Friday, October 13, 2017

Why a Rational Retiree Might Keep Going Back to that ATM

In particular, the presumption that a client will adhere to a deterministic spending schedule, wake up one morning, go to an ATM, and discover that the “money process” has reached zero is silly and naive.” — Moshe Milevsky[1].

Milevsky refers to periodic, constant-dollar spending from a volatile portfolio, as simulated in sustainable withdrawal rates (SWR) research.

It is with no small measure of sadness that I find myself disagreeing, at least under certain conditions, with three of my favorite retirement researchers — Moshe Milevsky, Michael Kitces . . . and me.

For Michael’s perspective, I refer to a comment he made somewhere on the Internet some time ago referring to a paper entitled, “A 4% Rule — At What Price” by Jason Scott, John Watson and William Sharpe[2]. That research showed the high cost of mitigating longevity risk by over-saving. The large amount of “fettered” assets that must remain untouched to survive long periods of poor market returns make SWR strategies economically inefficient and expensive. Wade Pfau has referred to fixed spending from a volatile portfolio as the least efficient strategy.

I couldn’t locate that comment from Kitces so I will do my best to paraphrase from my (aging) memory. The problem with the Scott analysis, I recall Kitces suggesting, is that retirees don’t “do that.” They don’t just keep spending the same amount no matter the circumstances.

That was my intuition, as well. And in fairness, we were all three mostly right, though the devil is in the details.

It was hard to imagine that rational retirees would keep spending the same amount from a portfolio that appeared to be spiraling into ruin. (Cue Richard Thaler laughing aloud[4]). But, while Michael used that intuition to question the Scott research, I have always considered it an invalidation of the constant spending model as a planning tool. (As a research tool, it taught us about sequence risk.)

A predictive model says, “If you do this (follow the model’s policies in real life) then you can expect these results. If we don’t expect people to follow those policies, then we shouldn’t expect the outcomes that the model predicts. And, clearly, most of us don’t expect rational retirees to “do that.” So, why believe the results?

Why rational retirees might keep going back to that ATM.
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I still have serious problems with the model, and not just this behavioral assumption, but it took a retiree going broke in his early 80’s to help me understand that there might well be rational reasons for a retiree to keep showing up at that ATM until it spits her card back at her.

(Please note this evidence that actual retirees go broke with SWR strategies and this isn't a hypothetical outcome that occurs only in Monte Carlo simulations. Considering elder bankruptcy rates, however, the evidence seems to show that the rate of ruin is an order of magnitude less than SWR models predict. On the other hand, I suspect the rate of reductions in standards-of-living is higher.)

A retiree contacted me after depleting his savings portfolio at age 82 with a failed SWR strategy. He was down to Social Security benefits and a little home equity and hoped I could show him a way out of selling his home and living off Social Security benefits.

Sadly, neither I nor several retirement planner friends could offer a suggestion beyond a home equity loan, which didn’t work out. It’s tough to rebound after you age out of the labor market.

After our discussions and a little thought, I realized that households with substantial savings relative to their spending might well see portfolio failure looming and reduce spending. If they do, they will likely see their portfolio recover, as I showed some time ago in a series of posts entitled, Clarifying Sequence of Returns Risk. You don't go broke with variable spending from a volatile portfolio. On the other hand, the spending is, well . . . variable.

Households with limited savings, on the other hand, may well find that their non-discretionary expenses gradually overwhelm their safe level of portfolio spending. Even though the portfolio would be doomed by continued spending, they will still need to pay for groceries and housing and may have little recourse other than to keep spending and pray for a tremendous bull market. They may find themselves in a “spending trap” in which they must sustain their level of spending simply to pay non-discretionary expenses with the knowledge that doing so will most likely soon bankrupt them.

If we consider that credit card debt is a major cause of elder bankruptcy, then we can expect retirees in such a spending trap to max out their credit cards to pay bills before depleting their credit along with their portfolio. (The 2017 Retirement Confidence Survey from EBRI notes that "18 percent of all workers describe their level of debt as a major problem and another 41 percent call it a minor problem.")

A credit card debt spending trap is similar. The household continues to spend from credit well past the point where they believe they can repay because it has no good alternative. We would not expect excessive credit card spending to be normal, rational behavior but if it is the best of a set of bad alternatives, we probably have to call it rational. Again, this occurs in households with little or no remaining savings.

I learned this lesson long ago when I was asked to help a lady who had run up $60,000 in credit card debt while her husband suffered a long bout of unemployment. "I didn't use the card at Nieman Marcus," she explained. "I bought groceries and clothes for my kids." Not irrational.

A similar conundrum applies to reverse mortgages. The sales pitches strongly suggest that a mortgagee can’t be forced from the home by foreclosure so long as the home remains their principal residence. In other words, just stay in the home and the reverse mortgage can’t be foreclosed. True, but notice how easily that suggestion rolls off the tongue.

A reverse mortgage borrower can lose her home through processes other than foreclosure. A retiree who chooses a reverse mortgage might find that despite her expectations when she retired, she no longer wishes to live in the home or can no longer afford its maintenance or the local cost of living. “Just” keeping the home as her principal residence might not be an attractive option.

I recently learned of a wealthy, retired corporate executive who lived in an expensive suburb of Houston. His wife developed dementia and her care bankrupted the household. Reverse mortgages were not a part of that story but it is easy to imagine that, had he borrowed one and spent most of the equity, he would choose to move to less expensive housing in a less expensive community even though that would trigger the mortgage’s repayment. While he could postpone repayment by just remaining in the home, that might not be his best option. Moving out, though it would trigger mortgage repayment, might be the rational choice.

So, returning to that “deterministic spending schedule,” I, too, prefer to believe that most people would note their deteriorating finances and reduce spending in time, but retirees with more limited resources might end up in a spending trap in which their portfolio’s death march is the best of a poor set of choices. They might also fall victim to the "boiling frog" scenario in which the deterioration is so gradual that it fails to set off trigger points in time (although the whole boiling-frog thing is fake news, according to The Atlantic.[3])

As a friend and Duke philosophy professor recently told me when I questioned people voting against their own interests, sometimes people are acting in their own interests but we just don't understand what those interests are.

This week that the Nobel Committee conferred its award to Richard Thaler seems appropriate to remind ourselves that our financial models are fairly irrelevant if we ignore the human behavior element or oversimplify it.

Sometimes a retiree may keep returning to that ATM for as long as possible because she has no better alternative. That's rational.


