Risks That Must Be Addressed When Developing A Retirement Plan

Financial planning as a profession is undergoing a meaningful change in focus.  Traditionally, retirement was the key goal for planners while working with clients, frequently with additional goals for educational expenses, family legacy, etc.   As the baby boomer generation approaches and enters retirement, planners are realizing that a successful financial plan has to address a much broader array of risks that might negatively impact the client and the success of the financial plan.  At a minimum, the planner needs to have a meaningful discussion with the client about each of the potential risks even if the opportunity for planning is minimal.

The risks range from unexpected changes before retirement actually starts to the impact of extended lifespans and the resulting physical and mental problems that frequently accompany increased longevity.  Some key risks to a successful retirement plan are:

Pre-Retirement and Retirement Planning Risks:

1. Forced Retirement risk – the possibility that work will end prematurely because of poor health, care-giving responsibilities, dismissal by the employer, lack of job satisfaction or other reasons.
2. Reemployment risk – the inability to supplement retirement income with part time employment due to tight job markets, poor health and/or caregiving responsibilities.
3. Unrealistic Expectations risk — the false belief that adequate resources have been acquired for fund retirement resulting in insufficient retirement income planning.
4. Social Security – not choosing the correct election for taking social security, resulting in less than optimal benefits

Risks during Retirement:

1. Long-term care risk – possibility of needing care at an uncertain time for an unknown period of time
2. Healthcare Expense risk – risk of having inadequate medical insurance
3. Frailty risk – the risk that, as a result of deteriorating mental or physical health, a retiree may not be able to execute sound judgment in managing his/her financial affairs and/or may become unable to conduct home maintenance.
4. Risk of the early death of a spouse – financial hardships that may arise upon the death of the first spouse
5. Longevity risk – the risk of living too long and outlasting one’s resources
6. Unexpected financial responsibility risk – when the client acquires additional unanticipated expenses during the course of retirement, such as the need to provide support for a parent, child or grandchild
7. Public policy change risk – an unanticipated transition in government programs that were embedded in the retirement planning process including, but not limited to significant tax increases, elimination of tax benefits, and elimination or minimization of government programs such as Medicare and/or Social Security to the point where they will not provide sufficient protection during retirement
8. Financial elder abuse risk — the possibility that an advisor or family member might prey on the frailty of the client, might recommend unwise strategies or investments, or might embezzle assets from the client.

Investment and Portfolio Related Risks:

1. Excess Withdrawal Risk (portfolio failure risk) – the depletion of retirement assets through poorly planned systematic withdrawals that lead to the premature exhaustion of retirement resources
2. Sequencing of returns risk – a portfolio that includes regular withdrawals will be adversely affected if there are negative returns in the first few years of retirement
3. Inflation risk – the risk that increases in the price of goods and services may impede your ability to maintain your desired standard of living.
4. Liquidity Risk – the inability to have assets available to financially support unanticipated cash flow needs based on investment vehicles selected
5. Reinvestment risk – the chance that as higher-yielding fixed income investments mature, the client may need to reinvest that principal and interest payments into lower-yielding fixed income investments
6. Investment risk – investing too conservatively, too aggressively, and/or inadequately diversify assets
7. Market risk – the risk from events that cause all security prices to fall

Many of these risks can be addressed through newer investment and insurance products like Long-Term Care insurance, Longevity Annuities, etc.  Many are more behavioral issues and require open discussion with the clients and, in some cases, their families to insure there is an awareness of the potential for diminished capacity and its implications.  The most effective financial advisors and planners will realize that the evolution of their profession requires them to think outside the financial “box” so that they can meaningful help their clients as they manage and mitigate the risks involved in the changing world that is “retirement”.

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