As a CPA, understanding the critical risks associated with retirement planning is essential for better serving your clients and ensuring their financial future – along with your own. In this article, we will explore five critical risks retirees need to consider and discuss strategies to help manage them.
1. Longevity Risk
Longevity risk is the possibility that you will live longer than anticipated and your retirement savings will be insufficient to support your lifestyle – or even run out. With advances in healthcare and technology, people are living longer than ever, making longevity risk a genuine concern. You should consider strategies such as annuities and Social Security planning to help manage this risk.
An annuity is an insurance product that guarantees a regular income stream for a certain period or the rest of your life. An annuity can be structured in various ways, such as fixed annuities, variable annuities, and indexed annuities, each with its own benefits and drawbacks.
Social Security is another tool for managing longevity risk. By delaying your Social Security benefits, you can increase your monthly payments up to 132% of the standard benefit amount. If you have a spouse, you can also consider strategies such as claiming a spousal benefit or coordinating benefits to maximize your combined Social Security payments.
If you remain healthy and vigorous, consider working longer than the generally expected retirement age. Not only will you continue to grow your nest egg, which will improve your lifestyle when you do retire, but you may also stave off the retirement blues and other neurological disorders associated with a sudden lack of brain stimulation and social activity upon retirement.
2. Health Risk
As you age, the likelihood of needing long-term care increases. Long-term care refers to the services and support required for individuals who can no longer perform the basic activities of daily living, such as bathing, dressing, and eating.
According to the U.S. Department of Health and Human Services, almost 70% of people turning 65 will require some form of long-term care during their lifetime. The average duration of long-term care is approximately three years, and the cost is high, often reaching tens of thousands of dollars per year.
Therefore, it is vital to plan for long-term care expenses. This can involve purchasing long-term care insurance, which provides financial assistance for costs related to long-term care. Additionally, you may want to consider other strategies, such as exploring federal and state government programs like Medicaid, which may help cover some long-term care expenses.
Just as important, however, is to be proactive throughout your life to reduce the chances of developing disease. Prevention is much cheaper than treatment, plus you will have a more fulfilling lifestyle in retirement if you remain limber and mentally sharp. You can achieve this by reducing alcohol and tobacco, improving your diet, and maintaining a consistent exercise regimen.
3. Mortality Risk
On the flip side of longevity risk is mortality risk – the risk of dying younger than expected, potentially leaving your spouse or loved ones with inadequate financial resources. To manage this risk, you may want to look into purchasing life insurance to provide financial protection for your family in the event of your unexpected passing.
Another consideration is estate planning, which involves preparing for the transfer of your assets upon your death. Estate planning can help ensure that your assets are distributed according to your wishes while potentially minimizing wealth transfer taxes such as estate tax, generation-skipping tax, and gift tax.
There are several strategies you should consider. For example, you can create a trust or series of trusts to manage your assets and distribute them to your heirs according to your desires. You transfer the desired assets out of your ownership and into the trust, thus reducing your estate and minimizing taxes owed upon death.
Estate tax has tax brackets like ordinary income and capital gains tax – but the highest bracket is even higher – 40% as of 2023. Fortunately, in 2023 there is a $12.92 million exemption on estate taxes. If your estate isn’t worth more than that, you don’t have to worry about paying a federal estate tax. However, as of January 1st, 2026, that exemption amount will reduce by half, adjusted for inflation. It would behoove you and your clients not to delay estate planning as there are time-sensitive strategies, such as Irrevocable Life Insurance Trusts (ILIT) with a 3-year lookback period.
Unlike a revocable trust, in general, an irrevocable trust can also help avoid the probate process, which can be time-consuming and costly, let alone painful. Probate can also lead to disputes, which is precisely what you want to avoid in a moment of grief.
4. Inflation Risk
Inflation risk is a significant concern for anyone, whether planning for retirement or just creating a yearly budget, especially in times of high or runaway inflation. Over time, inflation decreases the value of your hard-earned money, which means that the same amount of money will buy fewer goods and services in the future. When you go into retirement, inflation’s consequences multiply as you no longer earn money to help combat it. The corrosive effect of inflation may dwindle your retirement savings to such a degree that you may not be able to cover your expenses as you age.
In just three decades, inflation can reduce the value of your nest egg by half. For instance, if you have $3,000,000 at age 65 in 2030 and live until 2060, that sum would be worth only about $1,500,000 in 2030 values with only a 2.3% inflation rate. However, this scenario doesn’t account for annual withdrawals using a retirement strategy like the 4% rule, which would even further decrease the value of your nest egg year by year.
Inflation is affected by various factors, including government policies like money supply and federal reserve interest rates, the lowering or raising of taxes, and federal spending.
One strategy for managing inflation risk is investing in assets that perform well during inflationary periods, such as stocks, real estate, and commodities such as gold and platinum. These assets may provide a hedge against inflation by increasing in value at a rate that outpaces or keeps up with inflation.
5. Market Risk
The ability to create a large nest egg on which to retire is hugely influenced by the existence of the stock market and its many innovations, such as dividend-producing mutual funds and ETFs and the capability to generate compound returns. Unfortunately, the markets take away as much as they give. A poor sequence of returns (when the stock and bond markets have a series of down years) entering retirement can, if not ruin your portfolio, at least weaken it so significantly that it may not recover in your lifetime.
One strategy for managing market risk is to balance risk and return through a diversified investment portfolio. Diversification helps to spread risk across different types of assets, which can help to minimize the impact of market volatility on your overall portfolio. Depending on your risk tolerance and investment goals, this may include a mix of stocks, bonds, and other investments.
A popular strategy is to utilize more aggressive investments in younger years and generally shift to a safer, more conservative investment strategy to reduce a portfolio’s exposure to the market. For example, bonds often aren’t as affected by market downswings as stocks, making them a potentially lucrative investment vehicle heading into retirement.
While in retirement, a dynamic withdrawal strategy can be utilized to coincide with the ups and downs of the market. For example, when markets are high, a greater percentage of a portfolio can be pulled from, and in a down market, a lower percentage. This may not nullify the sequence of returns risk, but it can help minimize its effects better than a fixed-withdrawal strategy can.
In addition to diversification, retirees may also consider the importance of more secure assets in their retirement planning. Secure assets such as cash, certificates of deposit, and fixed annuities can provide a guaranteed income source and help mitigate the impact of market fluctuations on your overall financial security.
In Conclusion
In conclusion, as a CPA, it is critical to understand the five significant risks associated with retirement planning: longevity, health, mortality, inflation, and market risk. Each hazard presents unique challenges that you must address to ensure your and your clients’ financial security.
By incorporating these strategies into retirement planning, you can help your clients achieve their financial goals and ensure a comfortable retirement.
