Monday, June 11, 2012

Risks in Retirement

I’m back home from Chicago, where I attended an interesting forum on retirement income. One point I heard which helped clarify what I was already thinking is that when talking about retirement, it is important to consider:
  • retirement goals
  • risks that might prevent meeting those goals
  • retirement income building blocks and how they may be combined in a personalized way to best meet one’s goals and protect against the risks

The interesting detail I heard added to this list is that prospective retirees want to consider all of the retirement risks in one sitting. Get the pain out of the way. Sounds reasonable. I’d like to start exploring this here.

My main source for this discussion is the list of 15 risks created by the Society of Actuaries in their publication, Managing Post-Retirement Risks: A Guide to Retirement Planning. That publication provides a lot more detail. I’m just looking to provide an overview. I’m also going to list these in a different order from their publication in order to try to group the risks into two broad categories.

Macroeconomic / Political / Societal Risks

1. Sequence-of-returns risk: Financial market returns near the retirement date matter a great deal. Even with the same average returns over a long period of time, retiring at the start of a bear market is very dangerous because your wealth can be depleted quite rapidly and little may be left to benefit from any subsequent market recovery.

2. Inflation risk: retirees face the risk that inflation will erode the purchasing power of their savings as they progress through retirement. Even with just 3% average annual inflation, the purchasing power of a dollar will fall by more than half after 25 years.

3. Interest rate risk: Decreasing interest rates may provide capital gains for a bond portfolio, but they also lead to lower annuity payout rates and lower interest payments on reinvested funds. Increasing interest rates, on the other hand, may result in capital losses for a bond portfolio, though annuity payout rates and interest on reinvestments will grow.The risk here is if the duration of one's assets does not match the duration of their liabilities.

4. Credit Risk/Business Risk: Fears here include defaults by bond issuers, an insolvent annuity provider, a corporate pension plan which reneges on its promises, and the danger of holding one’s employer’s stocks in a 401(k).

5. Public Policy Risk: The government could change the rules. Possibilities include increased taxes, reduced benefits from Social Security or Medicare and Medicaid, increased contributions to Medicare, changing rules about IRAs, and so on.

Personalized Idiosyncratic Risks

1. Longevity Risk: You don’t know how long you will live and while it is great to live longer, it is also more costly and a bigger drain on your resources.

2. Employment Risk: There is a risk of losing one’s job involuntarily before the planned retirement date, or being unable to maintain desired part-time employment in retirement.

3. Loss of Ability to Live Independently: This one is self explanatory.

4. Change in Housing Needs: Retirees may need housing with greater accessibility or with ease of access by some caregivers.

5. Death of a spouse: This is a tough one, especially if the deceased spouse handled most of the family finances or had pensions/annuities which do not continue to the survivor. Two items worth reading about this include Jennie Phipps' "When Tragedy Strikes" and Bob Seawright’s "Typically Boyish and Socially Unacceptable."

6. Other Change in Marital Status: A divorce can completely change the picture for retirement income strategies.

7. Unexpected Health Care Needs and Costs: Health care prices tend to grow faster than consumer inflation, and it is hard to know how to plan for distant health care costs.

8. Lack of Available Facilities or Caregivers: Providers may not be available in the local area, couples may need to be split when one spouse requires greater care, and a subpar caregiver may be chosen.

9. Unforeseen Needs of Family Members: Retirees may find unexpected demands to help other family members, including parents, children, and grandchildren.

10. Bad Advice, Fraud, or Theft: As cognitive abilities decline with continued aging, retirees are increasingly at risk of becoming victims of fraud, even from family members.

One more which doesn’t appear to be on the Society of Actuaries’ list is the risk that a retiree makes a plan and then fails to stick to it by overspending.

Kind of depressing, but that is a basic list of risks. Can you think of anything else? Any tips on how to prepare for these risks, especially the one’s not really related to a retirement income strategy?


  1. Interesting list. I'd recast the last one - declining mental capacity to make good financial decisions (aka losing your marbles risk), whether through gradual attrition or some disease such as Alzheimers, which is growing more prevalent. Simplifying portfolios (e.g. fewer asset classes and ETFs; funds instead of individual securities), avoiding the necessity to face complex product evaluations later on, putting things on autopilot, having simple income strategies and products, finding trustworthy and capable alternate decision-makers and advisors all are possible methods of responding to this risk.

    1. Thanks for the suggestions. You are right... declining cognitive abilities should be separated from fraud/theft. Those are really two different issues. Got it.

  2. Some excellent points here. A lot of people don't seem to take the time to think about any of the risks involved in their retirement planning.

    1. Thank you Ruth. Interesting website too.

  3. Wade - it is great to see all these risks in one place and hopefully able to be addressed in an integrated way. My question is a little off topic, but has to do with the first risk - sequence of returns. A recent paper by PIMCO ( on the glide path used for target date retirement funds suggests that pre-retirees' fixed income allocation should be 80% when 5 or fewer years from retirement, 65% when 5-10 years away, and 50% when 10-15 years away. These allocations are much more conservative than I usually see recommended and I'm trying to figure out how to reconcile them with the 4% "rule" that generally recommends somewhere around 50% in stocks throughout retirement. I guess the bottom line is that the sequence of returns is important not only in retirement, but also several years before retirement, and I haven't see much else written on this. Love your blog!

    1. Thank you very much.

      Ah, the glide path / asset allocation question. I should write about this all in one place one of these days, because it is fragmented in bits and pieces all over my blog.

      The safe withdrawal rate studies based on historical data usually say 50-75% stocks. That is rather high compared to most other sources. Several reasons for this include: the historical data overweighs a period where bonds did very poorly, making stocks look better, and failure rates do not look at how big the failure is.

      You are right that sequence of returns risk also applies before retirement (in my opinion, some will disagree). You are most at risk when you have the most to lose, which is generally the years around the retirement date. A given percentage drop in wealth leads to the biggest lost of dollars. But the day you retire is incredibly risky too, because pre-retirement it is easier to stay employed than returning to work after retiring.

      Two other blog entries I have about asset allocation include:

      And I will revisit this again one of these days. Thank you.