[1] Financial Analysts Journal : It’s Time to Retire Ruin (Probabilities), Moshe Milevsky.

[2] A 4% Rule - At What Price? by Jason S. Scott, William F. Sharpe, John G. Watson.

[3] The boiled-frog myth: stop the lying now! The Atlantic.

[4] Richard Thaler, A Giant In Economics, Awarded The Nobel Prize, Forbes.


I will participate on a panel of retirement advisers in a Twitter chat sponsored by Thomson Reuters and entitled "When Can You Retire?" on Wednesday, October 18 from 2 p.m. to 3 p.m. ET. Follow @Retirement_Cafe and @ReutersMoney to join us.

A fellow retirement planner was told at a seminar this week that "95% of retirees should get a reverse mortgage at the beginning of retirement to create income." Aside from writing a will, I can't think of any single thing that 95% of retirees should do. I am told that Mark Warshawsky estimated that 14% of 62+ households could potentially benefit. Sounds much more reasonable to me. Still others might benefit from a reverse mortgage to create an emergency fund.

Monday, September 11, 2017

The Equifax Breach and Freezing Your Credit Reports

In the wake of the Experian breach, I have received a number of questions about what happened and what we should do to protect ourselves from identity theft. Identity theft is a significant financial risk to retirement. Fraud risk is number 13 on "the list" (Retirement is Risky Business – Here's a List.)

The Problem

Identity theft can hurt us financially in several ways but the two aspects I'll discuss here are theft from an existing financial account (PayPal, credit cards, Amazon, a broker, etc.) and thieves creating new financial accounts in your name.

Here are two examples of theft from an existing financial account.

Three or four times a year I am contacted by one of my credit card companies to inform me that they have detected fraud in my account, often before I even see it. Their solution is to issue a new card with a new account number. That fixes one problem but causes others because three or four times a year I have to change my card number at places that store it like Netflix and Amazon. Another time, Amazon informed me that someone had ordered a $4,000 TV from my account but that they had stopped the order because it was clearly fraudulent.

Most of these incidents work out OK, except for the inconvenience, because my credit cards are insured against fraud by the issuer.

A lot of elder theft and fraud, however, is committed by family members. If a family member steals your credit card, Social Security check or ATM card, you probably won't be reimbursed unless you are willing to file legal charges against that family member. Sadly, you need to take extra precautions to protect your PINs, passwords and other vital information from family members. Remember that many of them will have physical access to your computer.

The second risk involves someone stealing your identity and opening a new account in your name. Unless you are vigilant, they can use these accounts undiscovered for some time and you will have the nightmare of proving you aren't responsible for the charges. The accounts they open could be anywhere from PayPal to a home equity loan.

Who Steals Your Identity?

Often, the hacker who steals your identity is not the person who steals your money. Hackers steal personal information and sell it to fraudsters over the Internet. (The magic of specialization.) Thanks to the Internet, the hackers and fraudsters can be anywhere in the world. Russia, North Korea, and Eastern European countries are common homes for this activity, but it happens everywhere.

What does this mean to you? It means that you can take extensive precautions to ensure that you protect your valuable identity information only to see the thieves just steal it from someone you do business with who also has your information. 

The latter is largely beyond your control. You can't control your personal information that Experian or Target keeps and has promised to protect.

Where Do Thieves Find Your Information?

They can look over your shoulder for your password while you log onto the Internet or enter your PIN at an ATM. They could steal your wallet. They can steal your credentials while you use a public Wi-Fi connection at a coffee shop (I use a VPN to protect against this.) They could hack into your computer. But, the least-cost approach is to steal millions of ID's at a time from places like Equifax, Target, and Yahoo.[1]

If bank-robber Willie Sutton were an identity thief, he'd explain his attacks on large companies by saying, "Because that's where your data is."

Why rob your home, steal your wallet or hack into your PC to steal one ID when a thief can hack Yahoo and steal millions?

If the Home Depot breach was a bank robbery, the recent hack of the credit-reporting agency Experian was like robbing the Federal Reserve.

Should you freeze your credit reports? Yup.
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The Credit Reporting Agencies

There are three major credit reporting agencies, Experian, TransUnion, and Equifax. Most people have a file at all three, which should (but doesn't always) contain the same information about you. (You should check all three regularly at to correct any discrepancies.)

In addition to the three major agencies, there are about 40 others[2], most of which specialize. You should focus on the top three (and perhaps Innovis.)

When you apply for a new credit card, an apartment lease, or a reverse mortgage, for example, the company accepting your application will first check your credit record. Unless you have frozen your credit report at the credit-reporting agency they choose to check, this will be done easily and will not be reported to you.

This simplifies your life but, unfortunately, it also simplifies the life of the thief opening an account in your name.

Freezing Your Credit Reports

You also have the option of "freezing" your credit reports at these reporting agencies. If you order the agencies (plural, it only makes sense to freeze all three) to freeze your reports, they will provide you with a PIN number to unfreeze the account when you need to.

The bad guys can't open an account in your name without your PINs. This is less convenient for you because you have to unfreeze your reports when you want to open a new account. (This is typically less inconvenient for retirees because we tend to open fewer new accounts.)

My reports have been frozen for years, so when I recently opened a new account the lender called me to tell me that he couldn't run a credit check because my credit report was frozen. I try to remember this and unfreeze the account when I submit an application, but I often forget.

I asked the lender which agency his company uses and was told Experian. I knew then that I only needed to unfreeze the Experian reports so I logged onto, entered my PIN, and unfroze the account.

I could choose to unfreeze it for everyone or for one specific lender so I chose the latter. I could also unfreeze it until I chose to freeze it again or for a specific time period, so I chose to unlock my credit reports for this single lender at one agency (Experian) for five days, after which the account would once again be frozen to everyone.

Inconvenient? Yes, it cost me a few more days in the application process because I had forgotten about the freeze, but not nearly as inconvenient as identity theft.

Credit Monitoring Services

Many companies, including the reporting agencies, offer a service to monitor your credit report. Note that this is not the same as monitoring your credit accounts. After a breach, the hacked companies inevitably offer a year of free credit report monitoring service to help repair their image. "Free" is a fair price for this service and I generally take them up on it.

The problem with these services is that they won't notice a problem until your creditor reports it to the credit-reporting agency. (Again, they monitor your credit report at the agencies, not your actual Visa or PayPal accounts.) This is somewhat akin to checking the obituaries each morning to see if you're in them.

