Monday, July 3, 2017

Retirement is Risky Business – Here's a List

After we develop a set of major personal retirement goals for our mission statement as I described in A Mission Statement for Retirement and then review them with an advisor to identify any glaring omissions, there are a large number of financial risks that every plan should contemplate. Many of these won't come to mind when we consider a list of major retirement goals for our mission statement, but one major goal of the mission could be to mitigate as many applicable common retirement risks as we can identify.

A list of common financial risks in retirement can provide a good starting point, though this list is not exhaustive.

Let's start with a list of retirement risks the American College developed for the Retirement Income Certified Professional® (RICP®) certification because it is the most extensive I've found. A little too extensive for my taste, actually. I'm going to combine risks 3 and 11 because they're both essentially sequence of returns risk. (See the table at the end of the post for definitions.)

I have also omitted Risk 17 from my list. Timing risk is the risk that you will choose a time to retire just before the next few decades suffer economically. While that is clearly a risk everyone takes, it isn't one over which we have any control making it relatively useless for planning purposes.

Eighteen Retirement Risks from RICP®
  • RISK 1: LONGEVITY RISK
  • RISK 2: INFLATION RISK
  • RISK 3: EXCESS WITHDRAWAL RISK
  • RISK 4: HEALTH EXPENSE RISK
  • RISK 5: LONG-TERM CARE RISK
  • RISK 6: FRAILTY RISK
  • RISK 7: FINANCIAL ELDER ABUSE RISK
  • RISK 8: MARKET RISK
  • RISK 9: INTEREST RATE RISK
  • RISK 10: LIQUIDITY RISK
  • RISK 11: SEQUENCE OF RETURNS RISK
  • RISK 12: FORCED RETIREMENT RISK
  • RISK 13: REEMPLOYMENT RISK
  • RISK 14: EMPLOYER INSOLVENCY RISK
  • RISK 15: LOSS OF SPOUSE RISK
  • RISK 16: UNEXPECTED FINANCIAL RESPONSIBILITY
  • RISK 17: TIMING RISK
  • RISK 18: PUBLIC POLICY RISK
Adam Cufr, an RICP, created a list of 27 risks that largely builds on the RICP list. Some of these seem redundant to me. Nonetheless, there are some that clearly should have been added to the RICP list in my opinion, including:
  • Asset allocation risk, though I could also argue this is market risk,
  • Legacy risk, and
  • High debt service risk, important because it is a major cause of elder bankruptcy.
I'll split Legacy Risk into Legacy funding risk, the possibility that a retiree's desired bequests will not be adequately funded because the household depleted its wealth and Estate Planning risk, the possibility that the retiree's estate will not be distributed as he or she had intended.

For a third source, I like to include a list of cited reasons for elder bankruptcy from research by Deborah Thorne, Ph.D. (I wrote about this in Why Retirees Go Broke.) These include:
  • Credit Card Interest and Fees, or High debt service risk, as Cufr refers to it.
  • Illness and Injury, also called Health care expense risk,
  • Income Problems, such as losing a part-time job in retirement (Reemployment risk in the RICP list),
  • Aggressive Debt Collection, whereby retirees are unable to negotiate a settlement and feel bankruptcy is the best option. I'll roll this under High Debt Service risk, and
  • Housing problems, such as the mortgage payments increased, the respondent wanted to refinance the mortgage to lower the payments but could not, or a lender threatened to foreclose.


Retirement is risky business – here's a list.
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Housing problems is one category I believe is not already on the RICP list and should be, but I cite the Thorne study for two other reasons.

First, if a risk is one of the five major causes cited for bankruptcy then it should be given extra attention in a retirement plan.

Second, the main point of the Thorne study is that bankruptcy is most often the result of a series of interconnected financial problems that cascade into ruin. In other words, it is less likely that a household's ruin will result from a single risk on this list than to multiple risks. These losses might occur simultaneously and be unrelated, but it is more likely that one will cause another, which may cause even more. Most survey respondents reported more than one cause for their bankruptcy. A few cited all five common reasons.

Source: Thorne, Generations of Struggle.

I'll add Overspending risk to my list. Overspending risk is different than Excess withdrawal risk, which refers to withdrawing from a savings portfolio faster than the portfolio can recover with market gains. A household can overspend its way into crisis without even owning an investment portfolio. It is also different than High Debt Service risk or Credit Card Interest risk in that overspending is a risk whether or not it is financed spending.

I'll also add Interconnect-ed loss risk to my list to call attention to the possibility that individual risks are not necessarily independent of one another.

From a planning perspective, this means that we can't simply consider the possibility that the household will succumb to each risk on the list, but we must consider the possibility of simultaneous losses or even multiple, simultaneous losses that begin with a single loss.

The simultaneous collapse of the housing market and the stock market in 2007-2009 provides a recent example. For some households, foreclosure and market losses might also have led to unemployment and income loss for workers in these fields. The struggling household, in turn, might have increased credit card debt as the last remaining financial option creating a row of dominoes that tumbled into ruin.

Every retirement plan should consider all of the applicable risks on this list and their potential correlations.

