5 Risks that could potentially Destroy Your Retirement!
-Five big retirement risks that could potentially destroy your retirement. [music] Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, CERTIFIED FINANCIAL PLANNER™ Professional (CFP®), host of the Retirement Income Show and author of the upcoming book Core4. When we talk about retirement, one of the most important concepts to grasp is how different it is from the accumulation phase.
You’re working your entire life. You’re building money, you’re saving, you’re contributing to your retirement accounts and then once you get to retirement, you cross over a line. It’s almost this line of demarcation, the paychecks stop. You have to determine which accounts you draw income from, how much, you have to figure out how long will it last.
If something happens to you, will your spouse be okay? What about medical and long-term care? Once you cross over into the retirement phase, the risks that your phase are critically important, and there are far more of them in the retirement phase than when you were in the accumulation phase. We’re going to talk about five of the biggest risks and by no means, are these all the risks, but they’re five important ones and we want to cover them and then talk about what you can do as a solution to navigate your way around these risks. First big risk is what we call sequence risk.
This is sequence of returns risk, and it is if you’re in the five years before retirement or the five years after retirement, this 10 year window, we call it the retirement red zone. This is a very important concept to understand. What sequence risk is, it’s the combination of starting to take portfolio withdrawals combined with the potential for market losses. If we look at someone retiring with a million dollars saved for retirement, if they start taking 5%, $50,000, but in the year they retire, the market also goes down about 10% or their portfolio loses 10% of its value, they’ve lost 15% in the first year of retirement, bringing the million roughly down to about $850,000. Now, markets usually rebound. The only question in retirement is, how long does it take? Is it a one-year recession? Is it a two year recession?
In 1999, we had the dotcom bubble burst. Then in 2001 and ’02, the market was down three years in a row. The only question is not when will the market go down, but how long will it stay down when you’re taking distributions from the portfolio? Year two here, we take another 5%, but let’s presume the market loses another 10% or your portfolio goes down in value another 10%. Now, we’ve taken out 5%, but this withdrawal was based on a smaller number, so your income is lessed. With the portfolio dropping another 10% in value, these rough numbers here within two years of retirement, you go from a million dollar nest egg to about $722,000 of nest egg.
You’ve done nothing except take a couple of years of income and the portfolio’s lost 10% in consecutive years. These numbers get a lot worse if the year you retire, we get a 20% or 25% correction or two years in a row where it’s 20% and 10%. Sequence risk is one of the biggest risks when you’re about to start taking portfolio withdrawals. This window of let’s call it the danger zone for sequence of returns risk to have the greatest negative impact on your portfolio is between the five years before, and then the five years after retirement. That’s risk number one.
Risk number two is underestimating medical costs. When we talk about medical costs in retirement, there are really two components. You have the actual medical costs, which are your Medicare premiums, your supplemental insurance premiums and copays, doctors, hospitals, prescription drugs. These are medical related expenses that you have to come out of pocket and pay for. There are a lot of studies out there on the average out-of-pocket medical cost expenses in retirement. The studies range anywhere from $250,000 to over $400,000 over the course of a retirement, but that’s not it. We don’t just have to worry about these medical expenses.
In retirement, long-term care is a big concern. We have to worry about future home health care costs, possible nursing home costs, assisted living costs. A lot of times, maybe you just want somebody to come in and help you around the house when you get a little bit older and you can’t do these things yourself. Medicare does not cover home health care, nursing care, or assisted living for more than about the first 100 days. Medicaid will, but you have to spend down virtually all of your assets, very little income before you go onto the government program, Medicaid, which covers these expenses. My grandparents when they retired, I took a couple of years after college to take care of them. The reason was my grandfather had two aortic aneurysms and we had to do home health care and the nursing home.
The nursing home, this was almost 20 years ago was $10,000 a month. The home health care was a rural town in North Carolina. My grandparents were spending $40,000 a month. I know firsthand what these costs could potentially be. Those are a lot higher than your average cost, at least the home healthcare ones. As more and more people retire and we’re living longer lives, we need a medical plan in retirement to make sure that the portfolio is accounting for these future expenses. The number three risk is having either too much money in stocks or having too much money in bonds. Yes, you can have too much money in stocks and yes, you can have too much money in bonds. Now, the reason why bonds are very important to understand in retirement is traditionally, we put our safe money, our less risky money for retirement into a bond portfolio. You may have heard of the 60, 40 portfolio mix where 60% of your money’s in stocks, 40% is in bonds.
