Back when many of our parents and grandparents retired, depending on the type of work they did, the odds were good that they retired with a company pension. Research into the history of pensions shows that, in 1950, one-quarter of the private sector workforce had access to some form of company-ensured pension payments when they retired. Within ten years, that percentage had been cut in half. Today’s retirees are left to fend for themselves, for the most part, and as a result the prospects for financial security are precarious. In fact, as this Kiplinger report suggests, people retiring today are facing what the author terms “a perfect storm.”
Today’s Retirees are Unlike Their Predecessors
Financial adviser George Terlizzi wrote the Kiplinger article which first appeared last spring. He states, “Today’s retirees are unlike any other retirees in history: They’re living longer, and many of them want to spend more in retirement than previous generations. At the same time, the fear of running out of money is incredibly common, and for good reason.”
Terlizzi refers to what he calls “the bargain made decades ago” when traditional, defined pension plans gave way to the modern 401(k) plan. That shift, which began in the 1980s, was designed to give workers greater control over their retirement savings – but at the same time, the article observes, it also transferred “longevity risk” from the employer to the worker. “As such, these days few retirees can rely on a significant pension and must make their savings last for decades” – a chore made more difficult by a perfect storm of low interest rates, higher inflation and market volatility in the years ahead.
Low Interest Rates are a Boon to Borrowers, a Curse for Savers
As Terlizzi points out, the Federal Reserve has persistently kept the target federal funds interest rate (the benchmark for most interest rates) at a historically-low range of 0.25 percent or below – as low as zero percent. This cut, which goes back to the beginning of the pandemic in March of last year, was intended to fight the crippling effects of COVID on the U.S. economy. Economists expect rates to remain at rock bottom. “Interest rates are expected to stay where they are until 2023,” Kiplinger reports. “Even when they rise, they could stay relatively low for some time.”
As government spending expands to help right the economy, says Terlizzi, rates will stay low, which means retirees will face what he calls “an intrinsic tax in the form of persistently low rates paid on savings.” He adds, “Borrowers love low rates as much as savers detest them. This truth is very much in play today. This poses a problem to retirees who want to earn a reasonable rate of return while minimizing their investment risk.”
The Potential for Inflation Further Erodes the Value of Savings
“Coupled with persistently low interest rates, retirees could face increased inflation in the coming years,” says the article. Recent government spending proposals to fight the effects of COVID have already exceeded an astronomical $4 trillion, with more spending currently being hotly debated in Washington, all of which can certainly give rise to inflation. The Federal Reserve has said that it would allow inflation to rise above 2 percent for an indeterminate period. “Consider this,” Terlizzi writes: “After 20 years with a 2 percent inflation rate, $1 million would only have the buying power of $672,971” – a loss of one-third of savings value.
Will the awful inflation rates of the 1970s and early 1980s return any time soon? Economists say that’s unlikely. Still, as Kiplinger observes, “even a normal inflation rate is cause for concern among those nearing and in retirement. Over the course of a long retirement, inflation can eat away at savings significantly.” One unfortunate side effect, says the article, is that the combination of low interest rates and higher inflation “may drive many retirees to take on more market risk than they normally would” – further endangering financial health.
Low Returns and High Volatility Expose Retirees to Market Risk
Once in retirement, most seniors will start to withdraw funds from retirement accounts. Unfortunately, Terlizzi warns, if this happens when the portfolio is declining in value, the result can be what planners refer to as “sequence-of-returns risk.” This danger is often due to nothing more than unlucky timing, but the problem is still very real. “As a result, often the portfolio cannot fully recover as the market bounces back, due to the burden of regular withdrawals, and may be left significantly reduced.” This raises the specter of running out of money.
“Today’s retirees live in an uncertain world with an uncertain market,” Terlizzi writes. “No one could have predicted the pandemic or its economic effects, and similarly, no one can predict where the market will be next year, in five years or in 10 years.” Younger investors have the luxury of time and can hold on until the market recovers, but that’s not true of most retirees who are relying on their investments for income. At the very least seniors “need to rethink their retirement investment strategy.”
The Solution: Careful Planning and Good, Objective Advice
Terlizzi’s solution to the “perfect storm” facing retirees is to plan carefully and review frequently. Don’t succumb to the pressure to take on too much market risk in hopes of earning a reasonable rate of return. “The most fundamental step,” he says, “is committing to regularized, frequent reviews with your financial adviser. Depending on portfolio size and complexity, this is most often quarterly, but should be no less frequent than every six months. This time investment keeps retirees attuned to shifts in the portfolio that will sustain them for decades to come.” Terlizzi adds that a qualified adviser has many investment solutions in his or her arsenal that can help preserve funds in retirement.
Our advice at AgingOptions is to make sure your adviser knows how to prepare a financial dashboard. This is a vital step in planning. The dashboard allows you to see the effects of all your financial decisions, in order to help you make continual adjustments to your plan. Contact us and we’ll refer you to a professional adviser who can assist you. That way you can retire with greater confidence, and avoid getting caught in that perfect storm.
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(originally reported at www.kiplinger.com)
