Imagine this scenario: You retire and begin receiving your retirement income. But the monthly numbers seem too small. Where did the money go? Have you been robbed?
No one wants to get to retirement only to discover that their retirement income isn’t going to cover their needs and wants. You can imagine how frustrating this must be, especially if you feel like you tried to do the right things.
The problem is this: When it comes to planning for your retirement income, it’s easy to overlook some of the common factors that can affect this income. If these factors aren’t taken into consideration, then you may find that you will not have the enjoyable retirement you envisioned.
All investments carry risks – some, of course, are riskier than others and not all investments have the same risks. This means that sound retirement planning must take these risks into consideration, especially in terms of how they will affect later income. Here are the three main investment risks to consider:
- Market risk: This is the risk that creates changes in the price levels of the market that may reduce the value of your retirement savings. If you assume that market fluctuations average out over time, then you’ll estimate your return based on that average. Unfortunately, the market doesn’t always generate positive returns, and this can last for several years. This is known as a negative sequence of returns. If you withdraw money when dealing with negative returns, your retirement funds will run out faster than you planned, thus timing can be critical and cannot always be controlled.
- Reinvestment risk: The risk that when it is time to reinvest, you might have to do so at a lower level or return or take on greater risk to pursue the same level of return. In most cases, this risk happens with fixed-interest instruments like bonds or CDs.
- Interest rate risk: The risk that rising interest rates will cause some of your investments to drop in price. For instance, when rates rise, so do bond rates. This would make bonds bought during a lower interest rate less valuable. Additionally, some stocks and mutual funds drop with rising interest rates as investors switch to higher-yield bonds instead. Finally, higher rates can lead to a riskier business environment based on a higher cost of borrowing that can cause a domino effect leading to a recession.
Another factor to consider is inflation risk. This is the risk that the purchasing power of your money will go down over time, as the price of goods and services increases.
Fact: With 3% inflation, the purchasing power of your money will be cut in half in 23 years. With 4% inflation, it only takes 18 years to cut in half.
A simple example illustrates the impact of inflation on retirement income. If $50,000 is enough for your needs this year, you’ll need $51,500 next year for the same goods and services. In 10 years, you’ll need about $67,195.
Therefore, to outpace inflation, you should have some strategy in place that allows your income stream to have potential to grow throughout retirement.
(The preceding hypothetical example is for illustrative purposes only and assumes a 3% annual rate of inflation without considering fees, expenses, and taxes. It does not reflect the performance of any particular investment.)
Long-term Care Expenses
Long-term care may be needed when physical limitations impair your ability to perform everyday basic tasks. As life expectancies increase, so does the potential need for long-term care. However, paying for long-term care can have a significant impact on retirement income. And quite possibly at a time when your pool of resources are at the lowest near the end of your life.
While not everyone needs long-term care during their lives, ignoring the possibility and failing to plan for it can leave you or your spouse in financial trouble.
The Cost of Catastrophic Care
As the number of employers providing retirement health-care benefits dwindles, and the cost of medical care continues to spiral upward, planning for catastrophic healthcare costs in retirement is becoming more important. Despite the availability of Medicare coverage, you’ll likely have to pay for additional health-related expenses out-of-pocket, such as Medicare Part B and Part D prescription drug coverage. Plus, if you don’t choose to purchase supplemental Medigap insurance, you may need to cover Medicare deductibles, co-payments, and other costs. Click here to learn more about the ins and outs of Medicare.
The effect of taxes on your retirement savings is an often overlooked but significant aspect of retirement income planning. Taxes can eat into your income, significantly reducing the amount you have available to spend.
It’s important to understand how your investments are taxed. Some income, like interest, is taxed at ordinary income tax rates. Other income may be taxed at special lower rates, while still others can be exempt from federal income tax altogether.
Fact: Did you know that all income from a 401(k) and IRA (unless it is a ROTH IRA) are taxable, and that, in certain circumstances, Social Security income is taxable as well? Click here to determine if your Social Security benefits will be taxed.
You should understand how the income generated by your investments is taxed so that you can factor this into your overall projection.
Finally, you need to consider your retirement goals. Just what do you envision during these years? Globe-trotting will require different income than spending time locally with family and friends. Starting a new business venture will look substantially different than taking some classes to learn a new hobby.
When planning for your retirement, consider these common income robbing factors in tandem with your retirement goals will allow you to plan wisely and help you feel more in control of your retirement income. Click here to connect with us today to learn more about retirement planning and the factors that can affect you.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
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