Retirement risks: A comprehensive overview
For some retirees, retirement is an era of hope and fulfilment. For others, it is a minefield, littered with risks and pitfalls. The difference between the two groups is that one manages the risks of retirement far better than the other does.
After all, risks are an inherent aspect of life; how we choose to manage it matters. Indeed, none of the retirement pitfalls is insurmountable. When doing retirement planning, you should consider the potential or inherent risks associated with it.
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Purchasing power risk
With inflation being the norm and taxation being a financial reality, retirement income—particularly fixed retirement income—loses value precipitously over time. The concern to retirees is the loss of real value of savings and income in retirement.
Apart from being an inherent burden, this poses a dilemma to retirees in terms of how much risk to take when investing. Having an ultra-conservative portfolio exposed the retiree to purchasing power risk more while investing more aggressively increases the market risk.
Longevity risk is a fancy way to definethe risk of outliving your savings. Particularly when retirees fail to plan properly, they find themselves scraping the bottom of the proverbial barrel before their 10th year of retirement. Increased life expectancies are also placing an additional burden on retirees' nest egg. With inadequate nest eggs, other risks of retirement and longer retirement periods, longevity risk will be the most significant retirement challenge we face.
Trying to save or invest in the financial market has attendant risks, particularly retirees—who face shorter investment horizons. As we saw with purchasing power/inflation risk and longevity risk, retirees need to have some capital growth to sustain their standard of living throughout potentially longer retirement periods.
Even retirees who are annuity investors are exposed to market risk to an extent, especially where variable annuities are concerned. In difficult or uncertain economic circumstances, retirees may not be certain about retirement fund allocations. Managing market risk is about balance and comfort—portfolio diversification and risk tolerance.
The golden rule of financial planning is that you spend less than you earn. In retirement it is easy to fall in the trap of spending too much too quickly, particularly in the first few years of retirement. Failing to cut off spending leaks in retirement does not merely your retirement income; it threatens your retirement savings. This increases longevity risk and may force the retiree to take more risks in the hope of recouping lost savings and saving less in order to keep pace. Given that fixed retirement incomes decline significantly over time, it is wiser to be frugal initially and have more to spend later. The attitude that you could die tomorrow, so it does not matter does is irresponsible at best.
Household shock risk
"Retirement engineers" use the term "Household Shock risk" to denote uncertainties that create risks in domestic life. Household Shock risk captures the uncertainty provided by unforeseen expenses or circumstances within your household. Death of a spouse, illness, divorce and unemployment are some of the risk that can appear to thwart retirement plans and ambitions.
While retirement planners tend to focus on financial aspects of retirement, for mental health and well-being, retirees should also focus on the socio-psychological dimension of it. Some might face isolation as they get older or find themselves feeling inadequate or without purpose. Since most persons have spent the majority of their adult life in employment, this is quite understandable. Having a job provides an in-built social life. Those on the cusp of retirement and those who have already retired should become socially active after retirement, and find ways to keep themselves mentally active and alert during retirement.
Tax/ legislation risk
When things go wrong sometimes, it is easy to blame the government for what they did and did not do. Sometimes, governments introduce unfavourable legislation or changes in the tax structure that negatively affect retirees, like a reduction in the personal allowance or increase in property taxes. Tax or legislation risk is one retirement risk that is not under your control. This merely underscores the importance of properly managing the risks over which you have control.
As we become older, we become increasingly prone to illness, especially critical illness. You should note how many health insurers stop medical coverage for seniors once they cross a certain age—usually around 70. Huge medical bills and poor health combine to wipe the sheen off your golden years and make a dent in your standard of living. WIth health, prevention is far better than cure. Thanks to the availability of books on healthy living, you can get a headstart in living a healthy and productive retirement. It is in your hands.
The good news is that no retirement risk is insurmountable. Prudence, proper planning and living within your means are ways to ensure that you do not descend into poverty during your golden years. We are designed to overcome obstacles, or at least withstand many. Retirement risks are like potholes on the road—you can skilfully avoid them, allow them to give you a rough ride or have them derail you. Ultimately, it is your choice.
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