If you look at how we're wired as human beings, "retirement" is an odd concept. For the last 200 or 300 years, we basically worked until we died. Long before that -- as hunter-gatherers -- we relied on the care of our tribe for protection, while we offered the wisdom we'd accumulated over the years, in return.
It's unprecedented that individuals are expected to rely on a bank account alone to make ends meet for the last few decades of their lives. And yet... here we are.
I think there's a better question to ask instead of how "safe" is your retirement -- and that's how "fragile" are you, financially speaking, in the face of the most common retirement pitfalls? I'll walk you through three of the most common, and how you can test your readiness.
Can you pull out less than 4% of your nest egg and make ends meet?
In the financial planning world, there's something called the 4% rule. Basically, it says that in your first year of retirement, you can pull 4% of your money out, adjust that number up every year to match inflation, and you should have enough to fall back on indefinitely -- assuming a 50-50 mix between stocks and bonds.
But nothing makes this strategy more perilous than terrible investment returns in the first five years of retirement. That's because the money you pull out for living expenses is being "sold" for cheap valuations, and it won't have any chance to grow during the following three decades.
To get the gist of what I mean, check out this chart. It shows a nest egg of $500,000 that follows the 4% rule. In most years, the portfolio advances 5%. But each one has a two-year period where returns dip 33%. Of course, that's not common, but it's also not impossible.
The only difference is when this dip occurs: at the beginning, middle, or end of retirement.
There's really only one solution to such a problem: If this disaster hits early in retirement -- think of those who called it quits in 2007 -- taking out less than the standard 4% would allow for the next couple of years, until your account shores up.
Are you ready for long-term care?
Another unexpected force that could cause an immediate drain on your resources has to do with health expenses. While Medicare can help soften the blow from prescription medicine or expenses related to covered operations, there's nothing that costs quite as much as long-term care.
Consider this: According to Genworth, a Chicago resident will pay from $54,000 per year for a home health aide all the way up to $98,000 per year for a private room in a nursing home -- and that's per year. None of this includes the other expenses that come with living your life before the need for long-term care.
That's why long-term care insurance is so important. While it's not cheap by any means, the amount you have to give up should you need long-term care is much higher. It can quickly deplete whatever resources you may be counting on to provide for the rest of your retirement.
Changes to Social Security
It's highly unlikely that anyone receiving Social Security now will see their benefits meaningfully change because of legislation. The political costs would be too heavy. It's much more likely to see changes grandfathered in over time.
But that's why younger generations should work in more conservative estimates when it comes to Social Security income moving forward. Officially, the trustees of the Social Security Administration estimate that full benefits can be provided until 2035, after which time only 77% of benefits can be paid.
People more than a decade from retirement should make even more conservative estimates: Assume that you'll get only 50% of your "full" retirement benefit. This should build in a nice cushion should the program take even bigger hits.
How fragile are you?
How did you fare? If you want your retirement to be safe, you need to to the following three things: (1) plan on getting by withdrawing less than 4% of your nest egg if your portfolio takes a hit; (2) purchase long-term care insurance; and (3) if you're younger, assume that Social Security won't be as generous as it is today.
If you work on all three of these things, your Golden Years should be safe enough to let you sleep soundly at night.