Gabe Fransen | November 29, 2022
A big part of our retirement planning process has to do with identifying risks that could hurt our client’s retirement plans. We find it beneficial for our clients to understand what risks we are looking for, if the risks are applicable to them, and if so, how do we recommend mitigating the risk or planning for it. There are several common risks that we look for while we do our financial analysis.
This is the unknown of how long one will live. It would be easier to plan if we all had a preset date, but that is not the case. We are statistically living longer and living active lifestyles for longer, so we want to ensure clients don’t run the risk of outliving their assets. Longevity risk is also the risk multiplier for the rest of the risks. Meaning the longer you live, the more the other risks are magnified. This is why we have Longevity at the top of our list.
This is not Investment risk, as that can be mitigated with diversification of assets. Market risk is the case where it doesn’t matter what your investment is because everything is losing market value all at once. Examples of this would be the dot com bubble that started in 2000 or sub-prime crisis in the housing market that started in 2008. In these previously mentioned situations, for the most part, it didn’t matter what you were invested in, you couldn’t hide from losses, you just had to ride it out.
Order Of Returns
This concept of Order of Returns risk is related to when and how your assets are drawn down in retirement years. Can your plan sustain taking distributions from your assets when your assets are having a period of negative returns. When you are in the contribution phase and are adding assets to your retirement accounts, you can find benefit in a down market because you are able to buy assets at a low and when they go up, your gain is that much more. In the distribution phase of retirement, if markets are down significantly while you are taking distributions, can your assets still go as far as you need them to go?
Everybody’s favorite topic! Taxes may be the number one culprit as to why folks spend more than planned in their retirement years. When folks are in their working years, they often receive a paycheck after healthcare has been paid and after taxes have been paid. Oftentimes the transition into retirement means that medical expenses and taxation is coming out of their pockets, which feels differently than having those expenses paid before that money makes it to their pockets. Oftentimes folks are saving for retirement with 401k’s and 403b’s, very popular tax deferred retirement vehicles. It’s not until retirement where they really understand that they didn’t save money on taxes, they just deferred the tax burden until the distribution phase of their retirement years. They find out that with the rising cost of goods and services, they have to spend more just to maintain their lifestyle and continue to pay the tax on their distributions, a large budgetary item that got missed in their retirement plans. Ideally, folks would have pre-tax accounts, after tax accounts and never taxed again accounts at their disposal in retirement years to lessen the taxation burden in retirement years.
With current annual inflation rates where they are, Inflation is a buzzword right now. Historically speaking, Inflation is typically around 3%, but over the last several years, we have seen inflation closer to 2% which is part of the reason inflation is so high right now, some would say we are making up for lost time. But if you are not planning for annual inflation over the long term, your dollars are not going to go as far as you would expect them to go. So it is extremely important that a drafted retirement plan takes inflation into account to make sure the assets at your disposal can provide you the lifestyle you want or at least the lifestyle you are accustomed to.
Most folks will transition from working years where their Health Care, Dental Care, Eye Care, etc… is completely taken care of or partially taken care of by an employer. When transitioning into retirement where those expenses will need to be taken into account in their spending plan. Unfortunately, going back to inflation with these items, the cost of these items is increasing faster than most other goods and services.
Long Term Care
Long Term Care is a rapidly expanding need as folks are living longer and finding that at some point, they need a level of care that is not able to be provided by a spouse or a family member. Oftentimes Long Term Care is thought of as an insurance, and we have to remind folks that it is not an insurance, it is an event, an event that could last weeks, months or even years. This care is often very expensive and needs to be planned for. You can plan for it by transferring the risk, 100% to an insurance company, you can transfer part of the risk to an insurance company or transfer none of the risk and take on the risk yourself.
These are the common risks that we help our clients identify and then mitigate and plan for through our financial planning process. If we are able to help clients navigate these risk factors we believe that is the foundation to a solid retirement plan for them. Of course, situations change, so we review the plan and the mitigation steps for these risk factors on a recurring basis to make sure our clients are on track with their retirement plan or put further mitigation plans in place.