Common pitfalls on the road to retirement include spending too much, investing too little, and deviating from your goal. The good news is you may be able to prevent them with some self-control and foresight.
Certain dangers, such as a health emergency or a market decline, can’t be eliminated, but they may be mitigated with the right preparation and planning. Listed below are four potential threats to your retirement plan and some precautions you may take to mitigate them.
#1 Running out of money.
Americans are living longer than ever due to improvements in medical technology, awareness, and better lives. While that is great news, it raises the risk that you won’t have enough money in retirement if you’re one of the 28% of individuals who, according to a Society of Actuaries poll, underestimate their own projected life duration by five years or more.
Many people base their expectations on the longevity of their own families. Nevenka Vrdoljak, managing director and analyst, Chief Investment Office, Merrill Lynch Bank of America Private Bank, notes that life expectancies have increased significantly from one generation to the next.
However, you can delay receiving your Social Security benefits by waiting until you reach a later age. Suppose you wait until you’re 70 to start collecting rather than 62. In that case, your monthly income “may theoretically increase by 77%, as Vrdoljak puts it. She goes on to say that people “sacrifice income early on” because they expect bigger Social Security payouts in their “80s and 90s.”
Solution: Investigate whether or not an annuity suits your needs. The possibility of outliving retirement funds can be mitigated by purchasing a lifetime income annuity, which guarantees a steady stream of payments for the rest of your life. Due to this, it can also serve as a hedge against market volatility (see Risk #2). Due to the costs and hazards associated with annuities, it is important to discuss your options with your financial advisor before making a final choice.
#2 Market Fluctuations
While markets have generally risen throughout time, they are nonetheless subject to fluctuations. The value of your investments may decrease significantly if the market has a sharp decline just before or when you begin withdrawing funds from them in retirement, which might have serious long-term ramifications. Vrdoljak warns that if the first four or five years of your retirement are unfavorable, it might be impossible to recoup, even if the market improves.
Solution: Reevaluating your investment strategy. You may want to adopt a more conservative investment strategy as you approach retirement. A 100% cash, CD, and bond portfolio may underperform the market in the long run (see #3 Risk); thus, keeping some exposure to equities is necessary. Vrdoljak suggests striking a somewhat cautious asset allocation to lessen the likelihood of running out of money in retirement.
Withdraw your funds with caution. Talk to your financial planner about creating a withdrawal plan that accounts for your age, risk tolerance, and cash demands. When you retire, you may find that your safe withdrawal rate (the basis for your annual payment) shifts as you age.
#3 Inflation
Inflation, even little inflation, eats away at your purchasing power. Individuals in their golden years are particularly at risk. Every $100,000 invested over a decade at a reasonably modest inflation rate of 2% can be worth only $81,707 by the end of the time (Calculations as of June 2024, according to estimates made using the Bankrate.com inflation calculator.) And if you retire and live off your savings for the next 25 years, that number could end up at $60,346.
Solution: Look into possible investments that could keep up with inflation. Vrdoljak speculates, “That might be real estate or stocks.” Bondholders could benefit from diversifying their portfolios with Treasury Inflation-Protected Securities (TIPS). The interest rate on these government bonds fluctuates with the rate of inflation. She said these investments might help “balance” inflation if it were to spike for any reason. Make sure you take care of yourself in a way that won’t deplete your resources. If you don’t, you could be unable to provide for yourself and your loved ones in the way you’d like to down the road.
#4 Increases in the cost of healthcare
Financially, people don’t systematically plan for prospective healthcare bills, Vrdoljak adds. The potential of requiring long-term care is very crucial to think about. Health and Human Services report that 70% of Americans aged 65 and more will require some form of long-term care at some time in their lives. This may involve moving into an assisted living facility or just needing assistance with activities of daily living, such as bathing or cooking.
Even if you are lucky enough to avoid such expenses, it is probable that your healthcare expenditure will rise as you become older. It is also important to remember that Medicare does not cover all of these expenses.
Solution: Prepare yourself financially for needing long-term care. Long-term care costs can vary widely, and some people may be able to cover them on their own or with the help of their adult children or other relatives. However, long-term care insurance might be the solution for many others in a similar situation. Consider getting long-term care insurance when you’re in your 50s if that’s what you decide to do. The price increases with age and some medical problems may make coverage unavailable.
A health savings account is something to think about (HSA). Your eligible medical expenses can be paid using this tax-advantaged method if you have a high-deductible health insurance plan. Your contributions may be tax deductible, your investment growth may be tax-deferred, and any withdrawals used to pay for medically necessary costs won’t cost you any federal income tax. Your Health Savings Account (HSA) balance can be invested, allowing it to grow over time. And you may use the funds in your account to help pay for some expenses that Medicare won’t.