Retirement income planning is a distinct field in the financial services profession. The financial circumstances facing retirees differ dramatically from pre-retirees. For this reason, traditional wealth management approaches that focus on accumulating assets do not address a retiree’s needs.
Here are the top 7 financial challenges unique to retirees that must be taken into account when planning for this decumulation stage.
1. Reduced Earning Capacity
We may have a harder time making money. Physical or mobility changes as we age can make it tougher to do our old job. Sometimes we encounter ageism either through negative perceptions of our abilities or an employer’s desire to recruit younger, cheaper staff.
Many consider self-employment which means allowing for start-up costs.
Even if our own health is good, we may need to take time to look after a loved one or attend appointments with them. We may want more flexible hours or prefer to take a position of less responsibility with correspondingly lower pay.
Less income can be stressful in market downturns as paycheques have stopped or are less to fall back on.
2. Actual Spending Constraint
We spend our whole lives accumulating then suddenly that turns on its head and we start using what we have squirreled away. Our brain has a hard time adapting to the difference and accepting it’s ok to watch our net worth decline. Instead of enjoying the money we worked hard for we may become overly sensitive to daily expenses increasing, and one-off surprise expenses are more distressing.
We may struggle to justify treating ourselves or splurging because paycheques have stopped. There are no second chances to replace this money.
3. Heightened Investment Risk
Once we stop saving and start using our nest egg, we are vulnerable to sequence-of-returns risk. Poor returns early in retirement can throw a wrench into sustainable withdrawal plans. Market returns experienced near a retirement date matter a lot more than most people realize. Retiring at the start of a declining market is incredibly stressful. Did you know that even after positive average market returns during 30 years of investing, if negative returns are experienced in the early stages when you start spending from your portfolio, wealth can deplete rapidly through withdrawals?
While you’re still working, you can rely on your paycheck as your portfolio recovers, but this is no longer an option in retirement.
4. Unknown Longevity
The fundamental risk for retirement lies in the question: How long will your assets need to generate income? Retirement can be much shorter or longer than a person’s statistical life expectancy. Half of the population will outlive their life expectancy. A long life is wonderful but it costs more and is a bigger drain on a retiree’s resources. Imagine stretching your savings for 40 years instead of 20 years. If you haven’t planned for it, how would you feel?
5. Retirement Spending is Like a Smile and Spending Shocks
Spending isn’t the same through retirement, and I often describe it like a smile, a U Shape. More in early retirement, enjoy your time and health, then less as we slow down, and increasing as we age and need to pay for help.
Unforeseen expenses: health and long-term care, helping other family members, divorce, changing housing needs, home repairs, rising prescription costs, the list goes on and on. While contending with the other risks mentioned here, retirees must maintain financial flexibility to manage unplanned expenses. When budgeting for retirement, it is important to include a “rainy day fund” for surprises such as these.
6. Compounding Inflation
Do you recall what gas cost when you bought your first car? The price of a jug of milk or supper out when you got married? Inflation eroding purchasing power is a huge risk. While it may not be noticeable immediately, even low inflation can have a big impact over a lengthy retirement.
With a 3% average annual inflation, the purchasing power of a dollar will fall by more than half after 25 years.
Adjusting to account for inflation from year to year, CPP, OAS, and pensions are usually linked to the Consumer Price Index. Generous plans might use 80% of the CPI increase but many have a cap of 2.5%. Know what your plan provides to avoid surprises.
7. Declining Cognitive Abilities
Finally, we must consider that we may experience declining cognitive abilities, which can hamper our decision-making skills. It becomes increasingly difficult to make investment and withdrawal decisions as we enter advanced age. In addition, many couples don’t share the management of family finances. When the spouse who’s keeping track of finances dies first, the surviving spouse can run into serious problems if they do not have a clear plan in place. He/she can be vulnerable to financial predators or mistakes. Experiencing financial stress on top of losing your best friend is something we want to avoid. Build your professional network while you are still healthy.
This may all sound daunting, but the point of a retirement plan is to head off these concerns before they become a problem, so you can enjoy this next stage of life!