7 Major Retirement Risks to Avoid

The way people plan for retirement has changed dramatically over the last several decades. Those nearing retirement should avoid underestimating their longevity as well as stock market volatility. Here are the seven biggest risks retirees should avoid at all costs, along with tips to address them.

1. Longevity Risk

Average life expectancy has increased from 68.14 years in 1950 to 76.1 years in 2021. One of the biggest threats retirees face is outliving their savings, especially since a 30-year retirement is not as uncommon compared to past generations.

Pro Tip: Use a three-buck strategy to allocate savings that address immediate, near-future and long-term needs. Liquid is anything within the next five years; income is what will be needed for the next 30 years or more; and growth is to offset inflation, taxes and future health care expenses. Delaying Social Security from full retirement age until age 70 will provide additional retirement credits at about 8 percent per year, which means a larger benefit later on.

2. Inflation Risk

Since 1914, the average inflation rate has been 3.24 percent, and that number should remain constant even if the percentages are still relatively high for the next several months.

Pro Tip: Use Treasury Inflation-Protected Securities (TIPS) and Series I bonds to hedge against inflation. Stay away from speculative or high-risk investments, including private equity, penny stocks and alternative investments if they don’t match the investor’s risk tolerance.

3. Tax Rates Risk

The Tax Cuts and Jobs Act of 2017 lowered the top tax rate to 37 percent starting in 2018 with the majority of the legislation set to expire in 2026, including a lower standard deduction and higher overall tax rates. Pension, bank or annuity interest, short-term capital gains, ordinary dividends, municipal bond income and retirement plan withdrawals increase the chance Social Security benefits might be taxable. Increased Medicare Part B premiums is also another additional tax for those in retirement who earn over a certain amount.

Pro Tip: Convert a traditional IRA or 401(k) to a Roth in years when income might be lower. Nonqualified annuities (instead of CDs and other bank products) offer tax deferral, which helps with Social Security taxation and Medicare Part B premiums.

4. Health Care Costs Risk

Insurance, Medicare Part B premiums, drug costs, co-pays, co-insurance and deductibles can be costly in retirement. Fidelity estimates an average couple age 65 in 2022 may need about $315,000 saved (after tax) to cover those expenses.

Pro Tip: Health Savings Accounts (HSAs) offer tax-deductible contributions that grow tax-deferred as well as tax-free withdrawals if used for health care expenses. A qualified HSA funding distribution allows a one-time “trustee-to-trustee” transfer up to yearly contribution (whether individual or family) from an IRA or Roth IRA.

5. Long-Term Care Costs Risk

Long-term care is the most expensive cost with home health care, assisted living and skilled nursing costs increasing on average 1.71 percent to 3.64 percent per year.

Pro Tip: Long-term care insurance premiums aren’t guaranteed, which enables other types of “hybrid” policies such as life insurance and annuities with long-term care riders to be an alternative solution.

6. Lifetime Income Risk

Up until the 1980s, pension plans made up a substantial part of a retiree’s income. According to the Bureau of Labor Statistics, that number has decreased substantially to under 20 percent. Today’s retirees are often left figuring out for themselves how to create a guaranteed stream of income for life.

Pro Tip: Immediate and indexed annuities with income riders focus on the distribution phase in retirement. Don’t plan on using the same investments for accumulating wealth as those for what you will be living on.

7. Stock Market Risk

Sequence of returns risk is the danger of receiving lower or negative returns early when withdrawals are made in retirement. The 4-percent withdrawal rule is a safe withdrawal consisting of 60 percent stocks and 40 percent bonds first published in the Journal of Financial Planning in 1994. With low interest rates, this rule has been questioned, as data suggests it should be around 2.95 percent to 3.3 percent.

Also, the Rule of 120 (previously known as the Rule of 100) subtracts your age from 120 to get the right percentage of stocks and bonds in your portfolio. For example, a 55-year-old would have 65 percent in stocks and 35 percent in bonds. The problem is that timing and human nature tends to interfere.

Pro Tip: Don’t use outdated rules just to seek optimal exposure. Individuals should re-evaluate their risk tolerance and focus on saving as opposed to chasing higher investment returns.