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The 4 Biggest Financial Threats to Your Retirement

By Wendy Connick - Oct 22, 2017 at 8:02AM

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Working the most common financial threats into your retirement plan allows you to shrug off their effects once you retire.

If you ask most retirees what their biggest concern is about retirement, the cost of healthcare is likely to be at the top of their list. You might not realize that medical expenses are only one of several large financial stressors you can expect when you retire. If you fail to prepare for these other common threats, your retirement plan could fall apart when you least expect it.

1. Taxes

You can't escape taxes, even once you've retired. Any taxable income that you receive from retirement savings accounts, Social Security benefits, or other sources will compel you to pay a chunk of that money to the federal government (and possibly your state as well). If you don't factor taxes into your retirement plans, you'll likely find yourself painfully short on money after you retire.

The best way to deal with the retirement tax burden is to find sources of income that won't be taxed. Since income tax rates are based on your total taxable income for the year, and higher-income taxpayers pay a higher percentage, having only a small amount of taxable income makes for big savings. And the tax status of your Social Security benefits depends on how much other taxable income you have, so that's yet another benefit to focusing on nontaxable income.

If the bulk of your retirement income will be sourced from retirement savings accounts, then one solution to consider is to convert your accounts to Roth accounts. That will turn the income from these accounts into nontaxable income, as distributions from Roth accounts are not taxed. However, this conversion requires careful planning because you'll have to pay taxes on the money you move into the Roth account the year you move it.

Bear trap baited with money

Image source: Getty Images.

2. Inflation

As time passes, the cost of just about everything goes up year by year. Inflation makes your dollars worth less and less over time. Inflation can be a very sneaky retirement issue, because most people don't realize how large its long-term effects can be.

For the past several years, inflation's been quite low; historically, the average rate of inflation is around 3% per year. So when you're planning out your retirement contributions, it's best to assume that the value of the money you save will drop by 3% each year. That means the first 3% of any annual returns your investments produce will essentially get wiped out by inflation. Thus, if your retirement portfolio produces an 8% return this year, you really only got a 5% return after adjusting for inflation.

While there is no magic bullet to get rid of inflation, you can reduce its impact by choosing retirement investments that will typically produce returns substantially higher than 3% in an average year. That way, you know that your retirement investments will be growing even after you subtract the effects of inflation. This is one reason why retirees are recommended to keep a goodly percentage of their portfolios in stocks, despite the high volatility of these investments. Your retirement stocks are the best insurance you have against inflation erosion.

3. Recessions and depressions

When the economy takes a nosedive, your investments will likely do the same. There's no way to prevent a market crash, but what you can do is diversify your investments so that you have at least some holdings in your portfolio that will resist the effects of any one economic disaster.

Different types of investments don't behave the same way in the same circumstances. For example, moderate inflation is usually brutal for bonds because it comes hand-in-hand with rising interest rates. However, a moderate level of inflation is actually good for businesses, and stocks tend to prosper as a result. Thus, just having both stocks and bonds in your portfolio can give you some measure of protection.

You can increase your protection further by diversifying a bit more widely. Foreign investments, real estate, and commodities are three examples of investments that tend to behave differently from domestic stocks or bonds. Having a small portion of your portfolio in these types of investments is an excellent hedge against economic ups and downs.

4. Long life

People are living much longer these days than they were 50 years ago, and while that's certainly a good thing, it's not an unmixed blessing. First, a long lifespan means that your retirement savings accounts have to last that much longer. And second, the longer your retirement is, the more likely you are to face the sorts of financial threats discussed earlier in this article.

Delaying your retirement date would lead to a shorter retirement and thereby reduce your risk, and it comes with other benefits as well. For example, waiting until age 70 to claim your Social Security benefits means you'll get delayed retirement credits on those benefits, increasing the amount of your monthly Social Security check by up to 24% compared to claiming those benefits at full retirement age. Of course, you may not be willing to wait. In that case, it's even more important to contribute generously to your retirement savings accounts. That's the money that will keep you going once you're no longer bringing home a paycheck.

It's important to take all of these threats into account when doing your financial planning. Otherwise, something you didn't plan for could ratchet up your stress levels in retirement.

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