Key Takeaways
- Retirement comes with many risks that can be reduced through proactive planning.
- The risk of outliving assets (longevity risk) is retirees’ biggest fear.
- 70% of older adults will need some type of long-term care service during their lifetime.
- “Sequence of returns risk” refers to poor investment returns early in retirement.
- Retirees’ most frequent spending shocks are major home repairs and dental expenses.
What is risk? In a word, uncertainty—uncertainty that actual events will differ from carefully made plans and that bad things will happen. Two common financial concerns of older adults are losing money as a result of stock market downturns and running out of money during their lifetime.
Common causes of risk for older adults are previous investment decisions (e.g., stock weighting in portfolio), life events (e.g., retirement and widowhood), current events (e.g., tax law and Social Security changes), and the aging process (e.g., increasing frailty and potential cognitive decline).
Major risks in later life include:
- Longevity risk
- Heath (physical and mental) care needs
- Long-term care (LTC) needs
- Investment risks (e.g., market risk and interest rate risk)
- Sequence of returns risk
- Unexpected spending shocks
Types of Retirement Risk
Longevity Risk
The risk of outliving their money is retirees’ biggest fear according to research conducted over many years. Longevity risk is of little or no concern for retirees with high dollar amounts of guaranteed income (e.g., pension, Social Security, annuity) and of high concern to older adults who must withdraw money from invested assets to cover living expenses.
Health Care Needs
Health care can be a significant expense. Fidelity Investments’ 2025 Retiree Health Care Cost Estimate survey projected that a 65-year old can expect to spend $172,500 on medical expenses throughout retirement. This includes out-of-pocket prescription drug costs (9%), Medicare Part B and D premiums (44%), and other expenses such copays, deductibles, and coinsurance (47%).
Long-Term Care (LTC) Needs
LTC is required when people are unable to perform basic activities of daily living (ADLs) including bathing, dressing, eating, toileting, transferring (e.g., from a bed to chair), and walking or moving around. Care services can be provided at home or in an assisted living facility or nursing home.
Fact: 70% of people age 65+ will need some type of LTC service at some point during their lives.
Investment Risks
Older adults have less “recovery time” from market downturns and often become more conservative investors who need to withdraw money from investments to live on. Major investment risks include business risk (risk specific to a company or industry), inflation risk (risk of loss of purchasing power), and market risk (risk of investments affected by financial markets).
Sequence of Returns Risk
This is risk associated with poor timing of withdrawals from retirement savings during market downturns. It is not average return on investments that matters but, rather, the order in which retirees experience market returns (i.e., good years first/bad years last or bad years first/good years last). With bad years first, a good portion of savings is liquidated and not around to recover.
Unexpected Spending Shocks
Shocks are large, often unexpected expenses that wreak havoc on personal finances. Think illness, disability and family emergencies, for example. Research by the Society of Actuaries found that 19% of retirees and 24% of retired widows experience four or more financial shocks. The most frequently reported shocks are major home repairs and dental expenses.
Risk Reduction Strategies
Diversify Investments
Own multiple investments that generally respond differently to market volatility. Examples include stocks, bonds, and cash equivalent assets like money market funds and certificates of deposit (CDs). Studies have found that many baby boomers have more stock exposure than they should, thereby increasing sequence of returns risk, especially during early years of retirement.
Review Investment Portfolio
Check asset allocation weights (e.g., 50% stocks, 30% bonds, 20% cash) periodically and consider guidelines for how much stock to hold at various ages: 100-age (conservative risk tolerance), 110-age (moderate) and 120-age (aggressive). Example: the stock weight for a conservative 65-year old is 35% (100 – 65) with the remainder of assets held in bonds and cash.
Rebalance Portfolio
Transfer investments within your portfolio to get back to target asset allocation weights. This is best done with assets within tax-deferred retirement plans or via required minimum distributions (RMDs) from them. Otherwise, stock weights in a portfolio will trend upward over time when the stock market does well. This increases the potential for investment and sequence of returns risk.
Build a Buffer Account
Avoid withdrawing money from stocks during market downturns. Instead, hold two to three years of living expenses not covered by guaranteed income in cash assets. This is a buffer account—not an emergency fund—designed to pay bills during down markets. Example: $4,000 monthly expenses – $3,000 (Social Security) = $1,000 gap x 24 or 36 months = a $24,000 or $36,000 buffer account.
Maintain an Emergency Fund
Set aside adequate reserves to cover spending shocks that will eventually occur. Experts often recommend saving three to six months of essential living expenses, but if this isn’t possible, any amount of emergency savings is better than none! Emergency funds should be placed in liquid cash assets such as high-yield savings or money market accounts.
### Consider Annuities
Hedge longevity risk with an insurance company annuity contract that provides a stream of income for life. Annuities can be an effective way to generate regular income like a paycheck. Research has found that partial annuitization of retirement savings helps extend the life of a portfolio and reduces retiree stress. Look for low expense annuities from highly rated vendors.
Try Online Calculators
Search online for retirement and life expectancy calculators and try several of each to inform financial decision-making. Some examples include the FINRA Retirement Calculator to plan retirement savings, the CalcXML How Long Will My Money Last With Systematic Withdrawals? Calculator to estimate savings longevity, and ten life expectancy calculators described here.
Consider Postponing Retirement or Unretiring
Use output from financial calculators to determine if you have saved enough to not run out of money during your lifetime. If longevity risk is evident, continued work provides three benefits: increased Social Security benefits, more time to save money (e.g., in a 401(k) or IRA), and fewer years of savings withdrawals. Other benefits are daily time structure and socialization.
Create a Long-Term Care Plan
Don’t make “hope for the best” your LTC plan. Odds are, you will need help. Planning strategies include self-paying LTC insurance premiums, family members paying for LTC insurance, relying on others for care (be sure to discuss this with them!), earmarking money to self-insure, relying on Medicaid, paying with guaranteed income sources, or moving to a lifecare community.
Take Care of Yourself
Reduce the risk of illness and chronic disease (e.g., diabetes) and incurring high medical expenses that can deplete retirement savings. Recommended action steps include eating healthy meals, regular exercise, adequate sleep, regular physical exams, vaccinations as needed, and avoiding smoking and excessive alcohol consumption.
Strengthen Social Capital
Invest the time necessary to build and maintain strong relationships with family and/or friends. Having people you can count on (e.g., for rides to doctors and caregiving services) can reduce health and LTC expenses. In addition, maintain a team of trusted financial and legal advisors and take advantage of the SHIP program for 1:1 counseling about Medigap and LTC insurance.
Make Temporary Budget Cuts
You may be able to forgo inflation adjustments to savings withdrawals during down markets if you follow the “4% Rule.” This is a guideline to withdraw 4% of savings in year one of retirement, adjusted annually for inflation to maintain purchasing power. Yes, it is difficult to reduce spending from a higher level, but it is preferable to having your portfolio evaporate due to sequence of returns risk.
Final Thoughts
Retirement has risks which can be reduced but not eliminated. For example, portfolio rebalancing can reduce investment risk, purchasing an annuity can reduce longevity risk, a buffer account can reduce sequence of returns risk, an emergency fund can cushion the effects of spending shocks, and a healthy lifestyle can reduce the risk of incurring high cost medical bills.
Warren Buffet once said, “risk comes from not knowing what you’re doing.” Develop a plan for reducing your personal retirement risks and take action to control what you can.
