Risk is defined as the probability of loss or injury.
It generally weighs the downside potential of a particular investment or opportunity.
In regards to your retirement savings, there are several risks to consider.
Let’s take a look at five risks that could jeopardize your retirement savings:
Investment Risk
Most folks have their retirement savings sitting in some type of investment mix or portfolio.
Even a conservative investor may have a model portfolio with 20% stock!
Any time you invest money in the market, or even in investments like gold, you are taking on investment risk.
In simple terms, investment risk is the downside potential of a particular investment.
How to Deal With It
The first step is to assess your investment risk.
How aggressive of an investor are you? Do you lose sleep at night when the Dow drops a couple hundred points during the day?
Make sure your investment risk is in line with your comfort level and your risk tolerance.
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Longevity Risk
These days, retirement savings are affected more and more by longevity risk.
Longevity risk to your retirement savings has to do with how long you live compared to how long your money lasts!
Does longevity run in your family? Do you plan to hit the century mark?
Obviously the longer you live, the more money you will need to have.
For example, say you retire at age 65. If you plan on living to age 95, that is a 30-year retirement you need to pay for!
How to Deal With It
Of course none of us knows when we’ll see our last day on earth, but we can still plan.
Longevity risk can be dealt with by running numbers and making sure you’ve saved enough to cover your expenses and lifestyle for say a 30-year retirement life span.
You can also use things like annuities that provide guaranteed income for life – like your own mini-pension.
Health Risk
Ok, so we all face the possibility of being diagnosed with some catastrophic disease, however, the odds go up in retirement. It’s a natural part of life.
You could face the possibility of needing a stay in a nursing home, or having someone come into your home to help take care of you.
You could just be facing doctor appointments after doctor appointments and need some good medical insurance.
Either way – if you don’t have a game plan, you could be faced with having to go on Medicaid – which is basically welfare insurance. It requires you to “spend down” your assets so you can qualify.
How to Deal With It
Check into Long-Term Care insurance (which covers nursing home or at-home care) to see if it is a right fit for you. Also do some research on your health coverage for retirement.
Will you be on Medicare? Will you have your own individual coverage until 65 if you retire early?
Liquidity Risk
Generally in finance, liquidity risk is defined as the risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit).
I’m going to refer to it as something different.
I’ll define liquidity risk as the lack of having cash or short-term assets in retirement to help supplement your retirement income.
You’ll want to have a good cash-reserve and probably some short-term investments as well.
In other words, you don’t want all of your retirement savings tied up in long-term assets that potentially require big surrender charges to get out (i.e. – annuities, real estate investment trusts, B-share mutual funds etc)
How to Deal With It
Diversify your assets according to time-frames as well. In other words think about your retirement savings in three buckets: Cash, Short-Term & Long-Term.
Be sure you know if your accounts will have back-end charges or will require you to stay in them for a long period of time.
Tax Risk
I talk a lot about tax diversification. All too often, I see people falling in love with their 401ks and creating a huge retirement tax-time bomb for themselves!
When all of your retirement savings nest egg is sitting in tax-deferred accounts, you don’t have much room to maneuver around the tax implications.
How to Deal With It
Diversify your retirement savings from a tax standpoint. Check out whether you should open a Roth IRA.
If you can’t contribute to a Roth, then look into whether a Roth IRA conversion makes sense for you.
Don’t just throw everything you have into your 401k because it’s easy. Do the math, do some research and find out what makes sense for you so you can diversify your retirement savings.
What Other Risks Would You Include?
What risks might you put in this list?
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{ 7 comments… read them below or add one }
I have to disagree with diversifying between a 401k and a Roth IRA. All this strategy does is move one tax savings from one pocket to another.
Typically the argument is, “I don’t know where I’ll be tax wise, so I want to diversify my taxes.” Well, the question is simple, do you want to be rich when you retire? If so, you want to be taxed on the seed and not the harvest. In this situation, a Roth IRA is better.
However, I still wouldn’t invest in a Roth IRA. There are too many strings attached to the government’s qualified retirement plans. It’s easy to get money in, but difficult to access the cash.
I say, put your money in a vehicle that is liquid, safe, and interest earning. We use whole life policies to accomplish this. We create our own personal bank and there is on person that won’t be able to touch our gains…Uncle Same.
Number 5 is a big one and it never gets mentioned in the financial press. It’s as if it doesn’t exist. You deserve a lot of credit for making people aware of it.
Tax deferred means tax DEFERRED–you’ll pay taxes on it later. It doesn’t mean tax FREE!
If you have to rely primarily on tax sheltered accounts for your income in retirement, you could be facing a huge tax problem.
I’d like to bring up the risk of fraud.
As we get older, we are more acceptable to identity theft and other scams. While I’m not exactly sure of the way to counter these risks, we should all be aware of them. Perhaps have a son or daughter help with financial decisions? I don’t think there is an easy answer to this type of risk, but it does exist! Perhaps this is a good area for the church to assist! Perhaps churches could create a financial review group to help retirees with money decisions?
Trick any way you look at it!
Good point on Fraud Risk Don-San. Can’t believe Madoff, if you can imagine losing everything one day after a 12% return every year.
Kevin hit it on the head as well… we still gotta pay taxes on our 401k!
Cheers,
Sam
Good points! Especially about the longevity risk. I wrote a post way back when “First, set age to retire. Second, set age to die.”
Trying to predict how long you’ll live is a BIG x-factor. You lay it out clearly in the last sentence – 30 years of retirement to pay for!
FinEngr – Good way to put it – “Predicting longevity is the BIG X-factor”!
Thank you for another great post about How Are You Handling These 5 Risks to Your Retirement Savings? | Redeeming Riches. Where else could people get that kind of info in such a perfect manner of writing? I have a meeting next week, and I am on the look out for such information.
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