There are many retirement risk factors to consider when retirement planning. Many suggestions come from surveys, which can only represent general cases at best. Use this article as a guide. The best way to manage risk is to plan for every possibility (can it occur), regardless of the probability (will it occur). If applicable, planning should include a spouse or partner.
Deciding on a retirement age
When planning for retirement, one of the most critical decisions is the age at which the transition to the retirement phase will begin. Surveys suggest that most people have an expectation of retiring at the same age as their parents. There is also an expectation that the standard of living will be the same after retirement as during the working phase. In such a Voluntary Retirement scenario, financial plans can be developed that indicate the saving needed each year in order to achieve the desired post-retirement standard of living. Usually such plans assume maintaining the current job until retirement, along with a slowly rising annual income.
Premature, Involuntary Retirement can seriously disrupt plans developed based on a voluntary retirement scenario. The risk of involuntary retirement is higher that many people realize: as many as 25%  to 28%  of retirements fall into this category. The major factors contributing to this risk are the following:
- Decline in personal health, leading to the inability to continue working
- The need to quit working in order to take care of a family member
- Unexpected, extended job loss, especially when due to economic recessions. Note that even if a new job can be quickly found, it might pay substantially less than a previous position. This can lead to a lower earning potential at the most critical phase of retirement savings - just before retirement.
The prospect of an earlier-than-planned retirement creates a nasty shock for the potential retiree. Since the number of years left to accumulate retirement assets is less than planned, the annual savings must become substantially larger. This can seriously disrupt their pre-retirement lifestyle. And if sufficient savings can not be accumulated, the post-retirement standard of living must also be reduced. In fact, involuntary retirement is typically associated with a sharp drop in retirement spending. 66% of involuntary retirees report being bothered somewhat or a lot by not having enough income, whereas only 21% of voluntary retirees report similar feelings.
Voluntarily delaying retirement
There are financial advantages to delaying retirement. In 2007, and again in 2009, the Society of Actuaries asked retirees if their financial security would have increased by delaying retirement for 3 years. The most significant reason pre-retirees offered for delaying retirement is so they can continue receiving employer-provided health insurance; a significant benefit for those not yet eligible for Medicare. Other reasons for delaying retirement included:
- Increasing the amount received from Social Security
- Increasing the amount received from a defined benefit pension plan
- Having 3 more years to make contributions to investments
- Relying on your savings for a shorter period of time
The study found that pre-retirees were more likely than retirees to think that the factors listed above would increase their retirement security. In reality, financial security depends on individual factors. As detailed below, for actual retirees, working longer is not a popular choice.
It is also important for those who would like to work longer to plan realistically. Skills must be kept up-to-date and coworker networking must be maintained to keep pace in the workforce.
Retirement risk concerns
According to a survey by the Society of Actuaries (2009), the top risk concerns for retirees are:
- Health care: Inadequate funds to pay for health care and long-term care (highest concern)
- Income volatility: retirement income will vary with interest rate (highest concern - tied with health care)
- Inflation: savings and investments may not keep up with inflation
- Preserving the existing standard of living, including concerns to provide for a surviving spouse
Lesser concerns are for remaining in an existing home, providing for heirs, or being forced to rely on assistance from family members.
Managing financial risk
In this same 2009 survey, the most popular strategies to manage financial risk are:
- Debt reduction; most notably the elimination of consumer debt and paying off the mortgage
- Increase saving
- Reduce spending
Asset management strategies are also utilized as retirees age. The most popular strategies are to move assets into more conservative investments and to invest a portion of assets into stock or stock mutual funds. Less popular strategies include investing in real estate, purchasing an annuity, or choosing an employer plan that provides guaranteed income for life. Very few retirees choose to reduce risk by delaying Social Security, moving to a less expensive home, or working longer.
Managing health risk
By far, the most utilized strategy retirees employ for managing health risk is to maintain a healthy lifestyle. Next in popularity is the purchase of health insurance to supplement Medicare or participate in an employer-sponsored retiree health plan.
