When you’re working and saving for the future, risk is a relatively straightforward concept that consists of two key concerns:
- What happens to your loved ones if you pass on or become incapacitated?
- What happens to all your goals-based saving and investing if the bottom drops out of the stock market?
For the former, you can devise income replacement strategies using life and disability insurance; for the latter, your strategy could be to rely on the principles of asset allocation and diversification, possibly in conjunction with some hedging strategies.
As you transition to retirement, however, in addition to market risk a whole new set of risks emerge—each of which, if not adequately planned for and managed, could ultimately result in outliving your savings. So let’s take a closer look at each of these five risks: What they are, and how you and your advisor can effectively address them.
The 5 risks you need to plan for
1. Longevity risk
According to the Social Security Administration, the probability of at least one member of a healthy 65-year-old couple living beyond age 85 is greater than 75 percent.1 Retirees today are living longer, healthier and more active lives. You need to plan for a retirement that could last 30 years or longer by saving more and spending down a smaller percentage of your assets each year in order to avoid outliving your retirement savings.
A healthy 65-year-old couple who retired in 2017 can expect to incur total projected lifetime out-of-pocket healthcare expenses (including insurance premiums, deductibles, copays, hearing, vision and dental) of more than $400,000 in today’s dollars.2 This doesn’t include the escalating costs of long-term care, which the US Department of Health and Human Services estimates that 70% will need at some point in our lives.3
When it comes to healthcare costs, longevity can be a double-edged sword. Make sure you and your advisor address this essential income need before it derails a lifetime of saving and planning.
2. Withdrawal risk
The first few years of retirement—as you make the move from accumulating to spending down assets—are fraught with potential pitfalls. Many people enter retirement with unrealistic and unsustainable spending expectations. Determining what percentage of your portfolio you can draw down each year while maintaining a high degree of confidence that your savings will last is something that will vary greatly from individual to individual. The age at which you retire your asset allocation and risk tolerance, your gender and health, as well as your desire to leave a legacy for your heirs will all factor into the decision.
Your advisor will assist you in modeling various spending scenarios to identify an optimal portfolio drawdown percentage to meet your particular needs.
3. Inflation risk
When you’re working, pay raises and cost-of-living adjustments tend to easily offset the impact of inflation. Once you retire, however, that protection disappears. As a result, many investors fail to consider the potential impact of future inflation when they estimate and plan for retirement expenses.
Even though the past decade has witnessed historically low overall inflation, it’s the things retirees depend on (e.g., medical care, prescription drugs and hospital costs) that have experienced some of the highest rates of inflation. Given longer and longer retirements, the old rule of thumb that you move the lion’s share of your assets into fixed income as retirement nears may no longer work. Your portfolio will need reasonable growth just to keep pace with inflation.
4. Sequence of return risk
In the years leading up to retirement, the order of your annual returns has no impact on your savings. Whether the market goes up or down in a particular year isn’t really important—the only thing that matters is your average annual return. Conversely, once you cross the retirement threshold and begin drawing income from your investments, it’s the order of your returns that’s often more critical than the average return. Just a few years of significant negative returns early on in retirement can devastate a portfolio’s ability to generate lifetime income.
Your advisor can work with you to help lock in gains and explore a host of strategies, such as bond laddering, which can help to mitigate sequence of returns risk.
5. Distribution tax risk
Since there is always a great deal of uncertainty regarding future public policy and potential tax reform, planning for income taxes years down the road in retirement is an incredibly difficult endeavor. Given rising federal deficits, ballooning national debt and underfunded entitlement programs such as Social Security, however, it’s safe to assume that future taxes will inevitably be higher than they are today.
By strategically diversifying your retirement assets across taxable, tax-deferred, and tax-free accounts, you’ll gain more flexibility in deciding where to draw down funds each year depending on your changing tax situation. This retirement income “tax diversification” also affords you an opportunity to hedge your portfolio against potentially higher tax rates in the future by deferring drawdowns from your tax-free assets.
Navigating and prioritizing
Retirement income planning that considers all of these potential risks is a critical component of any comprehensive goals-based financial plan. At SunTrust, we’re adept at effectively managing all of these risks, not just one or two. Working collaboratively, your advisor will help you prioritize the risks that worry you the most—whether it’s managing the costs of healthcare, ending up with negative returns because you’re withdrawing too much income, or something else entirely —and put plans into place that may better protect you down the road.
This is why you’ll want to sit down with your advisor to develop a thoughtful strategy that will not only endure, but be flexible enough to adapt as your needs and circumstances evolve. By working together and using our collaborative SunTrust SummitView® planning approach, you’ll be able to craft a financial planning and retirement solution that addresses your needs today, and for years to come.