Making the transition from pre-retired (“employed”) to retired is often nerve-racking because we are entering a life-stage where the risk of unrecoverable financial ruin is possible.
Prior to retirement we can make financial mistakes, but we still have time to correct them through employment income. The key being both time and ability. Many have either claimed bankruptcy, or have been on the verge of bankruptcy, and proceeded to “bounce back” in their careers. Some notable names include Kim Basinger, Marvin Gaye, Burt Reynolds, Will Smith and Dave Ramsey. During our pre-retirement years, filing for bankruptcy essentially affords one the opportunity to rebuild their life. Once one enters retirement and no longer has the ability to generate income, this opportunity to rebuild their life after their financial assets are depleted is gone. Hence, financial ruin.
Since most retirees are not generating any income in the form of earned income through employment or as a business owner, they typically rely on other forms of income (ie: retirement assets, social security, pensions and inheritance) to live on. Many strategies have been developed, researched and marketed as strategies for safe income throughout your retirement. Some include the 4% rule, time segmentation, laddering, and the gone fishing strategy. All the strategies are viable approaches for a portion of the retirement population but may be sub-optimal for your situation.
Below is a list of nine risks that you will likely face in retirement. For the majority of retirees, it is not possible to completely diversify away all of the risks. It would, however, be prudent to assess your exposure to each of the nine risks and determine what impact it could have on your plan. If your retirement income plan is constrained, or you are concerned that you may run out of money during your retirement, it is important to be aware of the consequences of over exposure to one or more of these risks.
Inflation/Deflation – Inflation can erode the purchasing power of one’s assets while deflation can negatively impact the real value of your leveraged assets such as a home. In a deflationary environment, liabilities may remain constant (30 year mortgage note) while the real value decreases.
Credit/Issuer – An unexpected change in the issuers credit condition, such as a downgrade or default, can have a negative impact on your portfolio. Sears Holding and PG&E are recent examples.
Market – Unfavorable market conditions that last for an unanticipated period of time, or are much larger than expected can be detrimental to one’s portfolio.
Public Policy – Legislation changes such as tax law or Social Security benefit reduction can affect your income plan.
Spending – Higher levels of spending early in retirement can result in a significant lifestyle change later.
Income – Also known as interest rate risk. Changes in interest rates or market conditions can adversely impact a company’s dividend payout, thereby reducing your income.
Life Shock – Unexpected events such as divorce or death of a spouse can result in major changes to the portfolio. Relatively non-liquid assets such as a business, real estate, etc.,
Healthcare – A change in one’s health condition or a large unexpected medical event could require prolonged spending above and beyond the planned budget.
Longevity – Living longer than you planned or budgeted for will increase the likelihood of not being able to maintain you desired lifestyle.
Understanding your financial situation and the risks that you may face in retirement will help you reduce or avoid possible financial ruin.
Do you have a question regarding this topic, or would you like to learn more about how to evaluate your exposure to these retirement income risks? Please email me below:
Kevin Warman, CIMA®, RMA®
(last updated 01/14/2019)
References:
RMA® Curriculum | 6th Edition (Assessing Retirement Risks, by Francois Gadenne & Michael Zwecher)