You may have seen a TV commercial that shows a bank being robbed while a security guard just watches. "Aren't you going to do something?" a customer asks while lying face down on the floor.

"Oh, I'm not a security guard," he responds. "I'm a security monitor. My job is to tell you when your bank is being robbed. By the way, your bank is being robbed."

The credit report monitoring services are even less useful. They tell you that your bank was robbed, not that it is being robbed.

Protecting Against Fraudulent Accounts

Though credit freezes won't stop the first problem I described, someone accessing your existing financial accounts, they can prevent someone from opening a financial account in your name.

I protect my existing accounts with two-factor authorization everywhere it is available.[3] I also set up email notifications on every financial account that offers them to immediately notify me of unusual transactions, like those for large amounts or charges outside the U.S. Lastly, I set up email notifications for accounts that don't offer this service at[4]

For the second risk, someone opening an account in your name, I highly recommend that everyone — especially retirees, since they open fewer new accounts and may be more financially vulnerable — freeze their credit reports at all major credit reporting agencies. It may cost a few bucks, depending on your state laws[5] and it will be a little inconvenient, but it is worth the effort.

Here are some directions if you choose to freeze your credit reports.
  • Assume that your ID has already been stolen. That's the safest assumption and it's probably true. Many IDs have been stolen and the thieves are waiting for someone to buy them. Maybe they just haven't gotten around to yours — yet. Once you accept this fact, you will focus more on how to protect yourself after your information has been stolen.
  • Log on to all three credit reporting agencies (links below under "References") and freeze your credit reports.[6-8] Follow their directions. You will need to provide a good deal of personal financial information to do this online so they can be sure that you are you, but you always have the option of calling the phone number they provide.
  • Don't do this, of course, over a public Wi-Fi network.
  • Request a freeze at the smaller agency, Innovis, because as the Washington Post asks, "Why not?"[9]
  • Some concerns have been raised regarding weak PINs provided the agencies and whether PINs were stolen in the Equifax breach.[10] Equifax says they were not, but not everyone is willing to trust Equifax' word right now. To play it safe, you might want to change your PIN if you already had one. Equifax says they will add that ability immediately and begin providing more random PIN numbers, as well. 
I'll be changing my PIN because, well. . ., "why not?"


[1] 2017 Data Breaches - The Worst Breaches, So Far | IdentityForce®.

[2] Credit Reporting Agencies: Big 3 & Alternative Bureaus | WalletHub®.

[3] Two-factor authentication: What you need to know (FAQ) - CNET.

[4] Mint: Money Manager, Bill Pay, Credit Score, Budgeting & Investing.

[5] Details of credit freeze laws in all 50 states.

[6] TransUnion Fraud Alert

[7] Equifax Alerts

[8] Fraud Alert Center at Experian

[9] Innovis Security Freeze.

[10] After Equifax Breach, Here's Your Next Worry: Weak PINs, New York Times.

Friday, September 8, 2017

Social Security Claiming and Pig Races

The retirement planning question I am asked most frequently is when to claim Social Security benefits. I received a letter from a reader and a question from a friend at the local cafe on this topic just in the past three days.

Another friend sitting three rows behind me at a baseball game once stood up in the middle of an inning and shouted, "Hey, Dirk, what is the break-even age for claiming Social Security benefits?"

Since most Americans have not saved nearly enough for retirement, when to claim is often moot. Most people need their benefits right away and can't afford to delay them. But, if you can afford to wait, let me try again to explain why you probably should.

Here's the comment from a reader.
"My wife and I will retire in 4 or five years at about 66. We will each have small pensions and access to a little investment income. Social Security will be the 4th revenue stream. A financial adviser really wants us to wait until 70 to claim Social Security, but I'm concerned that we will have to erode our investments during that 4 or 5 year wait. Trying to forecast what that will cost us in lost investment income vs the higher Social Security benefit when claimed later is like betting on the pig races at the fair. An educated guess, a WAG, a stab in the dark. It doesn't help with the confidence and security we seek in retirement."  – Chris
(Isn't it interesting how often pigs come up in my retirement blog? I need to give that some thought. Think Like a Bayesian Pig.)

Chris, I believe the reason you are not getting a satisfying answer is that you're not asking the right question.

I deduce from your comment that you understand that if you live a long time, you will be better off financially by delaying claiming your Social Security benefits but, if you don't live a long time, you will be better off claiming them right away.

You are having difficulty deciding whether to bet that you will live a long time or a short time after you retire. You might as well bet on that pig race because just as you have no idea which pig is fastest, you have no idea how long you will live.

Social Security retirement benefits are a form of insurance. In fact, Social Security is the commonly used term for the federal Old-Age, Survivors, and Disability Insurance (OASDI) program. Before we delve into old-age insurance, let's consider a more familiar form of insurance, auto insurance.

By car insurance industry estimates, you will file a claim for a collision about once every 17.9 years.[1] That isn't terribly interesting information because you might not be average. You might go 30 years without an accident or have one tomorrow.  Planning your retirement or buying insurance based on averages is a very serious fallacy. Insurance should protect you from catastrophes, not from average losses.

You might ask – though, you probably don't — why you should pay thousands of dollars each year for car insurance when there is a 50% chance that you won't have an accident for nearly 18 years.

The answer is simple. A car accident could be financially catastrophic. Without insurance, it might cost you $40,000 to replace a car, not to mention hospital bills and a million-dollar liability judgment. So, we pay insurance premiums hoping that we never need to file a claim in order to avoid a potentially catastrophic outcome.

That's the definition of insurance. We accept a small, guaranteed loss (the cost of insurance premiums or delayed Social Security benefits) in exchange for protecting us from an unlikely but potentially catastrophic loss.

A reader asks: Is claiming Social Security benefits harder than betting on pig racing?
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How does that relate to delaying Social Security benefits, a.k.a., Old-Age, Survivors, and Disability Insurance?

Delaying Social Security benefits is like purchasing additional longevity insurance. The equivalent premium payment is forgoing some Social Security benefits that we would otherwise receive if we claimed at age 62.

The equivalent catastrophic loss in retirement is becoming impoverished when we are very old. Delaying claiming Social Security benefits is a way to buy more longevity insurance. Said differently, it's a way to transfer some guaranteed income early in retirement to provide more income later in retirement should we live to be very old.