The following table is my consolidation and "pruning" of the three lists discussed above. Links to the lists I curated are provided in the reference section below. Some of the explanations were taken from the RICP list (my edits are underlined.)

You can download a Word document containing this list and edit it as you like. Use it as a starting point and add risks that I missed. Risks that are unique to your household might warrant inclusion in the mission statement.

Major Cause of Elder Bank-ruptcy

Risk
Explanation
1
Health Expense Risk
For those who had employer health care coverage, retirement may mean paying more for medical insurance (Medicare Parts B and D and Medicare Supplement policies). Even with insurance, some expenses will be paid out of pocket. Also, chronic or acute illnesses may mean more significant and unexpected out-of-pocket expenses.
2
Income Loss Risk
Many retirees plan on working in retirement. Income loss risk is the inability to supplement retirement income with employment due to tight job markets, poor health, and/or caregiving responsibilities.
3
High Debt Service Risk
The risk of bankruptcy resulting from an inability to service debt, especially consumer debt. May result from spending beyond budget.
4
Housing Problem Risk
Risks to housing including mortgage payments increase, inability to refinance the mortgage to lower the payments, unpayable increase in property taxes or a lender threatening to foreclose. Includes reverse mortgage risk.
5
Dependent Risk
The risk that a loss due to one risk might cause losses due to other risks. (Formerly "Interconnected Loss Risk".
6
Long-Term Care Risk
Chronic diseases, orthopedic problems, and Alzheimer's can restrict a person from performing the activities of daily living, which will require financial resources for custodial and medical care. Includes Lack of Available Facilities or Caregivers risk, Change in Housing Needs risk and Uninsurable Medical Conditions risk.
7
Longevity Risk
No one can predict how long he will live. This complicates planning since a retiree has to secure an adequate stream of income for an unpredictable length of time.
8
Inflation Risk
When working, inflation is often offset by an increased salary. In retirement, inflation reduces the purchasing power of income as goods and services increase in price, impeding the client's ability to maintain the desired standard of living.
9
Excess Withdrawal Risk
When taking withdrawals from a portfolio during retirement to fund income needs, there is a risk that the rate of withdrawals will deplete the portfolio before the end of retirement.
10
Frailty Risk
Frailty risk is the risk that as a result of deteriorating mental or physical health, a retiree may not be able to execute sound judgment in managing her financial affairs and/or may become unable to care for her home.
11
Financial Elder Abuse Risk
The possibility that a family member or caretaker might steal assets.
12
Financial Advice Risk
The possibility that an advisor might recommend unwise strategies or investments or embezzle assets.
13
Fraud Risk
The risk of losing one's assets as the result of fraud or identity theft.
14
Market Risk
The risk of financial loss resulting from movements in market prices.
15
Interest Rate Risk
Technically, this is the risk that arises for bond owners from fluctuating interest rates. How much interest rate risk a bond has depends on how sensitive its price is to interest rate changes in the market.
16
Liquidity Risk
The risk that the retiree's assets cannot be converted to cash quickly and inexpensively enough to meet short-term expenses or debt.
17
Sequence Of Returns Risk
Investment returns are variable and unpredictable. The order of returns has an impact on the how long a portfolio will last if the portfolio is in the distribution stage and if a fixed amount is being withdrawn from the portfolio. Negative returns in the first few years of retirement can significantly add to the possibility of portfolio ruin.
18
Forced Retirement Risk
There is always the possibility that work will end prematurely because of poor health, disability, job loss, or to care for a spouse or family member. This event can quickly derail a retirement plan.
19
Employer Insolvency Risk
Employer-provided retirement benefits are an important part of retirement security for many. If the employer has financial problems, employees may lose their jobs and in some cases their benefits.
20
Change of Marital Status Risk
The loss, divorce or separation of/with a spouse is a major personal loss, but without planning can also result in a decline in economic security.
21
Unexpected Financial Responsibility Risk
Many retirees have additional unanticipated expenses during the course of retirement, in many cases due to family relationships and obligations.
22
Overspending Risk
The risk that a household will spend beyond its means and prematurely deplete savings or an investment portfolio.
23
Public Policy Risk
An unanticipated change in government policy with regard to tax law and government programs such as Medicare and/or Social Security can have a negative impact on retirement security.
24
Legacy Funding Risk
The risk that planned bequests are not funded.
25
Estate Planning Risk
The risk that one's estate will not be distributed as he or she had desired.
26
Asset Allocation Risk
The risk that one's asset allocation does not achieve expected results or is inadequately diversified.



REFERENCES

Retirement Risk Solutions, Dave Littell, RICP® Program Director, American College.



27 Retirement Risks: Which Is (Arguably) Most Damaging?, Adam Cufr, Fourth Dimension Financial Group, LLC.



The (Interconnected) Reasons Elder Americans File Consumer Bankruptcy, Deborah Thorne Ph.D.



Generations of Struggle. Deborah Thorne (Ohio University), Elizabeth Warren (Harvard Law School), Teresa A. Sullivan (University of Michigan).



Common Risks That Can Ruin Your Retirement, Ken Hawkins.



Society of Actuaries list of retirement risks. (Download PDF.)