Risks to Your Retirement Income
Learn more about risks related to healthcare, taxes and the market.
When it comes to planning for your retirement income, it’s easy to overlook some of the common factors that can affect how much you’ll have available to spend.
Below, learn more about how your retirement income can be impacted by investment risk, inflation risk, healthcare costs and taxes.
Investment or market risk is the risk that market fluctuations may reduce your retirement savings.
If you need to withdraw from your investments to supplement your retirement income, you’ll need to consider two important factors:
- The amount of your withdrawals
- Your investments’ growth and/or earnings
There can be periods lasting for a few years or longer when the market provides negative returns. During these periods, constant withdrawals from your savings combined with prolonged negative market returns can result in the depletion of your savings far sooner than planned.
Reinvestment risk is the risk of facing lower interest rates when reinvesting the proceeds of a financial instrument. This could mean investing at a lower rate of return or taking on additional risk to achieve the same level of return. This type of risk is often associated with fixed interest savings instruments such as bonds or bank certificates of deposit. When the bond or CD matures, comparable instruments may not be paying the same return you received on the matured investment.
Interest rate riskoccurs when interest rates rise and the prices of current investments drop. For example, during periods of rising interest rates, newer bond issues generally yield higher coupon rates, thus decreasing the market value of older existing bonds with lower coupon rates.
You also might see the market value of some stocks and mutual funds drop due to interest rate hikes because some investors will shift their money from these stocks and mutual funds to lower-risk fixed investments paying higher interest rates compared to prior years.
This is the risk that the purchasing power of a dollar will decline over time due to the rising cost of goods and services. If inflation runs at its historical long-term average of about 3%, the purchasing power of a given sum of money will be cut in half in 23 years. If it jumps to 4%, the purchasing power is cut in half in 18 years.
A simple example illustrates the impact of inflation on retirement income. Assuming a consistent annual inflation rate of 3%, and excluding taxes and investment returns in general, if $50,000 satisfies your retirement income needs this year, you’ll need $51,500 of income next year to meet the same income needs. In 10 years, you’ll need about $67,195 to equal the purchasing power of $50,000 this year. Therefore, to outpace inflation, you should try to have some strategy in place that allows your income stream to grow throughout retirement.
Long-term care expenses
Long-term care may be needed when physical or mental disabilities impair your capacity to perform everyday basic tasks. As life expectancies increase, so does the potential need for long-term care.
Paying for long-term care can have a significant impact on retirement income and savings. While not everyone will need long-term care, failing to plan for the possibility can leave you or your spouse with little or no savings if such care is needed. If you decide to buy long-term care insurance, don’t forget to factor the premium cost into your retirement income needs.
Catastrophic care costs
As the number of employers providing retirement healthcare benefits dwindles and the cost of medical care rises, 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. You may have to pay the rising premium costs of Medicare optional Part B coverage (which helps pay for outpatient services) and/or Part D prescription drug coverage. You may also want to buy supplemental Medigap insurance, which is used to pay Medicare deductibles and copayments and to provide protection against catastrophic expenses that either exceed Medicare benefits or are not covered by Medicare at all. Otherwise, you may need to cover Medicare deductibles, copayments and other costs out of pocket.
The effect of taxes on your retirement savings and income 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 in retirement.
It’s important to understand how your investments are taxed. Some income, like interest, is taxed at ordinary income tax rates. Other income, like long-term capital gains and qualifying dividends, currently benefit from special – generally lower – maximum tax rates. Some specific investments, like certain municipal bonds*, generate income that is exempt from federal income tax altogether.
Taxes can impact your available retirement income, especially if a significant portion of your savings and income comes from tax-qualified accounts such as pensions, 401(k)s and traditional IRAs, since the income from these accounts is generally subject to income taxes. Understanding the tax consequences of these investments is important when making retirement income projections.
Have you planned ahead?
Speak with your professional advisory team about these common risk factors and how their effects on your retirement can be mitigated. Working in tandem with your tax advisor, your financial advisor can develop a tailored strategy that reflects your unique situation and keeps your long-term goals in focus.
* Interest earned on tax-free municipal bonds is generally exempt from state tax if the bond was issued in the state in which you reside, as well as from federal income tax (though earnings on certain private activity bonds may be subject to regular federal income tax or to the alternative minimum tax). But if purchased as part of a tax-exempt municipal money market or bond mutual fund, any capital gains earned by the fund are subject to tax, just as any capital gains from selling an individual bond are. Note also that tax-exempt interest is included in determining if a portion of any Social Security benefit you receive is taxable.
Content prepared by Broadridge Investor Communication Solutions, Inc. Raymond James does not provide advice on tax, legal or mortgage issues. These matters should be discussed with the appropriate professional. Investing involves risk and you may incur a profit or loss regardless of strategy selected.