This is the catch, of course. We don't know if we will live a very long time and, if we don't, we will have given up those early benefits for no reason, like buying auto insurance and never needing to file a claim.

When we buy auto or life insurance, we don't know if we will have a huge accident or die while dependents still need our job income, either. We may be paying those premiums with no return and, in fact, we hope we are. We don't make a bet on when those things might happen, we buy insurance to protect ourselves if they happen because an uninsured loss could be really bad. The alternative is to hope we're lucky.

Short retirements are cheaper than long retirements. Let's assume that you will need $50,000 a year to cover your living expenses after you retire. A retiree who leaves the workforce at age 62 and dies at age 67 will need $250,000 to fund retirement. A worker who retires at age 62 and lives to age 92 will need $1.5M to fund retirement.

(Both numbers are actually smaller than this when we consider the time value of money, but let's keep it simple for now.)

In other words, if you don't live long, your retirement will be relatively cheap and if you become quite old it will be relatively expensive.

When you delay claiming Social Security benefits and only live a short time, you will reduce your income but it won't hurt much because you will also have a cheap retirement. If you live a long time, you will increase your income by delaying claiming and you will need the additional income because you will have a long, expensive retirement.

Now, let's look at the alternative bet of claiming your benefits early.

If you live only a short time after retiring, you will have maximized your Social Security income for a scenario in which your retirement wasn't that long or expensive. If you live a long time, you will have minimized your Social Security income for a scenario in which your retirement is relatively expensive.

The goal of delaying claiming your Social Security benefits is to make sure you have more money in the worst case scenario, living a very long, very expensive retirement. It's like taking some small, certain losses by buying car insurance to avoid an improbable catastrophic loss if you have the big accident.

Now, Chris, I suspect that you're trying to place a bet on whether or not you will live a long time. If you're healthy, you can't know how long you will live. If you're going to place that bet, you're correct, you might as well bet on the pigs.

A better way to frame this decision is as a purchase of additional longevity insurance to protect your household against a very long, expensive retirement instead of framing it as a bet on how long you might live.

Your comment says, "It doesn't help with the confidence and security we seek in retirement."

If it's confidence and security you seek, buy insurance. You get that by delaying claiming Social Security benefits as long as you can afford to do so, thereby taking the catastrophic scenario, inadequate income in old age, off the table.

You also say, "Trying to forecast what that will cost us in lost investment income vs the higher Social Security benefit when claimed later is like betting on the pig races at the fair."

You're trying to compare two very different things. Your investment portfolio is a liquid asset with no longevity guarantee — you can outlive your portfolio. Annuities and Social Security benefits are illiquid but they will provide income if you live to 120. You probably need both.

Like not knowing how long you will live, you can't know how much investment income this decision will cost you. You can only guess. If your investments go south, you will have been much better off with more Social Security income, and vice versa.

Since you don't know how long you will live or how your investments will turn out over the long term, the trick is to make sure you have an adequate floor of Social Security benefits, fixed annuities and the like to protect against a very long life and poor investment results. Invest what's left for upside potential and liquidity.[2] That will tell you whether delaying benefits is a good strategy for your personal situation.

It's a somewhat complicated optimization, but presumably, that's why you asked your advisor for help in the first place.

Delaying claiming Social Security retirement benefits is the most cost-effective longevity insurance you can buy. If you think of it as insurance and not a bet on how long you will live, you may find it makes more sense than pig races.


". . . no one knows the best asset allocation in advance", Does The 4% Rule Work Around The World?, Wade Pfau.

NOTE: My blog seems to be having problems accepting comments, as it does from time to time. Sorry, I hope to have that corrected soon. Meanwhile, you may need to click the "comments:" link in the very last line of the post that begins " 1 comment:" to display the comment entry box. If that doesn't work, you can email me at


[1] How Many Times Will You Crash Your Car? Forbes magazine.

[2] The Retirement Café: Build a Floor, Place a Bet.

Thursday, August 31, 2017

Three Degrees of Bad

The terms retirement writers use to describe retirement plan failure can be confusing. There are three progressive levels of failure: a loss of "market-funded" standard of living, a loss of standard of living below the household's "floor", and bankruptcy.

A fourth kind of failure, depletion of one's investment portfolio, can contribute to any of these three levels of failure or none of them depending on the extent to which the plan relies on investments to support the standard of living.

Investopedia defines standard of living as "the level of wealth, comfort, material goods and necessities available to a certain socioeconomic class or a certain geographic area."

Merriam-Webster defines standard of living as "a minimum of necessities, comforts, or luxuries held essential to maintaining a person or group in customary or proper status or circumstances."

Retirement writers and researchers often use the term "standard of living" in a more specific way that refers to the cost of purchasing these "comforts, material goods and necessities." For example, we might say that a household has adequate retirement assets to fund a $50,000 annual standard of living when what we mean is that the household can enjoy whatever standard of living $50,000 a year can purchase. We turn a dictionary definition into a dollar amount.

Losing Standard of Living

The term "floor" describes the amount of relatively safe income available to a retired household. The floor is generated from assets with no market exposure. It is often used in the context of "floor-and-upside" retirement funding strategies as I described in Unraveling Retirement Strategies: Floor-and-Upside.

Floor-and-upside strategies use financial products with no market risk, like fixed annuities, TIPs bond ladders, and Social Security benefits, to provide a floor, or minimum, of reliable income before investing any remaining assets in the stock market to provide the "upside" opportunity. The theory is that the retiree will be able to maintain some minimum standard of living (the "floor") even in the event of disastrous investment results in the upside portfolio.

Since nearly all Americans are eligible for Social Security benefits, virtually all of us have some amount of floor but the level of that floor can vary greatly. Wealthy households will be able to build a floor that completely protects their standard of living regardless of investment results, while other households may have a floor consisting of only Social Security benefits that provides very little safety. The higher your floor, the less market losses will harm you standard of living. A floor is insurance and the more wealth you have, the more insurance you can afford.

For example, assume that $50,000 a year is a retiree's desired standard of living but she believes that in the worst case scenario she could get by spending $40,000 annually. Spending less than this $40,000 a year would imply a significant change in her lifestyle.

With a floor-and-upside strategy, she might try to build a $40,000 floor with Social Security benefits and fixed annuities and invest any remaining assets in the stock market. She hopes to generate $50,000 or even more annual income at the risk of having only $40,000. Whether she generates more or less than the additional $10,000 annually depends on her investment results – it's "market-funded."

