How to Plan for Retirement Uncertainties
Updated: Jul 26, 2020
The uncertainties we face in retirement can erode our sense of confidence, potentially undermining our outlook during those years.
Indeed, according to the 2017 Retirement Confidence Survey by the Employee Benefits Research Institute, only 18% of retirees say they are “very confident” about having enough assets to live comfortably in retirement. Almost 40% were either “not too confident” or “not at all confident.“
Today’s retirees face two overarching uncertainties. While each on their own can lead even the best-laid strategies to go awry, it’s important to remember that remaining flexible and responsive to changes in the landscape may help you meet the challenges of uncertainty in the years ahead.
An Uncertain Tax Structure
A mounting national debt and the growing liabilities of Social Security and Medicare are straining federal finances. How these challenges will be resolved remains unknown, but higher taxes—along with means-testing for Social Security and Medicare—are obvious possibilities for policymakers.
Whatever tax rates may be in the future, taxes can be a drag on your savings and may adversely impact your retirement security.¹ Moreover, any reduction of Social Security or Medicare benefits has the potential to place a further strain on your retirement.
Consequently, you’ll need to be ever mindful of a changing tax landscape and strategies to manage the impact.
If you know someone who retired, or looked to retire in 2008, you know what market uncertainty can do to a retirement blueprint.
The uncertainties haven’t gone away. Are we at the cusp of a bond market bubble bursting? Will the Euro Zone find its footing? Will U.S. debt be a drag on our economic vitality?
Over a 30-year period, uncertainties may evaporate or resolve themselves, but new ones historically have emerged. This means understanding that the solutions for one set of economic circumstances may not be appropriate for a new set of circumstances.
Scottish Philosopher Thomas Carlyle said "He who could foresee affairs three days in advance would be rich for thousands of years.”² Preparing for uncertainties is less about knowing what the future holds as it is about being able to respond to changes as they unfold.
Taking withdrawals from a traditional portfolio exposes fixed-income investors to “sequence of returns” danger. In other words, experiencing negative returns early in retirement can deplete your portfolio more quickly than you planned and potentially undermine the sustainability of your assets. So you may want to consider a couple of strategies to help mitigate this concern.
The first is to have a pool of very liquid assets to fund two-to-three years of retirement spending; this may keep you from selling longer-term assets at an inopportune time. Through time, and depending upon market conditions, you may have the opportunity to replenish this cash reserve using gains from your retirement portfolio.
Another complementary strategy is to integrate annuities. This can help shift the risk of market volatility off your shoulders and onto the issuing insurance company.
The predictable guarantees of an annuity help to give retirees peace of mind, knowing that they can count on a steady stream of retirement income. Annuity contracts depend on the issuing company’s claims-paying ability. Annuities have contract limitations, fees, and charges, including account and administrative fees, underlying investment management fees, mortality and expense fees, and charges for optional benefits. Most annuities have surrender fees that are usually highest if you take out the money in the initial years of the annuity contact. Withdrawals and income payments are taxed as ordinary income. If a withdrawal is made prior to age 59½, a 10% federal income tax penalty may apply (unless an exception applies).
Until retirement, portfolio optimization largely focuses on the blending of different asset classes in the appropriate measure to create optimal portfolios. But in retirement, investors must integrate different retirement investment vehicles to enhance income and manage risk.
One of the industry’s leading thinkers, Ibbotson Associates, has done a great deal of research around this very idea.
In a landmark study, “Retirement Portfolio and Variable Annuity with Guaranteed Minimum Withdrawal Benefit,” Ibottson’s research came to several key conclusions that hold important ramifications for meeting the retirement-income challenge.
One of the study’s conclusions was that the addition of a variable annuity with a guaranteed minimum withdrawal benefits retirement portfolios—replacing cash or fixed-income allocations. It increases total income while it decreases risk.”¹