As more and more baby boomers are entering retirement, they will begin to find that the retirement that they envisioned is quite different than previous generations’ versions. What used to be a simple and short retirement supported with generous government assistance is now turning into a complex experience accompanied by cutbacks, market volatility and non-guaranteed pensions. With more investment options than ever before, many seniors are struggling to find the optimal asset allocation for retirement. On top of that, many will face chronic health issues that will adversely affect their standard of living towards the end of life. Here are four financial risks in retirement that seniors face today.
1. Longevity risk
Life expectancy in Canada and other developed countries has long been trending up. In fact, the average person in Canada will now live to 81 years. At first glance, longer life expectancy may appear to be a good thing. But there are several drawbacks to long life.
First, the prevalence and duration of chronic illnesses has increased due to modern medical advances. Treatment is now available for diseases that used to kill most people such as a stroke. Unfortunately, the survivors will usually live out the rest of their lives in poor health. This puts extra strain on healthcare professionals as well as the survivors’ pocketbooks, since home care and nursing homes are not often subsidized by the government. An individual without long-term care insurance may not be able to afford such care.
Second, seniors now have to plan their finances carefully for a lengthy retirement. Investments that are not guaranteed to last a lifetime may expose an individual to the risk of running out of money. Since companies are shying away from defined benefit plans, this is a very real concern for many retirees. When it comes to investments, seniors want to decrease financial risks in retirement by selecting those with guarantees. Because of this, annuities and segregated funds will continue to increase in popularity. Only insurance companies carry these products on their shelves and fortunately, they offer plenty of choice for consumers.
2. Uncertainty risk
The risk of uncertainty ties into the increased longevity of Canadians. The first two pillars of the Canadian retirement income system – OAS and CPP – has seen impactful changes in recent years meant to maintain their sustainability. This includes pushing back the qualifying age to receive OAS, increasing CPP premiums and increasing the incentive to delay receiving both pensions. These cutbacks won’t affect the current wave of retirees, but it’s a cause for concern for future generations. As actuaries continue to monitor these programs, you can be sure changes will continue to come to maintain their sustainability.
3. Market risk
While volatility in the stock market was relatively mild in 2013, this hasn’t been the norm since the turn of the century. Baby boomers experienced several crashes and corrections that forced them to take a long, hard look their portfolio. As they enter the decumulation phase, it’s imperative they don’t feel the full impact of these stock market adjustments by considering more conservative investments. But avoiding the stock market entirely and putting all your money in GICs is generally not a good idea, as noted by the next point.
4. Inflation risk
The risk of inflation also ties into the increased longevity of Canadians. The purchasing power of a retiree will be dramatically reduced over the course of a 25-30 year retirement. Conservative fixed income investments such as GICs and bond funds will not be able to provide enough growth to overcome the effects of inflation. Therefore, retirees will have to turn to stocks and expose themselves to market risk.
An option that alleviates some of the risk is inflation-linked annuities. They provide income for life with annual payments that are indexed to inflation. Of course, since you are receiving a higher level of income year after year, the drawback is that the initial income is substantially lower than non-indexed inflation.
What do you think? Are you worried about these financial risks in retirement? If not, how have you dealt or how will you deal with them?
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