Many Americans spend more time planning a vacation than they do planning for retirement! That maybe a small exaggeration, but is closer to the truth than most would admit. Retirement is the biggest purchase you’ll make in your life – bigger than your home and the cost of every vacation you’ve taken. Retirement will last many years and there are numerous unknowns. For a married couple both age 65, one is expected to be living at age 90…and reaching 100 or more is no longer rare. No doubt you’ll face many financials risks. Let’s discuss the seven I think most important.
Number one is outliving your money – this is the greatest fear of most retirees and is called longevity risk: the risk your retirement money will fall short or be depleted before you’ve run out of time. What can you do if you face this risk?
- Plan the use of your money and make sure you’re not taking undue risks that might result in losses – retirees have no way to recover financial losses.
- If you have equity in your home, find out about reverse mortgages that allow you to cash in your equity without selling your home and without having to make mortgage payments in your lifetime. A reverse mortgage is not for everyone and you should not use the money for investing and speculating but rather for living expenses or to implement an estate planning strategy.
- Make sure you get your Social Security right – most retirees don’t. Time the start of your SS benefits to save future taxes and have up to $225,000 more benefits during retirement. I encourage you to read my “Guide to Social Security” – you can get a copy from www.retirerx.com.
- Investigate “insuring your longevity risk” by arranging a guaranteed lifetime income from an insurance company.
- Control your expenses as best you can, don’t pay taxes if they can be legally avoided and get the best return you can without risking your principal.
Fighting longevity risk is best done by working with a financial advisor – something that most retirees don’t do and generally a very costly mistake.
The second financial risk is paying taxes you could have legally avoided. Every dollar paid in unnecessary taxes is one less dollar you’ll have for retirement. You should learn about tax-deferring earning if you do not currently need the money for retirement. The longer you postpone paying taxes the more you’ll have to earn interest. In fact, deferring taxes allows your money to grow faster with triple compounding: interest on principal, interest on interest and interest from money not paid to the IRS. Here are some ways to manage your taxes:
- Use tax-deferred saving places like annuities – safe and convenient but many retirees are not aware of this safe money place.
- Investigate converting some of your IRA and other qualified money to tax-free Roth IRAs. You should do this carefully to make sure you remain in the lowest possible tax bracket.
Again, I recommend working with your financial advisor to minimize your taxes.
The third financial risk is inflation – the constant increase in prices. A retiree’s inflation is not the same as a working person’s because more medical care and health-related services are needed. While inflation is largely out of our control, we can nevertheless manage it by opting for predictable, safe and reliable strategies to maintain your purchasing power. A common mistake is thinking you can hedge inflation by putting your retirement money in speculative investments that promise to keep pace with price increases – unfortunately the risk of such strategies might leave you with less money, not more. Since your major “inflation” risk is “health related and medical” I recommend you establish an emergency fund for such contingencies. Also, guard your health by exercising, eating right and refrain from using tobacco. Be aware that what your money buys is just as important as how much you have.
The fourth financial risk you’ll face in retirement is “the market”. It is virtually impossible to watch TV, listen to the radio or read a magazine without an ad telling you why your money should be “in the market”. If you now have market losses you’re told “don’t get out because the market will come back, you’ll be fine longer term or selling now means turning paper losses into real losses”. Or if you have a profit, selling means you’ll have to pay taxes and you’ll do better by staying put. These are myths of Wall Street designed to encourage you to keep your money “in the market” so fees and commissions will continue. The market is risky, as is obvious by what’s happened since 2000. Two major meltdowns and many are currently predicting a third. If you can’t afford the risk, don’t take it – losing your retirement money means you’ll run out of money before you run out of time. Do not invest like you did when you were working even if encouraged by your broker. Do what’s financially best for you, not what’s financially best for your broker. Please realize that “diversified portfolios” of stocks, bonds and other investments will rise and fall with “the market” and therefore, they too, are risky.
The fifth risk is fraud. We generally think of fraud when someone steals money – Bernie Madoff comes to mind. But in my mind there is also fraud when Wall Street misleads you into doing something that is not suitable for your circumstances. Of course, bad advice is not illegal but the results are the same: you and your money are separated. Always keep in mind that promises of high returns involve risk – always know this and never let anyone convince you otherwise. Bank CDs are rock-solid safe and that’s why they’re not earning much today – high dividend stocks and some bond yields may look attractive but there is risk. The promise of high reward and risk travel together – where you find one you’ll always find the other. If the promised return is above market, then so is the risk…always.
The sixth financial risk is the risks associated with reinvesting your earnings. You earn interest, dividends, profits, collect rent, have investments mature and all must be reinvested. To help manage reinvestment risks I advocate “laddering” retirement money so that your savings and investments come due at the time they’re needed. Many retirees have all their money in liquid accounts that can be “cashed in” at any time whereas the smart retirees spaces maturities so money comes available when needed. Granted this takes some planning but you’re assured money will be available when needed. Laddering also facilitates tax-deferred or tax-free growth that means more money later. Laddering retirement money is best done by working with your financial advisor.
The seventh and last financial risk I want to mention is “sequencing your withdrawals” to avoid spending down when your investments have losses. Of course, one way to avoid this is to avoid “the market” except for money you’ll need late in retirement. Other precautions like making sure you always have emergency money that can be accessed quickly if needed. Also, guaranteed-return places like annuities that offer principal protection, tax-deferral and conversion to a guaranteed lifetime income should not be overlooked. Once again, work with your financial advisor.
Of course there are many other risks and hazards you’ll face in retirement, but the ones we’ve talked about constitute your greatest “financial risks”. I recommended working with a financial advisor. It is my experience that the three biggest mistakes retirees make with their money are: (1) trying to manage it themselves without professional help, (2) keeping all their retirement money liquid as if it will be needed tomorrow and (3) taking unsuitable risk of loss. All of these are avoided by working with a financial advisor of your choice.
Will you spend less time planning the rest of your retirement than your next travel excursion? I hope not! Hopefully I’ve given you some help in having a better retirement. I wish for all of you long, and very happy, years of retirement.
Shelby J. Smith, Ph.D.