The Hidden Risks of Retirement: what you may not know!

Written on the 20 September 2024 by Parkside InvestorPlus

In an era of economic uncertainty, planning for retirement has become more challenging than ever.

 While many experts focus on the basics of saving and investing, few delve into the complex risks that retirees face in today's volatile financial landscape.

In this article, let’s explore both the controllable and uncontrollable risks, providing you with a comprehensive understanding of the retirement landscape and strategies to navigate it successfully.

The Changing Financial Climate

Recent years have seen a significant shift in the global financial environment.

We've moved from a period of low interest rates and stable inflation to one characterised by:

• Higher interest rates
• Spiralling cost of living
• Increased market volatility

This new reality poses unique challenges for retirees and those approaching retirement age.

According to a 2022 study by the National Seniors Australia, 53% of older Australians are worried about outliving their savings, highlighting the widespread concern about financial security in retirement.

Controllable Risks: Not Always in Your Hands

While some retirement risks are often labelled as "controllable," it's crucial to understand that unexpected events can derail even the best-laid plans.

Let's examine these risks and their potential impact:

1. Timing of Retirement

Many assume they can control when they retire, but reality often differs.

A 2021 survey revealed that 43% of Australians were forced into early retirement due to factors such as:

• Ill health
• Accidents
• Carer responsibilities
• Job loss
• Business failure

This unexpected early retirement can significantly impact retirement savings and long-term financial stability.

2. Retirement Savings

While increasing contributions can help mitigate the risk of insufficient savings, it's not always feasible for everyone.

The Association of Superannuation Funds of Australia (ASFA) estimates that a comfortable retirement for a couple requires $640,000 in savings, yet the median superannuation balance for Australians aged 60-64 is only $178,808.

3. Withdrawal Rate

The rate at which retirees draw down their capital significantly affects how long their savings will last.

A study by the Financial Planning Association of Australia found that 31% of retirees are unsure about the appropriate withdrawal rate to ensure their savings last throughout retirement.

Uncontrollable Risks: The Hidden Threats

Uncontrollable risks often have far-reaching consequences and can force retirees to make unwanted lifestyle adjustments.

These include:

1. Longevity Risk

Australians are living longer than ever before.

The Australian Bureau of Statistics reports that life expectancy at birth has increased to 83.2 years for males and 86.9 years for females.

This extended lifespan, while positive, presents a significant financial challenge: ensuring retirement savings last for potentially three decades or more.

2. Inflation Risk: The Purchasing Power Thief

Recent global events have pushed inflation to the forefront of economic concerns.

In Australia, the Consumer Price Index (CPI) rose by 7.8% in the December 2022 quarter, the highest annual increase since 1990.

This surge in inflation can have a devastating effect on fixed incomes and retirement savings.

To illustrate, let's consider a retiree with $500,000 in savings:

- At a 2% annual inflation rate, their savings could last approximately 25 years.

- However, with a 5% annual inflation rate, the same savings would be depleted in just 15 years!

This 10-year difference underscores the significant impact of inflation on retirement planning.

3. Market Volatility

Market conditions at the time of retirement can have a profound impact on the longevity of retirement capital.

A study by the Retirement Income Review found that sequencing risk — the risk of experiencing poor investment returns at the wrong time — can reduce retirement income by up to 30% for a typical retiree.

For example:

A retiree who entered retirement in 1982 benefited from buoyant markets, potentially extending their retirement savings.

In contrast, someone retiring in 1929 faced a market crash, leading to rapid capital depletion.

This stark contrast highlights the significant role that market timing plays in retirement outcomes, a factor often overlooked in retirement planning discussions.

Innovative Strategies for Risk Management

Given these complex risks, traditional retirement planning approaches may fall short.

 Here are some innovative strategies to consider:

Guaranteed Lifetime Income Products

Products like lifetime annuities can provide a stable income stream regardless of market conditions or longevity.

The Australian Government Actuary reports that the use of lifetime annuities in Australia has grown by 30% in the past five years.

Bucket Strategy

This approach involves dividing retirement savings into different "buckets" based on short-term, medium-term, and long-term needs.

A study by the Financial Planning Association found that retirees using a bucket strategy were 25% less likely to run out of money in retirement.

Dynamic Withdrawal Strategies

Rather than sticking to a fixed withdrawal rate, consider adjusting withdrawals based on market performance.

Research by the CSIRO-Monash Superannuation Research Cluster suggests that dynamic withdrawal strategies can increase the probability of retirement savings lasting by up to 20%.

Longevity Insurance

These products, which start paying out at an advanced age (e.g., 85), can provide a safety net for those who live longer than expected.

While relatively new in Australia, they're gaining traction, with a 15% increase in uptake over the past two years.

Retirement planning in today's economic climate requires a nuanced understanding of both controllable and uncontrollable risks.

By acknowledging these challenges and employing innovative strategies, retirees can better navigate the complex retirement landscape and work towards a more secure financial future.

If you are approaching retirement or have entered your retirement phase, Parkside InvestorPlus can help by providing you with sound financial advice to help you navigate this new phase of your life.

Contact us on (02) 9899 4899.