Five Ways To Protect Your Retirement Income

The Fidelity Viewpoints Team at Fidelity, list these common sense items to think about so you can enjoy a successful future retirement.

If you’re nearing or in retirement, it’s important to think about protecting what you’ve saved and ensuring that your income needs are met now and in the future. Here are five rules of thumb to help manage the risks to your retirement income.

1. Plan for health care costs – including long-term care

With longer life spans and medical costs that historically have risen faster than general inflation—particularly for long-term care—managing health care costs can be a critical challenge for retirees.

According to Fidelity’s annual retiree health care costs estimate, the average 65-year-old couple retiring in 2014 will need an estimated $220,000 to cover health care costs during their retirement, and that is just using average life expectancy data.1

Many people will live longer and have higher costs. And that cost doesn’t include Long-Term Care (LTC)expenses.

According to the U.S. Department of Health and Human Services, about 70% of those age 65 and older will require some type of LTC services—either at home, in adult day care, in an assisted living facility, or in a traditional nursing home. You can review the current and future cost of long-term care services from the LTC News cost of care calculator.

Consider: Purchase Long-Term-Care Insurance. The cost is based on age, so the earlier you purchase a policy, the lower the annual premiums, though the longer you’ll potentially be paying for them.

If you are still working and your employer offers a health savings account (HSA), you may want to take advantage of it. An HSA offers a triple-tax advantage: You can save pretax dollars, which can grow and be withdrawn state and federal tax free if used for qualified medical expenses—currently or in retirement. You can use money from your HSA to pay for your Long-Term Care Insurance premiums.

2. Expect to live longer

As medical advances continue, it’s quite likely that today’s healthy 65-year-olds will live well into their 80s or even 90s. This means there’s a real possibility that you may need 30 or more years of retirement income.

An American man who’s reached age 65 in good health has a 50% chance of living 20 more years, to age 85, and a 25% chance of living to 92. For a 65-year-old American woman, those odds rise to a 50% chance of living to age 88 and a one-in-four chance of living to 94. The odds that at least one member of a 65-year-old couple will live to 92 are 50%, and there’s a 25% chance at least one of them will reach age 97.2 And recent data suggest that longevity expectations may continue to increase.

Without some thoughtful planning, you could easily outlive your savings and have to rely solely on Social Security for your income. And with the average Social Security benefit being just over $1,294 a month, it likely won’t cover all your needs.

Consider: To cover your income needs, particularly your essential expenses, you may want to use some of your retirement savings to purchase an annuity. It will help you create a simple and efficient stream of income payments that are guaranteed for as long as you (or you and your spouse) live.

3. Be prepared for inflation

Inflation can eat away at the purchasing power of your money over time. This affects your retirement income by increasing the future costs of goods and services, thereby reducing the purchasing power of your income. Even a relatively low inflation rate can have a significant impact on a retiree’s purchasing power. Our hypothetical example below shows that $50,000 today would be worth only $30,477 in 25 years, even with a relatively low (2%) inflation rate.

Consider: While many fixed income investments and retirement income sources will not keep up with inflation, some sources, such as Social Security, and certain pensions and annuities can help you contend with inflation automatically through annual cost-of-living adjustments or market-related performance. Investing in inflation-fighting securities, such as growth-oriented investments (e.g., individual stocks or stock mutual funds), Treasury Inflation-Protected Securities (TIPS), and commodities, may also make sense.

4. Position investments for growth

A too-conservative investment strategy can be just as dangerous as a too-aggressive one. It exposes your portfolio to the erosive effects of inflation, limits the long-term upside potential that diversified stock investments can offer, and can diminish how long your money may last. On the other hand, being too aggressive can mean undue risk in down or volatile markets. A strategy that seeks to keep the growth potential for your investments without too much risk may be the answer.

The sample target asset mixes below show some asset allocation strategies that blend stocks, bonds, and short-term investments to achieve different levels of risk and return potential. With retirement likely to span 30 years or so, you’ll want to find a balance between risk and return potential.

Consider: Create a diversified portfolio that includes a mix of stocks, bonds, and short-term investments, according to your risk tolerance, overall financial situation, and investment time horizon. Doing so may help you seek the growth you need without taking on more risk than you are comfortable with. Diversification and asset allocation do not ensure a profit or guarantee against loss. Get help creating an appropriate investment strategy with Portfolio Review (login required) at Fidelity.

5. Don’t withdraw too much from savings

Spending your savings too rapidly can also put your retirement plan at risk. For this reason, we believe that retirees should consider using conservative withdrawal rates, particularly for any money needed for essential expenses.

A common rule of thumb is to use a withdrawal rate of 4% to 5%. Why? We examined historical inflation-adjusted asset returns for a hypothetical balanced investment portfolio of 50% stocks, 40% bonds, and 10% cash, to determine how long various withdrawal rates would have lasted. The chart below shows what we found: In 90% of historical markets, a 4% rate would have lasted for at least 30 years, while in 50% of the historical markets, a 4% rate would have been sustained for more than 40 years.

Withdraw conservatively

Keep your withdrawals as conservative as you can. Later on, if your expenses drop or your investment portfolio grows, you may be able to raise that rate.