6 key concerns of people heading into retirement

No matter how much of a net worth you have amassed, the real key to a successful financial future is knowing that you can count on a reliable, ongoing stream of income for the remainder of your lifetime – as well as that of your spouse or partner, if applicable.

In the past, many people worked for the same company throughout their entire career, and they were often, in turn, rewarded with a pension income from their former employer for the rest of their lives. On top of that, a number of these same retirees could also count on retirement income benefits from Social Security.

If these two income sources weren’t enough to cover their essential living expenses – although, in many cases, they were – the income gap could often be filled in with interest and dividends from personal savings or investments. Further, because life expectancy was shorter back then, income did not – on average – have to last very long.

But fast forward to today when people could literally spend decades in retirement. So, income has to stretch out much further than it did before. Making that even more difficult is the fact that many employers have done away with the defined benefit pension plan, and have “replaced” these with defined contribution plans – the most popular of which is the 401(k) retirement plan.

Defined contribution plans essentially “shift” the responsibility of having enough income in retirement to the individual, and away from the employer. Therefore, if an individual has not saved much money, it isn’t likely that they will be able to generate a significant amount of income from that source.

Defined Benefit vs. Defined Contribution Plans

In addition, while Social Security retirement benefits are still available to those who qualify, these only “replace” about 40% of pre-retirement earnings for average wage earners – and the percentage decreases for those who earn higher incomes throughout their working years.

Plus, the Social Security trust fund is on shaky ground, and it is slated to start paying out a reduced benefit amount in the future. This, too, can be a concern for those who are approaching retirement.

So, how can you set up an income stream that will continue to flow in, regardless of what happens in the stock market or with interest rates going forward?

One solution is to add an annuity to your retirement plan. With the right type of annuity in place, you can count on a specific dollar amount of income to arrive on a regular basis either for a pre-set period of time – like 10 or 20 years – or for the rest of your lifetime, no matter how long that may be.

Many annuities also offer a joint and survivor income option. That way, it will keep paying out throughout the second individual’s lifetime. Many spouses and partners choose this alternative to that they can ensure both will not run out of income. (Although the two income recipients do not necessarily have to be related.) In some cases, the dollar amount of the income payment will remain the same after the first individual’s death, while in others it may be reduced.

If retirement is just around the corner, a single premium immediate annuity, or SPIA, can allow you to contribute a lump sum – such as money from an IRA (individual retirement account) or an employer-sponsored retirement plan – and then begin receiving income right away (or at some point within the next 12 months).

However, if you are still planning for retirement and do not yet need income, a deferred annuity will allow you to generate tax-deferred growth on the money that is inside of the account.

A regular fixed annuity will typically generate a return that is based on a rate set by the insurance company, whereas a fixed index annuity will generate its return based on the performance of one or more underlying market indexes, such as the S&P 500 (usually up to a pre-stated limit, or cap).

With both fixed and fixed index annuities, your principal is protected – even if the stock market crashes. So, as you move closer to retirement – and keeping your money safe becomes more important – these financial vehicles can offer a viable solution.

Although annuities provide many enticing benefits, though, they can also have a lot of moving parts. With that in mind, it is recommended that you first discuss your retirement goals with financial professional before you make a long-term commitment to one. Once a financial professional has a better understanding of your particular needs and objectives, they can help you to narrow down which annuity – if any – is best for you.

Another key concern for retirees and those who are approaching retirement is keeping purchasing power on track over time due to inflation. During your pre-retirement years, it is possible that you received regular pay raises or you increased the price on goods and services that your business offered in order to keep up your income with rising inflation.

But unless you specifically plan for your retirement income to rise over time, you may find that the same amount of incoming cash flow won’t keep pace with increased costs – even on the most basic of items.

How Inflation Has Changed the Price of a Cup of Coffee Over Time

This can be particularly challenging as life expectancy has increased, because the longer you live, the higher your living expenses will likely be. So, without a strategy for increasing your retirement income, you may have to make some unappealing choices during your later years, such as:

• Going back to work
• Decreasing your standard of living
• Purchasing food or medication – but not both
• Depleting your portfolio and running out of money

Using just a 3.2% average rate of inflation, your income would have to roughly double in 20 years in order to keep pace with inflation. So, for instance, if your investments and/or other retirement income sources are generating $4,000 per month right now, this amount of cash flow would have to grow to $8,000 per month 20 years down the road.

Some sources of your retirement income may automatically adjust for inflation. For instance, while they are not guaranteed, in most years, Social Security has added cost-of-living adjustments, or COLAs, to help retirees’ income increase to meet higher prices going forward.

COLAs are based on a comparison of the prior year’s and the current year’s Consumer Price Index, and they can be extremely beneficial for keeping your standard of living in retirement up to speed with rising prices of goods and services.

Social Security Cost-of-Living Adjustments

With other retirement income sources, you may have to plan ahead, though, if you want the amount to increase. Annuities, for instance, may allow you to choose an ongoing increase in your income amount. If you are using a portfolio drawdown strategy, it could mean that you increase the amount of money, or the percentage of your assets, that are withdrawn in order to meet your future expenses.

