legal changes to reduce the cost of care for retirees on Medicare, the cost of healthcare continues to rise.  The New York Times reports that the average cost of health and medical care for a single person over a 20-year retirement will be $157,500 (2023). Women, because they tend to live longer, can expect to require more money for their medical costs than men. 

When planning for retirement, it is important to consider your current health, available healthcare plans, family history, and longevity.  These factors will impact how much you may need to set aside for your medical costs. While difficult to predict, long-term care costs will also need to be factored into your planning in the state you plan to live.

Inflation

Rising costs can be one of the most deceptive risks all investors, but especially retirees, will face.  Rising costs for normal living expenses or planned events like travel can cut into the retirement lifestyle that was originally planned. 

 For many retirees, investing more conservatively and holding a higher percentage of cash is the natural strategy to minimize the risk of loss from investing.  However, a portfolio that is overweight in cash or other conservative investments can lead to diminishing purchasing power through inflation.  The period from 2021 to 2023 saw the highest inflation rate in decades.  Despite receiving cost-of-living adjustments from Social Security, most retirees saw their standard of living decline due to higher costs and depressed returns in conservative investments such as fixed-income funds. 

 Maintaining some exposure to growth-oriented investments, such as stocks, can help preserve purchasing power over a retirement that may last several decades.

Taxes

Taxes and tax management can be difficult to predict in our constantly changing legislative environment.  Although infrequent, our federal tax laws change often enough that most retirees will live through one or more changes to the way their income is taxed or their retirement accounts are handled during or after their lifetimes.  It is impossible to predict what income tax rates will be in the future which can make certain choices difficult (such as retirement saving pre-tax or post-tax). 

Tax management is an important part of a strong income plan.  Balancing your taxable income with sources that are taxed at lower rates (capital gains or qualified dividends) or are tax-free (Roth IRA distributions) can be the difference between one marginal tax bracket and another.  With proper tax planning ahead of time, most retirees can avoid being forced to take more income than they need as a Required Minimum Distribution (RMD). 

Your Turn

While no one can predict exactly what retirement will look like, understanding the risks that can affect your financial security is the first step toward preparing for them. A thorough retirement plan should be flexible enough to adapt as markets, tax laws, healthcare costs, and personal circumstances change. Reviewing your plan regularly can help keep you on track throughout retirement.