Business Owners Face New Retirement Risks
|Rich Best has spent 28 years in the financial services industry, as an advisor, a managing partner, directors of training and marketing, and now as a consultant to the industry. Rich has written extensively on a broad range of personal finance topics and is published on several top financial sites. Recent books include The American Family Survival Bible and Annuity Facts Revealed: What You MUST Know Before You Invest.|
Business Owners Face New Retirement Risks
Business owners retiring today are facing more financial challenges than their parents’ generation. Healthcare costs are increasing at a faster rate than inflation and, due to increasing longevity, those costs will consume an ever-increasing portion of their retirement budget. More retirees are carrying mortgages into retirement and nearly half find themselves sandwiched between their aging parents and their own children who are struggling financially. Many are carrying upside-down mortgages and other debt into retirement. With the rising cost of retirement, many business owners are finding that their income needs are not much lower, and sometimes even higher, than their pre-retirement needs.
Confronting New Challenges
For as long as the need for retirement planning has existed (and that may only go back as far as the WWII era when workers began to actually retire), retirees have had to contend with inflation risk (the risk of loss in purchasing power) and market risk (the risk of loss in the market). But the game-changer, a factor that has profound implications for retirement planning, is longevity risk the risk of outliving your income, which is a terrifying notion for any retiree.
Today’s retirees face a new set of problems with regard to inflation. First, because guaranteed pension plans are generally a thing of the past, retirees must rely on their own capital to generate sufficient income for their extended lifetimes. Not only must they be able to accumulate capital at a rate that exceeds inflation, but they must also be able to sustain a rate of growth on their capital throughout their lifetime that at least paces inflation.
Secondly, and this goes back to longevity risk, inflation has a much more significant impact on purchasing power when assets and earnings are exposed to it for 20 or 30 years. Even a modest rate of inflation of 3 percent will cut purchasing power nearly in half over a 20-year period.
Market risk has always been a factor for retirees, but more so as pension plans began to disappear and retirees have had to rely increasingly on the accumulation of their own capital as a long-term income source. The implications of market risk were never more evident than during the market crashes in 2008, when the values of stocks and mutual funds held in retirement plans plummeted by as much as 40 percent almost overnight. Anyone within 10 years of retirement saw their dreams evaporate.
Where prior generations, secured by pension income, may have been able to avoid market risk, today’s retirees must be able to embrace it, if they hope to achieve and sustain any semblance of a comfortable standard of living. For today’s retirees, avoiding market risk will almost certainly expose their assets and income to the risks of inflation and longevity. The good news is that, with retirement timeframes stretching out 25 to 30 years, market risk can be mitigated through the normal ebb and flow of the market cycles.
Your longevity is a measure of the number of years of life expectancy and the risk is that you may exceed it. While that’s not a bad thing, your retirement plan is based on your life expectancy and your longevity risk could put you in danger of outliving your income.
The problem is, as you age, your longevity increases. For example, a 60-year-old male can expect to live until age 81, while a 70-year-old male is expected to live until age 84. And it keeps expanding the older you get. It’s more pronounced for females, who have longer life expectancies than men.
Planning for Compounding Risks
Many business owners work well into retirement and, when they do hang up their boots, they tend to focus on market risk and inflation risk when planning their income needs in retirement. However, when combined with market and inflation risk, longevity risk can have even more severe implications.
When planning for your income needs in retirement, it’s important to make realistic assumptions about your time horizon to ensure lifetime income sufficiency.