At the first level of retirement plan failure, our retiree would suffer a loss of standard of living providing less than her desired $50,000 of annual income but not falling below the floor level of $40,000.

Losing Standard of Living Below the Floor

At the second level of failure, the retiree suffers a greater loss of standard of living that drops income below $40,000 a year and requires a significant lifestyle change, but isn't a large enough deterioration of her finances to trigger bankruptcy.

If $40,000 of income is provided by "safe" floor assets, then how can a retiree's standard of living fall below $40,000? There are two ways.  First, no asset is perfectly safe, though TIPs bonds are pretty close. Social Security benefits might be reduced in the future. A pension plan might fail. In this context, "safe" means not exposed to market risk. A floor isn't totally safe from all risks but it is relatively much safer than an investment portfolio.

Second, standard of living can also be disrupted by unexpected expenses. A floor guarantees income; it does not guarantee that income will exceed expenses.

One challenge with this model is that the same standard of living has different price tags in different places. $50,000 purchases a higher standard of living in Manhattan, Kansas than in Manhattan, New York. Another challenge is that defining a floor amount is much easier in theory than in practice as you will see if you try making a list of living expenses you could live without.

Bankruptcy - The Real Ruin

A household whose wealth continues to decline below the floor level may end up in bankruptcy when liabilities significantly and permanently exceed assets. About 0.5% of retirement-aged Americans file for bankruptcy at some point[1], usually early in retirement. (The bankruptcy filing rate declines with age after early retirement.)

The term "ruin" better applies to bankruptcy than to portfolio depletion, which may or may not lead to bankruptcy.

Even in bankruptcy, a well-planned retirement can protect significant retirement assets. Social Security benefits are protected from creditors[2]. According to NOLO Press[3], "ERISA-qualified retirement accounts are generally protected from judgment creditors, as are employee welfare benefits (like medical insurance, HSAs, and employer disability benefits)". Non-ERISA plans are typically not protected.

Your state may provide additional protections in bankruptcy. A few states, for example, such as Florida, New York, and Texas, protect any annuity owned by a resident of the state from creditors. Check the bankruptcy laws for your state of residence.[7] Federal law also affords bankruptcy exemptions.[8] According to NOLO, "state law determines whether you can use federal exemptions or whether you must use your state property exemption list."

Portfolio Depletion

Perhaps the most common term to identify retirement plan failure is "ruin", as in "probability of ruin." In finance, this term is used in a number of ways that leave its definition somewhat imprecise:
"Risk of ruin is a concept in gambling, insurance, and finance relating to the likelihood of losing all one's investment capital or extinguishing one's bankroll below the minimum for further play." —Wikipedia.

"The complete loss of one's money and other assets." —Oxford Dictionary.
Definitions range from the total loss of all assets to the practically-total loss of investment capital only. In retirement finance, however, "ruin" almost always refers to the depletion of one's retirement savings investment portfolio.

While many retirees focus on the probability of totally depleting their investment portfolio prematurely, retirement's so-called "probability of ruin", a decline in portfolio value large enough to lower their standard of living without actually depleting their investment portfolio is far more likely and less catastrophic.

The magnitude of this risk depends on how much of the household's standard of living is funded by an investment portfolio compared to how much is funded by financial assets with no market risk. Higher "floor" lines, blue in the chart above, mean less risk to standard of living.

When sustainable withdrawal rate advocates say there's a 95% chance that you won't deplete your savings portfolio, they aren't promising a 95% probability that you won't lose standard of living. And when they say there's a 5% probability of ruin, they're referring to depleting your portfolio, which might or might not ruin your retirement.

A household that funds its standard of living entirely with Social Security benefits and fixed annuities can accept a greater probability of portfolio depletion — which is to say they can spend more, invest more aggressively, or both — than a household that depends on an investment portfolio to fund part of its standard of living.

Research by Wade Pfau[4] shows that purchasing fixed annuities can actually lead to larger final estates for this reason. "Though SPIAs [single-premium immediate annuities] do not offer liquidity, they provide mortality credits and generate bond-like income without any maturity date, and they support a higher stock allocation for remaining financial assets. Altogether, this allows a client to better meet both retirement financial objectives [spending and a legacy]".

In fact, there is a valid argument that depleting an investment portfolio before the end of retirement and relying on fixed annuities and Social Security benefits thereafter can be the most efficient way to fund retirement in some scenarios.

Three degrees of bad: Level of retirement plan failure.
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To quote more research by Pfau, "Certain circumstances, which we will explore, may allow retirees to accept a higher probability of “failure,” and spend more aggressively from their investment portfolio. Depleting the investment portfolio is not always catastrophic."[5]

Depleting the portfolio can be part of an efficient retirement plan, no big deal for household's with other sources of income, or catastrophic for a household that greatly depends on income from the portfolio.

How does this relate to the list of risks I posted in Retirement is Risky Business – Here's a List?[6]

Portfolio Depletion Risk is a combination of risks already on that list. A retiree's portfolio can be depleted by withdrawing too much from her portfolio periodically (excess withdrawal risk, overspending risk), by experiencing an unfortunate sequence of market returns early in retirement (sequence of returns risk), or by experiencing unexpected spending shocks (unexpected financial responsibility risk, health expense risk, and others), so I think this one is already well covered.

Although my previous list didn't identify bankruptcy risk separately, it did identify other risks that often lead to bankruptcy. Less than half a percent of elder Americans claim bankruptcy but the consequences are usually grave.

The magnitude of bankruptcy risk often depends on how well the retiree has protected assets from creditors. Since it demands a different kind of mitigation (asset protection), bankruptcy really should be identified as a separate risk. I'm going to add bankruptcy risk to the list and define it as the probability that a retired household will need to claim bankruptcy and its magnitude as the total value of all assets not protected from creditors.

Retirees with an investment portfolio may be exposed to the risk of losing market-funded standard of living. I will also add it to the list and define it as the risk of losing standard of living due to investment losses, presuming that standard of living does not fall below the household's floor of safe income. The amount of standard of living at risk is the amount expected to be generated by the investment portfolio. The probability of the risk can be estimated with Monte Carlo simulation.

There are three degrees of retirement plan failure that should not be confused. The first is a decline in market-funded standard of living. Not the best outcome, but still better than having your standard of living decline below what you might consider unacceptable. Mitigate this risk with a higher floor.

