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Afraid of Running Out of Money in Retirement? Securing Durable Retirement Income Doesn't Just Happen - Michael M. McDonough, Inc.
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Afraid of Running Out of Money in Retirement? Securing Durable Retirement Income Doesn’t Just Happen

Afraid of Running Out of Money in Retirement? Securing Durable Retirement Income Doesn’t Just Happen

Planning for retirement is a responsibility that causes financial anxiety for many. This is understandable. As the first generation to fund retirement predominantly via our investments, it is abundantly clear: we ‘Baby Boomers’ are increasingly “on our own” for retirement security.

With expanded life expectancy comes a longer retirement of unknown duration to fund. Corporate pensions are increasingly rare and demographic realities threaten already fragile government-provided ‘safety nets’ (Social Security, Medicare and Medicaid). Unexpected health care needs and costs can appear out of nowhere. Complexity abounds; risks are many. Critical factors and contingencies must be navigated amid uncertainty, at a time when our mental faculties may be in decline. These include inflation and interest rates, investment returns, our health and that of loved ones, and public policy, among others.

One way to lessen anxiety is to develop a plan for managing financial risks. A formal, written plan for creating your retirement income is a good place to begin.

“What’s my income?” is the central question retirees want answered. This query is generally followed by “how long will my income last?” and “will my income keep pace with inflation?” Answering these fundamental questions is very different than knowing your net worth or accumulated retirement sum. They require careful consideration of an optimal Social Security claiming strategy and a detailed, personalized plan to ensure your supplemental monthly income derives from stable investment.

Many types of risks capable of devastating your retirement security need to be identified, and mitigated or managed. Principal among these are Timing Risk, Inflation Risk, and Longevity Risk.

Timing Risk is picking a bad year to retire – like 2000 or 2008, just when stock prices are poised to fall. Some degree of investment risk is unavoidable. Central to understanding and mitigating this risk is to realize the best chance of achieving favorable investment returns entails keeping assets invested over long periods. One way to accomplish this is via time segmentation, or dividing investment assets into different ‘buckets’. One or two of the buckets are invested in a conservative manner to provide reliable income for, say, the initial ten years of retirement. Refraining from accessing the other investment buckets for such an initial period provides the time needed to enhance the odds of favorable investment returns for those assets.

There is no question those in the ” Retirement Red Zone” (5 years before after retirement) are particularly vulnerable to returns over this pivotal period.

As wealth approaches its zenith, investment performance impacts both accumulation and sustainable withdrawal rates in an amplified, if not immediately apparent, way.

Inflation Risk is the risk that rising prices could threaten your standard of living in the future. Inflation’s compounded effect can be dramatic, particularly over what could be an extended retirement period. Annual inflation of say 2.8% may sound benign; however, compounding at such a rate over 25 and 30 years would require $1,994 and $2,290, respectively, to fund today’s $1,000 outlay.

Longevity Risk describes the potentially adverse economic consequence of a long life – i.e. the risk of outliving your savings. Evaluating your longevity odds using current health information and actuarial tables can be illuminating.

An antidote to longevity risk is securing guaranteed income for life, regardless of how long that is.

Social Security is designed to provide lifetime, inflation-adjusted income. Its value is significant, and coordinating an optimal strategy is essential. While every case is unique and demands a personalized analysis, the approach of having the higher-earning spouse delay the start of benefits to age 70 can constructively serve as longevity insurance. [Social Security benefits increase by 8.0% for each year from age 62 – 70 the start is deferred.]

Survivor planning is one of the most important aspects of Social Security planning.

A core principle here is understanding that if both spouses are receiving Social Security and one spouse dies, the surviving spouse starts receiving the higher of the two benefits and the other benefit ceases.

A plan for creating retirement income should try to anticipate and mitigate major risks to the extent possible. Converting savings into sustainable income for one or two lives entails good decisions in an increasingly complex and uncertain world, a challenge exacerbated by persistently low interest rates and somewhat elevated asset prices. With proper guidance, however, the job is not insurmountable.

Michael M. McDonough, RICP®, AIF®, CPA (inactive)
Michael M. McDonough, RICP®, AIF®, CPA (inactive)