Risk in Retirement, Part 2: How to Minimize Your Chances of Running Out of Money

Welcome to part two of our retirement risk series, where we’re bringing you tips and tricks to take your retirement planning to the next level. 

One question we’re often asked in retirement planning is, “Will I run out of money?

It’s a valid concern, especially for those who worry they may be past the age of working to gain an income. In part one of this series, we talked about the factors that affect retirement risk.

Today, we’re going to look at mitigating risk – by focusing on the elements of risk that you are able to control.

Whether you’re already retired, or your retirement date is in the future, keep reading! We have tips and tricks for reducing the risk of running out of money in retirement before you’ve reached your golden years. 

6 Ways to Lower Your Probability of Running out of Money in Retirement (Before Your Golden Years)

1. Harness the power of a spending plan

First, in order to understand how we can manage the risks related to money in retirement, we need to understand the three types of expenses. 

Expense type #1: Essential expenses (a.k.a., predictable expenses)

Essential expenses are the ones you have to pay in order to avoid losing your house and health – mortgage payments, food, utilities, and so on. It can often feel like we don’t have much control over these expenses (you’ve got to eat!), but in reality we do have a fair amount of control, it’s just that we sometimes make decision that lock us into long term expenses that could snow ball and have a big impact on your risk of running out money –for example,a big house with high maintenance costs, mortgage and utility bills. 

Think hard anytime you commit to a long-term expense, because locking your self into one can impact your risk of running out of money later on. Your circumstances may change, but your high expense will likely still be there.

Expense type #2: Discretionary expenses

Discretionary costs consist of your “fun” spending, like travel, entertainment and gifting. 

In a tough financial situation, you could theoretically cut back on these expenses, and then pick them back up again once the storm has passed. One way to help weather these storms is to be clear about the values that underlie the “fun” expenses. 

Are there other ways to bring this value into your life that may not cost as much money? For example, if you love to travel, and your underlying motivation is for adventure, consider other ways to experience a sense of adventure closer to home, that may not lead to as big a hit on your savings. Perhaps acting as a tourist in your own home town or trying something new that you’ve never done before.

Expense type #3: Unpredictable expenses

Lastly, we have unpredictable expenses, which are the toughest to plan for because you likely won’t see them coming. Sudden costs associated with health issues, car maintenance and home repairs fall into this category. 

Although, we can’t always control these expenses directly, there are actions we can take to lower their probability of happening (for example, living a healthy lifestyle). Another action we can take is to limit their financial impact by purchasing insurance.

For example, it’s important to maintain insurance throughout your retirement – especially health insurance to help cover unexpected medical issues. You may also want to invest in long-term-care insurance to help cover expenses in the event that you need to move to a retirement home or similar facility. Beyond your health, you can also insure your home and car against damages. 

To mitigate risk, it’s important to consider all three types of expenses in your retirement plan, and how you can strategically adjust them, if need be.

2. Make sure your emergency fund is full

Another piece of the puzzle is an emergency account. Many people think that once you hit retirement, you no longer need an emergency fund. After all, you don’t have to worry about corporate layoffs affecting your income. But emergencies can happen at any age – and a “what-if” account helps protect you against the unexpected.

3. Build a complete retirement income plan

Retirement planning involves thinking about both your future expenses and your future income. Although you may not be working at that point, you’ll probably still receive income in the form of Social Security benefits, pensions, annuities, and/or savings. 

It’s also essential to factor in the inflation rate and taxes to estimate the amount of money you will need in retirement.

4. Make sure your money is working for you

While saving too much money is not a problem many people have, there is such a thing as having too much cash

If you’re setting aside money for the long term, make sure it’s working for you in the meanwhile. Put your retirement savings in appropriately allocated investment portfolios that give you a better chance of keeping up with or outpacing inflation.

The problem with putting all or most of your money in savings accounts is that the annual percentage yield for the average savings account is much lower than inflation. Currently, the average APY is 0.23%, but the inflation rate is sitting at 6.4% – exponentially higher than the savings rate. 

If you put $1,000 in savings right now, next year you would have $1,002.30. But after a year of 6.4% inflation, that $1,000 would need to be $1,064 to be worth the same amount.

In contrast, the S&P 500 has had an average annual return of 11.88% per year since 1957, and the NASDAQ has returned 15.1% on average since 2007. 

5. Create a long-term, tax-efficient distribution plan

Retirement accounts, such as IRAs and 401(k)s, have strict tax laws and regulations that impact the tax implications of distributions form these accounts. Done incorrectly, moving money from these accounts and missing deadlines can lead to severe tax penalties. 

For example, you have to start taking your Required Minimum Distributions (RMDs) from retirement accounts once you turn 73 (changed from 72 last year, and legislation is in place that is aimed at eventually pushing this back to 75). 

If you fail to take your RMDs at the right age, the IRS will tax the amount you should have withdrawn up to 50%. 

Before you make any big changes to your accounts, it’s best to seek the help of a financial advisor.

6. Check in with your advisor frequently

Regular check-ins with your financial advisor can ensure that your retirement income plan is on track. Your advisor can also help you adjust your plan based on changes in your life, such as a change in income or health issues, and keep you aware of any new tax laws or regulations that may impact your retirement income.

Retirement planning will never be completely risk-free, but with proper budgeting and planning, you can mitigate those risks and enjoy your retirement with peace of mind.

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