The second is a decline in standard of living below what the retiree considers to be the minimum acceptable floor. This will likely result from expense shocks. Mitigate these risks with insurance when possible (health insurance, umbrella liability insurance, and long-term care insurance, for example), by setting aside reserve funds, or both.

The third level is bankruptcy, which represents the most severe failure of the retiree's finances. Asset protection is an important component of a good retirement plan. It is also worth carefully considering those risks that most often lead to bankruptcy, the first five on the list[6].

An unplanned, premature depletion of the household's investment portfolio can lead to poor outcomes but that event is not a single level of failure. Depending on the extent to which the retiree depends on that portfolio to support his standard of living, portfolio ruin can expose the household to one of the three levels of retirement plan failure or it might be acceptable.

A good retirement plan will address each of these potential poor outcomes (risks) separately as they have different levels of severity and are mitigated in different ways. You can identify these levels of risk in your retirement plan by:
  • Calculating the amount of your standard of living that will be market-funded (subject to market risk).
  • Calculating the amount of floor income that will be generated (from safe bonds, Social Security benefits, pension plans, fixed annuities, etc.)
  • Calculating the total of assets protected from creditors. Review your state's bankruptcy protections. If your state permits use of federal exemptions, review those, as well.
Sketching a chart like the one above from this information may provide some interesting insights into your plan's levels of risk.


[1] The (Interconnected) Reasons Elder Americans File Consumer Bankruptcy: Journal of Aging & Social Policy: Vol 22, No 2, Deborah Thorne, Ph.D. (Downloads PDF).

[2] Can I Keep Social Security Benefits in Chapter 7 Bankruptcy?,

[3] Can Judgment Creditors Go After My Retirement Accounts?,

[4] An Efficient Frontier for Retirement Income by Wade D. Pfau, Wade Pfau, Ph.D.

[5] Taking Portfolio Spending into the Real World For Retirees, Wade Pfau, Ph.D.

[6] Retirement is Risky Business – Here's a List? (download spreadsheet).

[7] Bankruptcy Exemptions by State,

[8] The Federal Bankruptcy Exemptions,

Wednesday, July 26, 2017

Katrina, Fukushima and Retirement Risk: When Risks Create Risk

What is a retiree's greatest risk of financial ruin? Long-term care costs? Longevity risk? Market risk? Inflation?

The answer is none of these individual risks but a combination of interrelated or "dependent" risks.

The empirical argument to support this is research published by Dr. Deborah Thorne entitled, "The (Interconnected) Reasons Elder Americans File Consumer Bankruptcy"[1] that I reviewed in Why Retirees Go Broke. Dr. Thorne concludes:
"The data also suggest that the majority of elder bankruptcies result from multiple interrelated crises, rather than a single unfortunate event."
Note that I am talking about financial ruin or bankruptcy here and not the loss of a retiree's standard of living. I generally consider two classes of retirement plan failure: loss of standard of living and the more-severe bankruptcy or "ruin." Retirees rightfully worry about inflation, market losses, and spending too much from their retirement savings portfolio and a single "unfortunate event" may be all that is needed to suffer a loss of one's standard of living.

But, ruin appears to result most often from multiple dependent risks according to Dr. Thorne's research, such as an illness that results in job loss and large medical bills that, in turn, generate unserviceable credit card debt that ultimately forces the household into bankruptcy. Dependent risk losses can fall like dominoes.

In my last post, Retirement is Risky Business, I listed 26 potential financial risks of retirement. I'll probably add a few in the near future, so let's call it thirty-ish.

Not all of the risks on that list will apply to every household. For example, if you don't have a spouse then you obviously don't have a risk of your spouse dying. So, let's say that you are exposed to only twenty of the risks on the list.

If you calculate your exposure to each of those twenty risks and total them the sum will provide an underestimate of your overall risk and perhaps even a false sense of security.

Not only are risks difficult to quantify but they are even difficult to identify and they are often inter-dependent (not independent). Here are three major reasons it is misleading to merely check off the list of risks:
  • Unknown unknowns,
  • Hidden risk exposures, and
  • Dependent risks.
Financial risks are uncertainties by definition but there are some uncertainties that we aren't even yet aware of — unknown unknowns.

Not long ago we weren't aware that identity theft would one day be an issue for retirees or that credit default swaps could imperil our personal finances. There are undoubtedly risks in our retirement future that we don't yet foresee.

An example of hidden risk that will be closer to home for most retirees can be found in broadly held mutual funds. A retiree who holds a half dozen large cap funds may feel well diversified. She will likely find, however, that most of the funds own Microsoft, Alphabet and other broadly-held company stocks[3] and that her exposure to the risk of these individual stocks is greater than expected. ( has a feature called X-Ray that will help you find these overlapping stocks but another solution is to hold fewer mutual funds.)

In other words, some risks may not be on your list simply because you overlook them.

The far more complicated and potentially much greater risk that will not be addressed by checking off a list of individual risks is what the risk management field refers to as "dependent risks."

Dealing with Dependent Risk”, published by Claudia Klüppelberg and Robert Stelzer[4] in 2012, defines dependent risk and demonstrates its complexity. The paper begins with this paragraph:
In most real life situations we are not only confronted with one single source of risk or one single risk, but with several sources of risk or combinations of risks. An important question is whether individual risks influence each other or not. This may concern the time of their occurrence and/or their severity. In other words, we need to understand how to model and describe the dependence structure of risks. Clearly, if risks influence each other in such a way that they tend to occur together and increase the severity of the overall risk, then the situation may be much more dangerous than otherwise.
Here’s an analogy. Maybe you recall the classic Microsoft game Minesweeper[5]. Imagine a similar game except that it's played on a large field with different kinds of mines scattered around to represent individual retirement risks. Let's call it Risksweeper. Each mine has a different probability of exploding, representing risk probability, and each has a different potential “blast radius” range representing risk magnitude.

Classic Microsoft Minesweeper game winner and loser.
The goal of Minesweeper is to figure out where the mines are and to avoid "stepping on" one and ending the game. Notice that when you step on one mine (the red one on the right) they all explode. In the Risksweeper game, stepping on a single mine can end the game or only leave the player weakened but stepping on a mine that causes other mines to explode is likely to mean "game over."

The Risksweeper mine that I'll call “Medical Expense Risk” can make a small bang with a small blast radius (a $5,000 doctor bill). If we get the small bang, it is unlikely to set off other nearby mines and result in financial ruin.

