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Retirement Risk Factors to Watch For

Vanguard's Colleen Jaconetti talks about how preparing for risks now protects your retirement future.

Christine Benz: Hi, I'm Christine Benz for Morningstar. As retirees begin drawing on their portfolios, it's important that they take stock of the risk factors that could get in the way of their goals. Joining me to discuss some of the most significant risks that retirees should troubleshoot is Colleen Jaconetti. She's a senior investment analyst in Vanguard's Investment Strategy Group.

Colleen, thank you so much for being here.

Colleen Jaconetti: Happy to.

Benz: Colleen, you and the team put together this road map to financial security, with a lot of helpful tips for thinking about retirement planning. There was a section about risk factors that retirees ought to have on their radar, and I want to cover some of them and talk about the ways, the practical ways, that retirees and pre-retirees can think about troubleshooting them.

So, let's start with one that I think is top of mind any time we have market volatility and that's market risk, the threat of a bad market environment really upending your well-laid plan. So, what are the best ways to address that in terms of troubleshooting and making sure that it really doesn't upset your quality of life in retirement?

Jaconetti: I guess there's a few things. I guess the first thing would be selecting the proper asset allocation. So, make sure that you have only as much in equities that you're comfortable with, kind of sticking with in good and bad markets. And then, after that, I would say, diversify within that. So, kind of a broadly diversified portfolio will help mitigate some of the losses that could occur in the portfolio. And then, another thing, another risk, actually, that they could think about is keeping--another thing they could do, is keep their fixed expenses low. So, the percent of the portfolio that is in fixed expenses--of their spending that's fixed--means that they can't really cut back. So, having a dynamic spending strategy, which helps them reduce their spending in times when there is more volatility, will help their portfolio last longer.

Benz: The basic idea is, if that bad market environment, I think it's especially important if it hits right early on in your retirement, if you can be willing to pull back a little bit and spend less, that can be really impactful in terms of helping make your money last.

Jaconetti: Absolutely.

Benz: Let's talk about another big wild card. I definitely talk to retirees where this concern is top of mind. This is healthcare risk, long-term care risk, the risk of needing a big outlay later in life to cover long-term care. How should people think about that? And I know Vanguard has done some great research in this space.

Jaconetti: Yes. I think we actually have done a study with Mercer about who should even be concerned about health risk or how many people should be concerned. So, I think a lot of people are very precautionary worrying about it. And we actually found that only 50% of people have zero healthcare costs in retirement. Beyond that, up to 25% of retirees have up to $100,000 and only 15% actually have $250,000 or more. So, I think that's one good thing to help people keep in mind is I think people sometimes are a little bit afraid to spend or enjoy their retirement because they have the potential healthcare risks.

Now, another way to think about the healthcare risks, to mitigate them, would be to have insurance.

Benz: Right, of course.

Jaconetti: Some sort of – everyone would have Medicare, say, but a supplemental Medicare policy. So, if you pick a policy and are thoughtful about picking the policy that kind of aligns with what's important to you, there may be additional costs now, but it would ensure that you have the care that you would like to have later on.

Benz: I think another thing is--and this I think is where insurance really comes into play--is, I hear 15% might have these really high costs later in life. Well, what if I'm that 15%, someone might be thinking, and that's why insurance is there.

Jaconetti: Yes. And especially for people if they seem to have very long life expectancy, if they have a family history of very long life expectancies, they will be more likely than say someone who has a history of shorter life expectancies, or smoking or other risk factors, that they would think they would not be living quite as long.

Benz: Well, the longer you live, certainly the more likely you are to experience cognitive decline, the data show that. So, you mentioned longevity risk, and it's funny to call living a long time a risk factor. Most of us want to live a long time. But when you think about kind of protecting a plan against you being the person who lives to be 105 or something like that, how should people think about laying the groundwork there? It sounds like making sure that you're insured for healthcare costs. What else?

Jaconetti: So, beyond that, I mean, people can really think about considering annuitizing a portion of the portfolio. So, this will be somewhere where someone could say, I have a Social Security benefit of, say, $25,000 or $30,000; I have fixed expenses each year of, say, $50,000 and that gap, say, between the $50,000 and the $30,000, might be something that people want to annuitize, so that you are very sure that you could cover for the rest of your life the basic living expenses that you would have. So, to me, that would be one area where I would consider an annuity. The other thing they could do is moderate spending. Again, the flexibility and spending and being able to moderate spending through time if you experience longer-than-expected life expectancy will be very helpful.

Benz: We know that people generally do tend to spend less unless they have some big healthcare expense later in life. One thing you wrote about in this paper dealt with what I think is underdiscussed in retirement planning. You called it event risk. This is just the idea that your spending plan would have some kind of shock. You need a new car and you hadn't been expecting to buy a new car. Let's talk about how people can plan for those sort of spending events that might have been unplanned.

Jaconetti: Well, the most important thing, I think, is even planning ahead, just looking ahead and thinking about, do I have an older home, do I have an older car or my children possibly in a position where they would need assistance or even parents? So, I think just thinking a little bit ahead of them, maybe having contingency reserve, so setting aside a portion of the portfolio for emergencies can really help people be in a position where they're not spending down their portfolio intended for retirement, but they actually have extra money set aside to take care of those things.

Benz: Emergency funds aren't just for working folks; people who are retired should think about them, too.

Let's talk about tax and policy risk. This one seems really hard to troubleshoot, the idea that, oh, my tax rate might be X here in 2019, but we don't really know what will happen in the future. How should people think about that?

Jaconetti: I think the biggest thing there is really just kind of keep in their plans kind of act to keep your fixed expenses low as possible. Because if in the future, you have higher taxes, because of change in taxes and the taxation of your income, or your Social Security benefits are cut, or they are taxed at a higher percent, all of that would obviously help to result in your portfolio being prematurely depleted. So, if people can cut back and be able to reduce their expenses to absorb some of these additional costs, that would probably be the best way that they could mitigate it.

Benz: I guess another thing to think about at the portfolio level would be--Vanguard has done some great work in this space--tax diversification, right? That even though making traditional tax-deferred contributions gives me that tax break while I'm making the contribution, later on maybe I want to have some of my withdrawals be tax-free or maybe just taxed at my capital gains rate.

Jaconetti: Absolutely. Yes. Having your money spread across taxable, tax-deferred, and tax-free assets just gives you flexibility in the future.

Benz: Colleen, great set of risk factors to think about. Good food for thought. Thank you so much for being here to discuss them with us.

Jaconetti: Thanks.

Benz: Thanks for watching. I'm Christine Benz for