4 big retirement risks — and how to prepare for them

Overspending, investing too conservatively and veering away from your plan — these are some of the most common traps you can fall into on the way to retirement. The good news is that you have the potential to avoid them with a little discipline and forethought.

Other risks — like a health crisis or a market downturn — can’t be avoided, but you can employ strategies to help manage them. Here are four of the most common dangers to your retirement strategy and the steps you can take to prepare for them.

1. OUTLIVING YOUR MONEY

Thanks to advances in medical science as well as healthier lifestyles, Americans are living longer than ever. That’s great news, but it also creates the very real possibility that you might outlive your retirement assets — especially when 28% of people underestimate their own likely life span by five years or more, according to a Society of Actuaries survey.¹

“People look at how long their parents or relatives lived. But life expectancies have grown markedly from one generation to the next,” says Nevenka Vrdoljak, a managing director and analyst, Chief Investment Office, Merrill and Bank of America Private Bank.

WHAT YOU CAN DO:
Think about delaying the age at which you claim Social Security. “By claiming at age 70 as opposed to 62, your monthly income could potentially go up 77%,” Vrdoljak says.² “You sacrifice income early on, knowing you will likely have higher Social Security payments if you reach your 80s and 90s,” she adds.

Find out whether an annuity might be appropriate for you. Investing in a lifetime income annuity could help you avoid the risk of outliving your retirement savings by providing a path to income for as long as you live. For this reason, it also can offer protection against market risk (see Risk #2). Because annuities come with certain costs and risks, be sure to talk to your advisor about all the pros and cons before making a decision.

2. CHANGES IN MARKETS

Even though markets historically have gained over time, they do move up and down. If there’s a significant market drop shortly before or early in your retirement — just as you’re starting to tap into your assets — the value of your investments could shrink to an extent that brings long-term consequences. Even if the market subsequently improves, “if the first four or five years of your retirement are bad, it can be difficult to recover,” Vrdoljak says.

WHAT YOU CAN DO:
Take a second look at the way you invest. As you near retirement, shifting to a more conservative investment approach may help protect against market downturns. At the same time, it’s important to maintain some exposure to stocks — a portfolio consisting only of cash, CDs and bonds may lose ground to inflation over time (see Risk #3). To find a suitable balance, Vrdoljak notes, “a moderately conservative asset allocation may help reduce your risk of outliving your money.”

Draw down your assets thoughtfully. Speak with your advisor about developing a withdrawal program that takes into account personal factors such as your age, risk tolerance and liquidity needs. The percentage of assets you can safely draw down each year — the way you build your retirement paycheck — might change as you age.

3. INFLATION

Even a modest amount of inflation reduces your spending power over time. People in retirement are especially vulnerable. Over a 10-year period, a relatively low inflation rate of 2% can bring the value of every $100,000 saved down to $81,707 (Calculations as of June 2022, according to estimates made using the Bankrate.com inflation calculator.) And over a 25-year period — probably a reasonable expectation for the length of your retirement — that number could fall to $60,346.

WHAT YOU CAN DO:
Consider investments that could grow along with inflation. “That might be real estate or stocks,” Vrdoljak says. If you have bond holdings, you may want to consider adding some Treasury Inflation-Protected Securities (TIPS). These government bonds offer returns that vary with the inflation rate. “If inflation accelerates for whatever reason, these investments could help offset that,” she notes. “You need to take care of yourself in a sustainable way. If you don’t, then you risk not being able to care and provide for yourself and your loved ones in the way you’d like over the long term.”

4. RISING MEDICAL EXPENSES

“When it comes to financial planning, people don’t systematically plan for potential health-care costs,” Vrdoljak says. “In particular, it’s really important to take into account the possibility that you’ll need long-term care.” According to the U.S. Department of Health and Human Services, 70% of Americans age 65 or older will at some point need that sort of care—which can include not just residence in a care facility, but help with daily activities like bathing or assistance with household chores.³ Even without such costs, it’s likely that your health spending will increase as you age—and it’s important to note that Medicare does not fully cover these costs.

WHAT YOU CAN DO:
Plan early for long-term care costs. Some people may be able to pay for long-term care out of pocket or are able to rely on grown children or a relative for assistance. But for many others, long-term-care insurance may be the answer. If you do choose long-term care insurance, try to purchase it in your 50s—well before you need it. The cost rises as you age and may not be available if you develop certain medical conditions.

Consider a health savings account (HSA). This is a tax-favored means of paying for qualified medical costs available to people with a high-deductible health-care plan. Contributions are generally tax deductible, earnings are tax-deferred and distributions for qualified medical expenses are free from federal taxes. Your HSA balance also can be invested, giving it the potential to grow over time. And the money in your account can be used to help with qualified costs that Medicare doesn't cover. (For more information about how the CARES Act affected HSAs and other investment accounts, read this.⁴)