On the other hand, the Medical Expense Risk mine can sometimes make a big bang (a $250,000 doctor bill) with a blast radius large enough to set off other mines. If the second mine is also a big one, like job loss, for instance, its blast radius may set off still other mines. If the third mine is large enough, the field starts to look like one of those mouse-trap-and-ping-pong-ball demonstrations of a nuclear chain reaction[6] or like Dr. Thorne’s description of interconnected losses leading to elder bankruptcy.

The biggest risk on the playing board is not medical expense risk, consumer debt risk or longevity risk; it's a chain reaction of multiple dependent risks.

In the following diagram, the solid circle represents the radius of a "typical" blast (a $5,000 doctor bill, for example) and the dotted line surrounding it represents the radius of an "extreme" blast from the same risk (a $250,000 doctor bill).

Risk management literature refers to the amount of connectedness, or dependency, between two risks as probabilistic distance. The less wealth, or “safety margin”, a household has the closer together the mines are situated on the field. Less probabilistic distance between the mines means that smaller bangs are more likely to set off a chain reaction that can lead to ruin.

Very wealthy retirees have very sparse “minefields” and have to be pretty unlucky for an explosion to be “extreme” enough to set off a chain reaction. A $5,000 medical expense might be easily paid by a wealthy retiree but represent an "extreme" loss to a marginally-funded household.

As you imagine this Risksweeper game (or view the mouse traps) it should become obvious that figuring out how closely all of the various risks are linked and the probability that explosions of various sizes will cause other explosions is incredibly complicated when you need to consider twenty or thirty dependent risks and even a few levels of inter-dependency. (This is, after all, a small scale version of the problem nuclear scientists had to solve at Los Alamos in the 1940's except they were trying to cause a chain reaction.)

You should also see that the retiree’s risk is not fully represented by the individual mines alone but includes the risk that one large bang can set off another and possibly even start a chain reaction of cascading financial losses leading to ruin.

Katrina, Fukushima and Retirement Risk: When Risks Create Risk.
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A simple list of retirement risks does not take this connectedness into consideration, although I did include “Interconnected Loss Risk” in that list. (I'm going to refer to it as "Dependent Risk" going forward.)

Dependent risk analysis is a staple of many fields from nuclear power plant design to insurance to aerospace engineering but it appears to be rarely referenced in retirement literature. A Google search of "dependent risk and retirement" turned up a single reference including both terms and it's from the field of political science research[7] referring to retiring from an election. Dr. Thorne's analysis of elder bankruptcy data tells us that retirees should also be should be concerned about it.

Modeling these dependent risks can be done using a statistical construct referred to as a “copula” [8], but as Klüppelberg and Stelzer note, “copulae provide a way to characterize the dependence structure completely, but are rather complex objects.” The complexity seems to make them unrealistic for typical retirement planning processes, not so much because the math is complicated (it is) but because we don't have a good understanding of the probability distributions of the risks to model.

It seems likely, however, that if one did undertake a detailed analysis of the dependence risk structure of retirement using a copula the results would be the same as Dr. Thorne discovered with empirical bankruptcy evidence – the biggest risk is a sequence of dependent risks.

The scenario above describes a series of three dependent risks, healthcare expense risk, job loss risk and credit risk. A retiree might, however, succumb to the interdependence of even more individual risks.

Let's go back to the assumption that a retiree is exposed to 20 risks and that we only wish to consider failure due to a single pair of those risks. We would need to think about combinations of 20 risks taken two at a time, or 190 scenarios.

Twenty risks taken three at a time generate 1,140 scenarios. I won't bother with the household exposed to more than 20 risks or those scenarios of 4 or 5 combinations of dependent risks except to note that 30 risks taken 2, 3, 4 or 5 at a time would require an unmanageable analysis of 174,406 scenarios. Copulae are a probabilistic approach to solving the problem at this scale.

Importantly, Klüppelberg and Stelzer also note that “For risk assessment it is mainly the dependence structure of extreme events that matters. Thus, measures for dependence in extreme observations provide useful dependence measures for combined risks.”  The impact of dependent risks are largely felt under extreme conditions and are far less an issue under normal economic conditions. By definition, "normal conditions" means relatively small bangs that are unlikely to start a chain reaction.

Clearly, there are far more potential risk scenarios than we can reasonably expect to consider for a retirement plan. We might, however, be able to identify and consider the most impactful scenarios. We might do that by identifying the most common causes of bankruptcy or “ruin”, the ultimate retirement plan failure, and then considering only extreme losses resulting from those risks. This only identifies the worst cases, of course, but that might be the only manageable analysis.

As I described in Why Retirees Go Broke, elder bankruptcies are most often the result of one, two, three, four or five of the following risks:
  • Credit card interest and fees,
  • Illness and injury,
  • Income problems,
  • Aggressive debt collection, and
  • Housing problems.
Aggressive debt collection is probably beyond our ability to manage, so let’s drop it from the list. Although neither market loss nor inflation is commonly cited as a cause of bankruptcy, they are common fears of retirees so I will add them to the list for the sake of a good night's sleep. This modified list of greatest concerns (biggest bangs) is then:
  • Credit card interest and fees,
  • Illness and injury,
  • Income problems,
  • Housing problems,
  • Market losses, and
  • Inflation.
Combined, these six scenarios considered one, two and three connections deep generate 41 scenarios. Still a lot, but perhaps manageable. Adding Klüppelberg and Stelzer's warning about extreme conditions, analyzing this smaller subset of risks only under such conditions might provide a good if incomplete start.

This also raises the issue of how we can best deploy our retirement assets to mitigate retirement risk. It appears that our goal should be to first avoid the worst case, a chain reaction leading to ruin. A chain reaction will likely have far worse outcomes than any individual risk.

This implies that we might want to use our risk-management assets first to "shield the biggest potential blasts" rather than spread these resources broadly to minimize all risks. Perhaps long-term care insurance and securing housing deserve priority consideration over market or inflation risk, for example, since the former are commonly-cited reasons for bankruptcy and the latter are not.

Because with dependent risk "it is mainly the dependence structure of extreme events that matters",  analyzing retirement risks independently may be adequate under normal conditions. But, we are probably underestimating our vulnerability under extreme conditions (think the 2007-2009 simultaneous crash of the mortgage and stock markets).