Other strategies include:
- Self-insuring: Saving for the possibility of large health expenses or long term care
- Purchasing long-term care insurance
- Arrangements with a continuing care retirement facility (less popular)
Application of risk management strategies
Risk management strategies start with identifying risk events that apply to a retiree's unique situation. Relying on survey data or other research is a good start. The retiree should understand that this information 1) may not apply to the retiree's situation and 2) may utilize different assumptions that can lead the retiree astray.
Then for each risk event, choose an appropriate risk management strategy and incorporate it into a retirement spending plan (see the sidebar on the right). Regardless if a risk is possible or not (can it occur), having a plan prepared in advance is time well spent when a low probability risk unexpectedly occurs in reality.
One technique to incorporate these events is to plan for a "risk-free" retirement. Then, extend the budget for each risk scenario. This can be done in a spreadsheet by adding columns for each scenario and copying the formulas across. Reduce each category by a percentage. For example, if one spouse is disabled, car expenses go to 50%.
Risk Events That Apply to Both Pre- and Post-Retirement
- One or both spouses become disabled
- One spouse passes away
Pre-retirement Risk Events
Pre-retirement risks affect your ability to save for retirement.
- Job loss
- Health/medical crisis
- Unanticipated expenses for children or parents
Post-retirement Risk EventsINCOME RISKS
- Living too long
- Death-of-spouse induced loss of pension
- High inflation
- Financial market meltdowns
- Long-term care without insurance coverage
- Unanticipated expenses for children or parents
Risk management strategies
Strategies for Managing Financial Risks
- Invest in stocks or stock mutual funds
- Cut back on spending
- Increase savings
- Eliminate all consumer debt, such as by paying off credit cards and loans
- Completely pay off your mortgage
- Move assets to increasingly conservative investments as you get older
- Buy real estate or invest in property
- Buy a product or choose an employer plan option that will provide you with guaranteed income for life
- Work longer
- Move to a smaller home or less expensive area
- Postpone taking Social Security
Caveat: The above investment recommendations (stocks, real estate, annuities, etc.) should be evaluated against your specific portfolio needs. If unsure, ask in the forum for advice.
Strategies for Managing Health Risks
- Maintain healthy lifestyle habits, such as a proper diet, regular exercise, and preventative care
- Purchase health insurance to supplement Medicare or participate in an employer-sponsored retiree health plan
- Buy long-term care insurance
- Save specifically for the possibility of having large health expenses or needing long-term care
- Move into or arrange for care through a continuing care retirement community
- Erik Hurst, Understanding Consumption in Retirement: Recent Developments, Chapt. 3 in Recalibrating Retirement Spending and Savings (eds. John Ameriks and Olivia Mitchell), Oxford University Press (2008) pp 29-45.
- Marie-Eve Lachance and Jason S. Seligman, Involuntary Retirement: Prevalence, Causes and Impacts, Paper presented at the annual meeting of the Association for Public Policy Analysis and Management -APPAM (2009), 47p.
- Key Findings and Issues–Process of Planning and Personal Risk Management PDF, page 6.
- Key Findings and Issues–Process of Planning and Personal Risk Management PDF, page 10.
- 2009 Retirement Risk Survey, full report, page 15.
- 2009 Retirement Risk Survey, full report, page 17.
- 2009 Retirement Risk Survey, full report, page 20.
- 2009 Retirement Risk Survey, full report, page 23.
- 2009 Retirement Risk Survey, full report, page 45.
- 2009 Retirement Risk Survey, full report, page 48.
- Page numbers are from the Adobe reader, not the report.
Society of Actuaries (SOA)
From the Society of Actuaries (SOA):
- Post Retirement Needs and Risks. Research related to financial risks and needs after retirement
- 2009 Retirement Risk Survey, the complete (full) 2009 report. Extracts are listed below.