What to do when things go wrong in retirement
Listening to this week’s Informed Choice Radio podcast, I was struck by how it related to income in retirement.
You’d be asking for trouble if you retired on the hope that you will live in a perfect world where nothing goes wrong. After all, if you intend to retire in your mid-60s, retirement will likely make up about one-third of your entire life.
The things that can go wrong in retirement are mostly what Frank Supovitz would call the “Oops” type. But failing to plan for them will constitute a “Damn” (the podcast explains what I mean).
The podcast tells us that you can prepare for things going wrong ahead of an event.
Here, retirement is unique. Frank Supovitz has run the Super Bowl year after year, but you won’t have retired before, and you won’t retire again.
But you can prepare by finding out what has gone wrong in retirement for other people, and then you can start to prepare for it.
Fortunately, Financial Planners have helped millions of people into and through retirement, and we can use that experience to help you.
Relying on investments for retirement income is a relatively recent phenomenon. To date, hardly anyone has funded the full retirement journey from investments – retirement has been mostly financed by guaranteed income (state and final salary pensions). So we need to learn from the related sphere of investments too.
Some things will almost certainly go wrong in retirement, and some things which might not, but the chances are high. You need to have a plan for both types of event when you do stop work.
What Will Go Wrong?
• One of you will die first. I’m amazed how often retirement plans don’t take this into account. It’s usually has a more significant impact for those living on guaranteed income (like final salary and state pensions). Statistics and our experience tell us that this lack of preparation affects widows more than widowers. A good financial plan will recognise this and include solutions.
• Your Financial Literacy will decline. Studies show that financial literacy declines by 1% per year from the age of 60. Unfortunately, confidence in our financial literacy tends to remain the same, which can, by itself, create vulnerability as we get older. Building a relationship with an excellent Financial Planner at retirement is the best way to protect you against this risk.
• One of you will get ill. Your financial plan should include provision for the things you want to do before your health declines, and it should also help you to manage the financial implications of worsening health.
• Stock markets will crash. Don’t fool yourself! We may well have had ten years without a significant setback, but that won’t continue for the next thirty years. Retirees don’t need to worry much about the depth of the market fall; the duration of the fall is much more significant. In the last 30 years, the FTSE index has lost more than 20% on three occasions, taking seven months, five years and three years to recover. You need to decide what preparations you will make for these sorts of crashes before you stop work – a sound financial plan will prepare you.
I’ve seen a lot of retirement plans, and I’m amazed at how many ignore the first three events and mention the last one.
What Could Go Wrong?
We could have an infinite list here! But some things are more likely than others, and you should prepare for these too.
• Misestimating Your Expenditure. It’s pretty easy to omit an item of expenditure – usually, because some elements of spending are infrequent, but also sometimes because we don’t want to admit to them – the Wise household doesn’t like owning up to the amounts it spends on bikes and shoes! A good financial planner can sense check your expenditure. And you do need to own up to those guilty pleasures – for me, a retirement where I had no money for bikes would be truly miserable. Over-estimates are just as common as under-estimates, but over-estimates are much easier to deal with.
• Spending Shocks. Longevity has increased the likelihood of spending shocks. Our experience is that the cause of spending shocks is often your children or grandchildren, where declining health or marital breakdown can result in retirees wanting to help out. A good financial planner can help you to consider the financial consequences for you of helping out so that you can make an informed choice about what to do.
• Inflation. This almost made it into the list of “what will go wrong”. We all seem to have short memories where inflation is concerned. Most financial plans confidently predict that inflation will average 2.5% or 3%, glibly ignoring the fact that CPI exceeded 4% in 2011, and has hit 7.5% during the past 30 years. Inflation is less of a concern if a large part of your income is guaranteed to increase in line with it (e.g. state pensions and final salary pensions) or your investment strategy has taken it into account.
• Higher Taxes. Tax policy has treated pensioners pretty well in recent years, with a variety of measures reducing the amount of tax deducted from their income, compared to previous generations of retirees. It seems unlikely that the favourable tax regime can continue indefinitely, and some preparation appears sensible. Diversifying your investments so that you receive income from different sources is key here, and again a good financial planner can help.
Trying to identify risks and taking action to avoid them is possibly more important for retirement than for earlier phases of your life, when your human capital can be used to put you back on track.
If you can identify an “Oops”, you may be able to avoid a “Damn”!