Retirees face several risks when planning for retirement. Some of the biggest risks retirees face are market risk (assets will decrease in value), inflation or purchasing power risk ($1 today might not get you the same amount of goods 10 years from now), business risk and interest rate risk. These all pose serious problems for retirees, but with the right plan in place these risks may possibly be mitigated.
Another risk retirees certainly should be planning for (but I’m not sure how many are), is longevity risk. Longevity risk is the risk that retirees outlive their assets. Life expectancy is only getting longer on average. This is overall a positive — because everyone wants to live as long as possible!
But the nuance here: as life expectancy rises, retirement assets must last longer.
The average life expectancy for a 65 year old male is 84.3 and the average for a 65 year old female is 86.6 according to the Social Security Administration website. Remember that life expectancy is simply an AVERAGE of when people of a certain age die. Some people wont’t live to their life expectancy while some people will outlive it by many years. It is impossible to predict where you will fall.
Running out of money while in the late retirement years is the worst case scenario for a retiree. What are you supposed to do then? Unfortunately there is really no good answer to that question. This is a problem that can’t be solved after it happens — it needs to be prevented before it occurs.
There are several strategies to help prepare, so a retiree may not run out of money in retirement.
- Plan for longer than the average life expectancy. Many financial planning and insurance planning tools now build in an assumption that the person will live to at least 95 years old. Some even go as far as 120 years old! If a person dies with money left over, that money can be passed on to a loved one or left to a favorite charity.
- Don’t flip 100% to defense in your portfolio as soon as you retire. A typical retirement age is 65 years old, give or take a few years. Meaning the retirement assets have to last for maybe another 30 years! During the early retirement years it would be wise to keep a portion of the assets invested in the market. This will also help to prevent against inflation risk.
- Save more for retirement in your early years (20’s and 30’s). I fall into this category and can tell you from first hand experience, saving for retirement is on the back end of my priority list at the moment. But just know that the earlier you start to save for retirement the more time (compound interest) works in your favor.
- Have a higher risk tolerance in your early years. Investing in the markets is scary. But there is no reward without risk. Higher risk investments make sense for younger investors because they have more time to make their money back in the event of losses. Taking high risks during retirement years is not advisable.
It may be tempting for a new retiree to splurge in their early retirement years. I understand the temptation; you’ve been working your whole life and you earned all this money. You should be able to spend it on whatever you please and enjoy the golden years. I urge retirees to think twice about behaving this way because it could seriously damage their financial future when it is needed most. Spending in retirement needs to be mapped out and adjusted accordingly on (at least) an annual basis. A retiree’s retirement assets are all they have to live on for the rest of their life. It’s far better to end up with money left over at the end of your life than to run out of it during retirement.
Retirees would be wise to live by the old saying, it’s better to be safe than sorry.