Maintaining your financial security in retirement is harder than ever. There are factors threatening your plans for lifetime income security.
Retirees have had to deal with some of these trends for years, but others are relatively new, or are becoming more significant.
Your job isn’t done when you retire.
Things change during retirement, and you have to keep up with the changes.
Too often, people who appear to be financially secure at the start of retirement see their assets dissipate because of unforeseen events and mistakes.
While there are a range of trends and factors you need to monitor during the post-career years, there are five I believe are the paramount threats to retirement security for today’s retirees and those soon to retire.
The foundations are crumbling. It’s no secret that both Social Security and Medicare aren’t in good financial shape. Every year the Trustees for Social Security and Medicare issue a report assessing the condition of the programs. While the details change from year to year, the long-term outlook isn’t good.
Each year that Congress doesn’t act, we are closer to the time when the programs can’t fully pay the promised benefits.
These two programs are important to the financial stability and independence of most retirees, more than many pre-retirees realize. The importance of the programs grows the longer a person has been retired.
I don’t join the pessimists who say the programs will disappear and you can’t rely on receiving anything from them. But changes are likely, and you have to build flexibility in your retirement plan so you can adapt to those changes.
Changes to Social Security and Medicare are most likely to affect those in the top half of the income and wealth rankings. As in the past, changes to the programs are likely to be means-tested with reduced benefits and higher costs imposed on better-off retirees.
Social Security benefits used to be tax free.
Now, they are taxed to those with incomes above certain levels, with the higher income beneficiaries having up to 85% of their benefits taxed. Higher-income taxpayers also pay the Medicare premium surtax; the higher the income, the higher the surtax.
We’re likely to see similar changes in coming years.
While Congress talks as though such changes will affect only the wealthy, many people who consider themselves to be middle class often pay a share of these penalties.
Retirement could last a long time. The first generation of post-World War II retirees lived an average of about five years in retirement.
Various factors have increased life spans so that now most people can expect to live 20 or 30 years in retirement.
A growing percentage will be retired much longer, even spending more time in retirement than they did working.
Yet, when people are asked about longevity, they greatly underestimate life expectancy.
Underestimating the length of retirement causes people to spend too much in the early years of retirement and increases the risk of running out of money later in retirement.
Some people have good reasons to expect they won’t have an extended retirement. Everyone else needs to plan for those post-career years to last several decades.
Many financial planners now argue that married couples should plan for at least one spouse to live past age 90 or even 100.
The fastest-growing age groups are the elderly elderly, those ages 80 and older. To maintain security in retirement, assume you’ll be among that group.
Investment returns are likely to be disappointing. Since the market bottom in 2009, we’ve had one of the best periods ever for investment returns.
Propelled primarily by aggressive monetary policy, returns in both stocks and bonds were well above historic averages.
The monetary stimulus seemed to find its way primarily into the equity markets, giving stocks one of their best periods of returns ever, comparable only to the post-World War II and mid-1980s periods. Bonds also had extremely high returns as interest rates declined to near zero.
Don’t expect these types of returns to repeat in coming years.
Stocks are at high valuations, and central banks are withdrawing monetary stimulus.
Even if extraordinary monetary policies are resumed in the next recession, they’re unlikely to be as effective as they were in the post-2008 period.
Bonds are likely to return only their current yield, and that’s if you buy individual bonds and hold them to maturity. Buy bonds through mutual funds or trade them, and you’re likely to lose money as interest rates rise.
Your retirement shouldn’t depend on achieving the level of returns we’ve seen since 2008. In fact, returns for stock and bond indexes are likely to be less than long-term historic averages, because central bank policy pulled years of returns forward into the last few years.
If you don’t anticipate modest returns in your retirement plan, you’re likely to fall short of your goals.
Inflation still will be a mighty foe. The relatively low inflation of recent years and its steady decline that began in 1982 caused many people to forget history and become complacent.
Inflation in the U.S. has averaged about 3% annually over the long term.
The sub-2% rate since the financial crisis is an anomaly. The Federal Reserve wants inflation to increase, and you should expect it to.
Even historically low inflation is dangerous to retirees.
An average annual inflation of 3% cuts your purchasing power in half over 24 years and by close to 20% over only five years.
Even a more modest 2% inflation reduces your standard of living by 20% over 10 years.
Remember, retirees are likely to face a higher inflation rate than non-retirees.
You have to factor in an inflation rate above the headline Consumer Price Index into your plans.
Perhaps the most common retirement planning mistake is failing to consider inflation in retirement plans.
Many people enter retirement with income that roughly matches their spending and feel comfortable. But they overlook that prices and costs are likely to rise over time.
The damage from inflation doesn’t happen over night, but it is painful over time.
Your taxes aren’t likely to decline during retirement. There was a time when older Americans received a lot of tax breaks. There still are a few breaks for those who are older and less well off.
But for most Americans it’s dangerous to believe your taxes and tax rates are going to decline in retirement.
Governments at all levels know that older Americans are where the money is.
It’s one of the largest generations in history and definitely the wealthiest. Governments need money, and they have no choice but to find ways to impose them on older Americans.
That’s why few older Americans have seen their taxes and tax rates decline over time and aren’t likely to in the future.
The taxes you’ll pay under the Tax Cuts and Jobs Act are likely to be the lowest for the rest of your life.
Tax increases on retirees often aren’t direct tax rate increases. Instead, back door or stealth taxes are imposed.
Classic tax increases on retirees are the inclusion of some Social Security benefits in gross income and the Medicare premium surtax.
Other taxes often aren’t directly targeted at older Americans but hit them more than younger taxpayers.
The alternative minimum tax and the net investment income tax are prime examples.
The bottom line is that for most retirees taxes are one of the three largest expenses in their spending plans, and the tax bills aren’t likely to decline.
Congress and state and local governments are far more likely to increase your taxes than to reduce them.
Your retirement plan needs to be able to deal with these and other threats to your financial security.
A good plan will have flexibility and a cushion.
You also need to stay on top of trends throughout retirement so you can make modest adjustments to changing circumstances before major adjustments are needed.