How to Alleviate Four Common Fears for Retirees

After working and planning for years, the sweet stuff of retirement is supposed to follow. However, even after long-term planning, there can still be some concerns.

You never know what the future may bring, especially when it comes to stagnant markets or even corrections. That doesn't have to leave you uncertain about your retirement, though. Here are some common financial retirement concerns and strategies to address them. Realize that managing risks is generally more important for retirees than for workers who are in the accumulation phase of investing because retirees may not have time to wait for an economic or market recovery after a down period. Plus, retirees may have additional goals and needs for their portfolio.

One of the biggest financial fears retirees can have is investment loss. Because the markets tend to move cyclically, there's a good chance you'll experience a market downturn during retirement. This can be doubly painful if you're a retiree because if you need to sell investments for additional cash, you may have to do so at a large loss. For retirees, this is called "sequence of return risk," because withdrawing investments in a down or declining market can cause you to liquidate too many shares, which then leaves fewer shares to grow if the market bounces back.

A flooring strategy can potentially reduce this sequence of return risk if you start planning at least a year before retirement. You can also use this strategy at any time if you're already retired. Just be sure to evaluate your investment liquidation strategy if you do want to implement a "floor" of income. 

Here's how the flooring strategy works:

• Calculate your total expenses for all your out-of-pocket essentials, such as housing, food, utilities, medical premiums, and prescription drugs.
• Total your guaranteed lifetime income sources, such as Social Security, pensions, and annuities/longevity insurance.
• If your guaranteed income covers your essential expenses, congratulations. You've already limited the need to sell off your market investments to cover essentials. Because you've met your essential expenses with lifetime income, you can delay selling investments in a declining market and potentially wait until the market stabilizes. You still might need extra income in a year for nonessential expenses or an emergency, so make sure you have an emergency fund you can tap first, then look to liquidate investments last.
• On the other hand, you may not have enough guaranteed income to cover your essential expenses. This means you'd have to sell some of your investments just to meet your basic/essential needs. To reduce this sequence of return risk, you need to complete your "floor" of income. Consider using some of your invested assets to purchase guaranteed lifetime income (such as an annuity or other income producing investments) to supplement your income and fill the gap between the essential expenses you must cover and the amount you already can cover with the income you already identified.

With this strategy in place, the rest of your assets remain invested in the market while your basic needs are covered, and you can limit selling too many shares caused by taking withdrawals during a declining market. Remember, it's still important to diversify. Consider investments that aren't correlated to the stock market because a little extra diversity in your portfolio may help you weather market downturns.

A flooring strategy can potentially provide some reassurance that your basic needs are covered and your market investments aren't being depleted by regular withdrawals.

When you're younger, you can weather a market decline several ways: investing more, working longer, getting a second job, or just waiting it out because you won't need to use your retirement savings for years. But once you're close to or in retirement, running out of money becomes a serious concern. Few people would want to—or can—go back to work at age 95 if they ran out of money. The flooring strategy helps here too. Lifetime income means just that: An income stream that'll last no matter how long you live. By using annuities and other lifetime income sources strategically—just to meet your essential expenses—you can cover basic needs and (hopefully) avoid becoming a burden to your family or others.

Only use your investments to cover discretionary expenses that can be postponed until you can determine which assets make sense to sell. You can even employ tax-loss strategies by selling some losers with some winners to lower your tax bill. Keep in mind that if an investor is considering a sale, then the tax implications should be considered. Be sure to consult your tax advisor before pursuing a tax strategy.

If you have substantial discretionary expenses, such as vacations, gifts, car purchases, home renovations, and so on, another strategy to add to your floor is a "time segmentation" strategy.

Here's how time segmentation works:

• Determine your discretionary income wishes for the next five years. (Remember, essentials are covered by your floor.)
• Consider a bond ladder, a portfolio of individual bonds with staggered (hence "laddered") maturities, or an annuity ladder, an investment strategy that entails the purchase of immediate annuities over a period of years to provide guaranteed income, to cover these expenses. You may need to liquidate some investments to purchase the bonds or annuities.
• Each bond or annuity provides income. In some instances, the principal that comes due could cover your discretionary expenses. However, it is important to note that not all immediate annuities return principal.
• Invest the rest of your market-based investment assets in five-year increments. For example, your second portfolio is invested for five years, the third portfolio for 10 years, the fourth for 15 years, the fifth for 20 years, and so on.
• As you get close to the expiration of the first five-year period for your bond/annuity ladder, you can create another ladder for years six through 10 using the market assets you have in portfolio two. All your other portfolios remain fully invested. 

This discussion has been highly simplified and does not consider transaction costs, inflation, taxes, and other material concerns. Time segmentation can get even more advanced. Using what we've discussed so far can help you understand the nature of retirement risks and some of your choices to reduce those risks.

Another way to reduce the chances of running out of money is to carefully manage the timing of when you start collecting your Social Security benefits. A retirement professional can help you structure your portfolio and coordinate your distributions with your Social Security income in a way that allows you to lengthen the life of your money.

Women in particular need to maximize Social Security payments because of their longer expected life spans. Remember that your Social Security payment will be reduced by your Medicare Part B premium, so you won't have all your Social Security payment available to spend.

You can also consider investing in income-producing assets during retirement. Rental properties and other real estate projects, certain business investments, and other assets can continue to create income, which can provide a way to avoid relying on stock market performance during your retirement.

As we get older, it's common to see an increased need for health care. It's natural, as a retiree, to worry about a major health event that can set you back financially. But it's possible to prepare to some degree for such events.

If you aren't yet retired, consider contributing to a Health Savings Account, or HSA, to build up your tax-advantaged portfolio. An HSA provides a tax deduction when you contribute, and the money grows tax-free as long as it's used to cover qualified health care expenses. To qualify, you must be covered by a high-deductible health plan.

You may also consider long-term care insurance in case you ever need to be in a long-term facility that might not be covered by Medicare or Medicaid. Medicare covers only shorter-term medical needs. And with Medicaid, you'd need to deplete all your assets to qualify. When considering long-term care insurance, it's generally recommended to purchase a policy in your 50s or early 60s, as long as you're healthy and insurable, to secure a more affordable premium.

Inflation is often called the "quiet killer" of retirement. Over time, prices rise, making your money less valuable. A dollar today is worth more than a dollar tomorrow. Keeping up with inflation is an important part of retirement planning.

If you haven't already retired, one strategy to offset inflation is to increase your retirement contributions so you have more money saved. You can also consider investing in annuities or other products that offer Cost-of-Living Adjustments, or COLAs. Social Security offers this adjustment, although medical costs have tended to increase faster than the Social Security COLA.

Another strategy is to look for diversified growth investments that can potentially provide an inflation-beating rate of return. That way, your money grows faster than inflation and might insulate you from some of its effects. The flooring strategy and/or time segmentation may also help. All these strategies can potentially help reduce the risk of running out of money, and they keep part of your portfolio fully invested in long-term growth assets that have the potential to keep up with inflation.
 

One of the best things you can do for yourself is to plan ahead. Meet with a financial planner to create a plan that might help you avoid unpleasant surprises in the future. The earlier you start, the more likely you are to avoid the common fears faced by retirees. Having a plan in place and making consistent contributions to a retirement portfolio can go a long way.