Well, when you look at the economic environment that we’re in, where interest rates today are at all time lows, and that means your bond interest payments are very small. Then as interest rates gradually increase in the economy, your bond values will go down. If you have 30, 40, 50, 60% of your money in bonds right now, and that’s your less risky retirement strategy, you have to look at what’s going to happen to the value of those bonds as interest rates rise. This is the five-year chart of the Vanguard total bond market index fund. The trend is pretty clear here. As interest rates started rising in 2015 when the federal reserve started raising short term rates, as interest rates rise, the value of bonds in general have gone down. If you’re thinking about putting 40, 50, 60% of your money in bonds, you have to be prepared for very low returns most likely over the next 5 to 10 years, if interest rates continue to rise. There are better ways to invest your safe money or your less risky money than bonds.
Then, of course, having too much money in stocks, that can be risky because if you’re more heavily allocated to aggressive instruments, the market could go down 10, 15, 20, 30, 40%, and then you could be a victim of that sequence risk that we talked about in number one. Your number four big risk for retirement is inflation. Inflation is a silent killer. We always hear people talking about inflation, but in retirement, it’s extremely detrimental if you’re not planning to have increasing income in retirement. Simply depending on your portfolio to grow in value over time could be a risky proposition if you’re working with a general accumulation phase strategy of just stocks and bonds.
The reason is bonds struggle in a rising interest rate environment, and stocks could have a little bit more risk for some of your appetites. We need a plan. We need an income plan that segments parts of our portfolio out that are going to give us increasing income over time. The reason is, when we look at inflation and it how erodes your purchasing power over time, if you have $100,000 income starting retirement, in about 10 years, based on historical inflation data, these are just rough estimates, your approximations, your purchasing power, you still have $100,000 coming in in this example, but your purchasing power after 10 years is only about $75,000.
After 20 years, your purchasing power is cut in half, it’s about $50,000. When we look at retirement, medical long-term care, those are the costs that later in life we really have to be concerned with and those costs are going up. They’re increasing 3, 5, 7, 8% per year depending on which particular costs you’re looking at, but we can’t have an income plan that we know costs are going up and our purchasing power is eroding over time. Inflation is a silent killer. It’s a big risk for retirement, and we need a retirement income plan that gives us increasing income to maintain the purchasing power of our dollars over time. The number five risk is something that I hear too many financial advisors recommending and too many prospective clients that come in here adhering to this recommendation or this advice.
That’s, do not defer all of your IRAs until you have to take required minimum distributions. The big risk is deferring your IRAs too long. Now, when you retire, you get to decide where you take your income from, how much income you take. Ultimately, that determines what tax you pay. Very simple example here. Many people retire with non IRA assets. It might be $300,000, $500,000. Whatever number that is for you, when we take money out of this account, it can be taxed multiple ways. It could be tax-free. We could pay 15% capital gains rates. We could pay 15% dividend tax rates and various other. When we take money out of the IRA, it’s always taxed at income tax rates. By letting the IRA simply defer until you have to take mandatory distributions, right now that’s at age 70.5, but Congress is working on a new law to extend that to either 72 or 75.
What we do is we allow this account to balloon, and we’re creating a major tax risk for the future, because not only do we have to mandatory distribute from this account, it’s likely the taxes could be higher in the future. As a matter of fact, under current law in 2026, personal income tax rates are going to be a lot higher. By simply deferring this, as long as possible, you increase your tax wrist. Depending on how big your IRA is, if we start to get mandatory distributions because they increase as time goes on, you could have income coming out of here that not only bumps you into higher income tax brackets, but also higher Medicare tax brackets, possibly your Social Security being taxed at higher rates, and even net investment income tax.
The tax code is filled with these potholes and these traps and the things that you need to be aware of. Having a retirement income plan that intelligently distributes from your non-IRA, and your IRA, and maybe even you have a tax-free Roth IRA, in a manner that’s customized to your needs and your objectives is the best way to have a retirement income plan. It’s not this blanket advice, “Defer your IRAs until 70.5.”
That’s what a lot of people are telling you, but I’m telling you you really should consider doing something different. Those are the five big risks for retirement. To navigate around these, the complexities that are involved with retirement income planning, Social Security planning, Medicare, medical long-term care, you really need to find a retirement advisor who was well versed in these topics and can construct a personalized, customized solution for you and be there with you to guide you and monitor things along the way.
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