In contemplating retirement there are some known factors, some partially known factors and some unknowable factors. Knowing as much as you can about these factors is important in planning for a successful retirement. Each of these factors presents a risk. The risks are:
1. Increased taxes
2. Inadequate career earnings
3. Excessive retirement spending
4. Inadequate savings
5. Increasing inflation
Individuals have more or less exposure to these risks. At times, taxes and inflation will be bigger risks generally, and at others they will not be risks. For the last decade, neither taxes nor inflation have been significant. The next decade may well be different.
1. Increased taxes - For a retired person, an increase in taxes presents a risk to after-tax income. For instance, a retirement income based on the interest paid from a municipal bond portfolio will be greatly reduced if that income changes from being tax-exempt to taxable. Likewise, if Social Security and Medicare are reduced through means testing, after-tax income falls. In planning a retirement which includes these elements, a sensible person will make some calculations to insure that after-tax income will outlast such happenstance. Similarly, a general increase in tax levels will affect all income, whether from pensions, Social Security or other sources. Modeling at least a moderate rise in tax levels is a helpful guide to having adequate after-tax income.
2. Inadequate career earnings - Whether from unemployment, underemployment, or early retirement, inadequate career earnings affect a retiree's financial position. Employment breaks in a career can increase debt, decrease assets including savings, and reduce pension benefits. Each of these misfortunes affects disposable income in retirement. Savings above the minimum while working will help overcome any periods of lower or no savings.
3. Excessive retirement spending - Dreaming of an extended world tour after retirement? Such a trip could ruin your chances of outliving your money. Even more mundane spending, such as inadequate health insurance or unexpected home repairs, could unwind your retirement plans as well. Provision should be made to save for known large expenditures separately from normal retirement savings. Allowances for the unexpected should be added into your retirement budget.
4. Inadequate Savings - Voluntary postponement of gratification is not natural. It is a learned skill. Americans in the last few decades have largely lost their taste for saving. It is not taught in our schools nor in our homes. It is not surprising that such a very small minority of Americans approaching retirement have saved adequately. The toll of inadequate saving during a career is continued work (if you're blessed with a job and good health), or survival on a public pension. A savings rate of 10% is a very good start, but is not achieved by most. A still higher rate would be even better. You can raise your rate of savings today by changing your way of life.
5. Increasing inflation - A problem from our past; and now a threat to our future, inflation could unravel the best retirement plan. In the seventies, inflation exceeded 10% for several years. For many, what had been an adequate or even generous retirement income became paltry and meager. Even in more recent and more moderate inflation times, a retirement income from 30 years ago buys about half what it used to buy. Building inflation into your planning is essential, and adding a cushion for increased inflation is prudent.
It isn't sufficient to save for retirement. A prudent person saves for retirement and saves to cover risks both known and unknown. It is a pitiful thought that you may run out of money before you die. But, a more pitiful thought is years of worrying about running out of money when it is too late to help yourself.
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