- Potential for outliving one’s assets;
- Threat of rising living costs;
- Impact of increasing health-care costs;
- Uncertainty about future level of social security benefits; and
- Damage to long-term financial security
With so much at stake when planning a retirement income stream, it pays to take a step back and see whether your plan takes into account the major obstacles to retirement income adequacy.
When you take this big-picture view, consider the five major challenges most retirees face: the potential for outliving one’s assets; the threat of rising living costs; the impact of increasing health-care costs; uncertainty about the future level of Social Security benefits; and the damage to long-term financial security that can be caused by excessive withdrawals in the early years of retirement.
Understanding each of these challenges can lead to more confident preparation.
Standard & Poor’s suggests you consider these five risks to your retirement income, including outliving your assets and higher health-care costs.
Points to Remember
• Today’s retirees have to assess several threats to enjoying a financially comfortable retirement. These include the potential for outliving their assets and the corrosive effects of inflation on future income.
• A sound retirement income plan needs to address specific risks, such as longevity, rising health-care costs, and excessive withdrawal rates, that can lead to premature depletion of assets.
• Demographic trends are likely to put added stress on government-run programs, including Social Security and Medicare, which help retirees balance their budgets.
• The goal of retirement income planning is to create a sustainable, predictable stream of income that also has the potential to increase over time.
Examining the Issues
Longevity. While most people look forward to living a long life, they also want to make sure their longevity is supported by a comfortable financial cushion.
As the average lifespan has steadily lengthened due to advances in medicine and sanitation, the chance of prematurely depleting one’s retirement assets has become a matter of great concern.
Inflation varies over time, as well as from region to region and according to personal lifestyle. Through many ups and downs, US consumer inflation has averaged around 4% over the 50 years ended December 31, 2006.
If inflation were to continue increasing at a 4% annual rate, a dollar would be worth 44¢ in just 20 years.
Conversely, the price of an automobile that costs $23,000 today would rise to more than $50,000 within two decades.
For retirees who no longer fund their living expenses out of wages, inflation affects retirement planning in two ways:
- It increases the future cost of goods and services, and
- It potentially erodes the value of assets set aside to meet those costs—if those assets earn less than the rate of inflation.
Health Care
The cost of medical care has emerged as a crucial element of retirement planning in recent years.
That’s primarily due to three things: Health-care expenses have increased at a faster pace than the overall inflation rate; many employers have reduced or eliminated medical coverage for retired employees; and life expectancy has lengthened.
In addition, the nation’s ageing population has placed a heavier burden on Medicare, the federal medical insurance program for those aged 65 and older, in turn forcing Medicare recipients to contribute more toward their benefits and to purchase supplemental insurance policies.
Because of the higher cost trends affecting private health insurance, the same retiree relying on insurance coverage from a former employer will have to allot nearly $300,000 to pay health insurance and Medicare premiums, as well as out-of pocket medical bills, according to a Money magazine report.
Excess Withdrawals
The decision about how much money may be safely withdrawn each year from a retirement nest egg should take into consideration all the risks mentioned above.
But retirees also must consider the fluctuating returns that their personal savings and investments are likely to produce over time, as well as the overall health of the financial markets and the economy during their withdrawal period.
Addressing the Risks
While the risks discussed above are common to most people, their impact on retirement income varies from person to person.
Before you can develop a realistic plan aimed at providing a sustainable stream of income for your retirement, you will have to relate each risk to your situation.
For example, if you are in good health and intend to retire in your mid sixties, you may want to plan for a retirement lasting 30 years or longer.
And when you estimate the effects of inflation, you may decide that after you retire you should continue to invest a portion of your assets in investments with the potential to outpace inflation.
Developing a realistic plan to address the financial risks you face in retirement may seem beyond your capabilities. But you don’t have to go it alone.
An experienced financial professional can provide useful information, as well as valuable perspective on the options for managing successfully what may stand in the way of your long-term financial security.