On the other hand, global financial meltdowns occur far more frequently than we might expect. Business Insider[9] claims there have been 57 stock market crashes, defined as a 20% or greater decline in one or more of the four major stock market indices, since 1950 and Wikipedia[10] provides a long, depressing list of global financial crises throughout history, leaving one to wonder how typical "normal conditions" actually are in this context.

Speaking of chain reactions and dependent risks, the Fukushima Daiichi nuclear disaster[11] resulted from a chain of dependent risks, which one might expect to have been thoroughly studied by the experts that designed a nuclear power plant.

The plant began to automatically shut down, as designed, when it detected an earthquake on March 11, 2001. About an hour later the plant was inundated by a tsunami, also anticipated in safety plans, although this one was 15-meters high. The tsunami topped a seawall and then flooded generators that powered the plant's cooling pumps causing the nuclear "accident." But, over one thousand people living near the plant died as the result of a fourth dependent risk – the evacuation plan.

What are the odds of experiencing an earthquake and a flood within the same hour? Probably quite low unless the earthquake causes the flood. This is the essence of dependent risks.

The string of dependent risk losses that resulted from Hurricane Katrina in 2005 disaster was similar[12]. New Orleans survived the hurricane but the resultant flooding of the Mississippi River from torrential rains upstream caused levees to fail, flooding the city. The flood from the breaches shut down most of the 149 pumps designed to pump flood water out of the city. Ultimately, many more people were killed or devastated by a failed evacuation. Like Fukushima and elder bankruptcy, the risk to New Orleans residents was much greater than the individual risks of a hurricane, failed levees or disabled pumps in isolation.

A reverse mortgage is a retirement example that also creates dependent risk. Borrowers are generally protected from foreclosure except in specific cases (inability to pay property taxes or maintain the property, for example) so long as they live in the home. It appears that actual foreclosures are, in fact, quite rare. In theory, a borrower needs only to continue to live in the home to avoid losing it but as a colleague of mine used to say, "just notice how easily that rolls off the tongue."

Imagine that a household experiences extreme medical expenses or the loss of a spouse after much of the home's equity has been spent and the survivor can no longer afford to live in the home or community or no longer wishes to. Leaving the home would render the mortgage due and payable with practically the same outcome as a foreclosure. The household would lose the home as a result of illness or death of a spouse triggering loss of standard of living exposing the risk associated with the reverse mortgage.

If the borrower set up the mortgage with tenure payments he or she would also lose those – yet another dependent risk – and be unlikely to have assets to replace that expected future income. Considering reverse mortgage risk, medical expense risk and loss of spouse risk separately without evaluating the dependent risks they create would not uncover this vulnerability.

(This is not an argument to avoid reverse mortgages, by the way – all financial strategies have risks and rewards. It is an argument to understand the risks as well as the rewards.)

Some general conclusions can be drawn:
  • Retirement risk is more than the sum of its parts, potentially much more. Mitigating individual risks independently ignores dependent risks which may be much greater.
  • The retirement field doesn't appear to have widely considered dependent risk nor do retirement plans.
  • A thorough statistical analysis of dependent risk is typically well beyond the reach of a financial planner or do-it-yourselfer.
  • Dependent risk grows under extreme economic conditions.
  • Analyzing the inter-dependence of the few risks generally responsible for financial ruin and only under assumptions of extreme conditions may be manageable and helpful.
  • The greater a retired household's safety margin (i.e., its wealth) the less likely a loss will be "extreme" enough to trigger dependent risk losses.
  • Households with marginal retirement resources are more susceptible not only to independent risks but also to dependent risks.
  • Dependent risk may result in the worst-case outcomes so consideration should be given to prioritizing them when allocating risk-management resources.
Bottom line, your retirement plan likely has a great deal more risk under extreme conditions than you know and it probably goes without saying that more wealth means less risk. These plans are acceptable if everything remains normal but if we could count on everything remaining normal we probably wouldn't need to plan much in the first place.

Evaluating retirement risks individually and in isolation, a common practice, is somewhat akin to analyzing the risk of driving your car by reviewing its safety features and ignoring the fact that there will be other drivers on the road.

Please note that I have made a few changes to the table of risks, including the downloadable version, in my previous post, Retirement is Risky Business.

Optional homework for this week's post is to play a game of Minesweeper[5] and to watch a short video of ping pong balls tripping mouse traps[6].


[1] The (Interconnected) Reasons Elder Americans File Consumer Bankruptcy, Dr. Deborah Thorne (download PDF).

[2] The Big Short, Michael Lewis.

[3] Top 10 Companies Held By Mutual Funds

[4] Dealing with Dependent Risk, Claudia Klüppelberg and Robert Stelzer, 2012. Download PDF

[5] Minesweeper game online.

[6] Mouse Trap Reactor video.

[7] Systematically Dependent Competing Risks and Strategic Retirement, dependent risk in election decisions.

[8] In probability theory and statistics, a copula is a multivariate probability distribution for which the marginal probability distribution of each variable is uniform. Copulas are used to describe the dependence between random variables. In the present context, random variables represent risk.

[9] Here's every stock market crash in the past 60 years, Business Insider, June 8, 2016.

[10] Financial Crises throughout history, Wikipedia.

[11] Fukushima Daiichi Accident, World Nuclear Association.

[12] Hurricane Katrina,

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®
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

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.
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.
High Debt Service Risk
The risk of bankruptcy resulting from an inability to service debt, especially consumer debt. May result from spending beyond budget.
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.
Dependent Risk
The risk that a loss due to one risk might cause losses due to other risks. (Formerly "Interconnected Loss Risk".
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.
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.
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.
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.
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.
Financial Elder Abuse Risk
The possibility that a family member or caretaker might steal assets.
Financial Advice Risk
The possibility that an advisor might recommend unwise strategies or investments or embezzle assets.
Fraud Risk
The risk of losing one's assets as the result of fraud or identity theft.
Market Risk
The risk of financial loss resulting from movements in market prices.
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.
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.
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.
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.
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.
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.
Unexpected Financial Responsibility Risk
Many retirees have additional unanticipated expenses during the course of retirement, in many cases due to family relationships and obligations.
Overspending Risk
The risk that a household will spend beyond its means and prematurely deplete savings or an investment portfolio.
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.
Legacy Funding Risk
The risk that planned bequests are not funded.
Estate Planning Risk
The risk that one's estate will not be distributed as he or she had desired.
Asset Allocation Risk
The risk that one's asset allocation does not achieve expected results or is inadequately diversified.


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.)