Risky Business?

“Don’t judge each day by the harvest you reap but by the seeds that you plant.”

~ Robert Louis Stevenson

Question:  What are the biggest risks to successful retirement income planning?

Answer:  There are seven key factors that could impact the outcome of your retirement income plan. Be aware of these when designing, implementing, and monitoring your plan. 

1.Investment or market fluctuations may reduce your retirement savings. If you need to withdraw from your investments to supplement your retirement income, consider the amount of your withdrawals and your investments’ growth and/or earnings. During periods of negative returns, constant withdrawals from your savings along with negative market returns can result in the depletion of your savings far sooner than planned. 

2. Reinvestment risk occurs in low interest rate environments, like we’re experiencing now, making it a challenge to reinvest the proceeds of a financial instrument. This may 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.

3. Interest rate risk occurs 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.

4. Inflation risk occurs when the purchasing power of a dollar declines 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. To illustrate: 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 a strategy in place that allows your income stream to grow throughout retirement.

5. Long-term care expenses may be needed to cover care if 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.                            

6. Catastrophic care costs relate to the rising costs of traditional medical care as fewer employers provide retirement healthcare benefits to retirees. Even with 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 want to add 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 aren’t covered by Medicare at all. Otherwise, you may need to cover Medicare deductibles, copayments, and other costs out of pocket.

7. Taxes are an often overlooked yet important part of retirement planning. Taxes can potentially reduce income.  Interest income 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 may reduce 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.

Are you Ready?  Speak with your professional advisory team about these common risk factors and how their effects on your retirement might be managed. Working strategically with your tax advisor, your financial advisor can develop a tailored strategy to reflect your unique situation and keep your long-term goals in focus. If you’d like us to run hypothetical projections for you, we’re here to help. Stay focused and plan accordingly. 

* 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.

The opinions expressed are those of the writer as of August 23, 2021, but not necessarily those of Raymond James and Associates, and subject to change at any time. Every investor’s situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment.

“Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.” 

This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at (239)389-1041, email darcie.guerin@raymondjames.com Website: www.raymondjames.com/Darcie.