Health care is one of the biggest expenses that you can face in retirement. According to a recent survey by Fidelity Investments, an average retired couple that was age 65 in 2022 needed, on average, approximately $315,000 saved in after-tax dollars to cover health care expenses for the remainder of their lifetime.

While that figure may appear to be astronomical, it does not even include the cost of a potential long-term care need, which could add an additional five or six figures per year to your overall health care spending tab.

Depending on where you live, just one month in a skilled nursing home facility could cost in excess of $9,000. Receiving long-term care at home usually costs less, but still averages in the $5,000 per month range in the U.S.

With an average need for this type of care being between two and three years, it is easy to see how long-term care services could quickly drain even a nice-sized portfolio. Given that, a strategy for protecting yourself from the high cost of long-term care is a must when you are planning for retirement.

A good health insurance plan can help you with at least a portion of these costs. For instance, Medicare will pick up various expenses for inpatient hospitalization, doctor visits and necessary medical equipment. But this program also comes with a significant amount of out-of-pocket deductibles, copayments and coinsurance costs. It also pays very little, if anything, for long-term care services.

Because of that, many who are planning for retirement will include long-term care insurance or another type of safety net to protect assets from being depleted. Today, there are various alternatives available that can keep you from purchasing an insurance policy that you may never use.

For instance, there are “hybrid” plans that combine long-term care and life insurance coverage or long-term care and annuity income. These are often appealing because benefits can be paid out for a variety of circumstances – even if you never require long-term care services.

But because these plans can include a lot of “fine print,” it is recommended that you go over which of these, if any, may be right for you and your specific short- and long-term planning objectives.

Unfortunately, most people in the U.S. have to deal with taxes throughout the majority of their life – and in some cases, even afterward. Taxes can have a significant impact on the amount of money you have available to actually spend in retirement.

But because future tax rates are unknown, it can be difficult to plan ahead for just how much you might have to pay. If the past is any indication of the future, though, it is possible that you will be paying more taxes down the road than you are today.

For instance, over the past 110 years, the top federal income tax rate has been as high as 94%, and it has been at 70% or more in 49 of those years. With that in mind, it is essential to include tax planning in your overall retirement strategies. Otherwise, you could net out far less spendable income that you had planned for – and this, in turn, can drastically reduce what you have available to spend towards your desired lifestyle.

Top Federal Income Tax Rates 1913 – 2023

In addition to paying federal income tax, if you live in an area where there are also state income taxes imposed, this could reduce your net spendable income even more. In 2023, the states that impose taxes on residents’ income include the following:

• Alabama
• Arizona
• Arkansas
• California
• Colorado
• Connecticut
• Delaware
• District of Columbia
• Georgia
• Hawaii
• Idaho
• Illinois
• Indiana
• Iowa
• Kansas
• Kentucky
• Louisiana
• Maine
• Maryland
• Massachusettes
• Michigan
• Minnesota
• Missouri
• Montana
• Nebraska
• New Hampshire
• New Jersey
• New Mexico
• New York
• North Carolina
• North Dakota
• Ohio
• Oklahoma
• Oregon
• Pennsylvania
• Rhode Island
• South Carolina
• Utah
• Vermont
• Virginia
• West Virginia
• Wisconsin

One way to help reduce (or eliminate) the amount of taxes that you will pay on your retirement income is to take advantage of the Roth IRA (individual retirement account). Unlike traditional IRAs – which are funded with pre-tax dollars, grow tax-deferred and are taxable upon withdrawal – Roth accounts are funded with after-tax dollars, but the earnings and the withdrawals are tax-free. This is the case, regardless of what the income tax rates are in the future.

In order to open and contribute to a Roth IRA, though, you must meet certain income limits. There are also maximum annual contribution limits for IRAs (both Roth and traditional) that you may not surpass.

Maximum Annual IRA Contribution Limits (in 2023)

But, if you generate more than the upper level of the Roth IRA earnings limit, there are still strategies you can use to take part in the benefits that Roth IRAs can offer. One of these is converting a traditional IRA to a Roth.

Roth IRA Income Limits (in 2023)

The money that is involved in a Roth IRA conversion would be taxable in the year it is moved from the traditional to the Roth IRA account. However, by doing so in a low-interest rate environment, you could ultimately end up saving countless dollars on future taxes – particularly as income taxes are expected to rise within the next few years.

Before you move forward with a Roth IRA conversion, though, it is important that you first talk over your goals and strategy with a retirement income specialist. That way, you can better ensure that you are not leaving yourself open to any unexpected tax-related consequences.

Another potential avenue for reducing your taxable income in retirement is to generate some of your incoming cash from a permanent life insurance policy. Although many people think about life insurance only in terms of the death benefit it can provide, this flexible financial vehicle can do so much more.

Permanent life insurance policies include a death benefit and a cash value component where the funds are allowed to grow tax-deferred. This money can be accessed through either withdrawals or loans.

While withdrawals that are considered gains are taxable, with a properly structured permanent (i.e., cash value) life insurance policy, you can access funds tax-free through a policy loan. And, while interest will accrue on the balance of this loan, any portion that is not repaid before the insured’s death can instead be paid off using the policy’s death benefit, with the remainder being paid out – free of income taxes – to the beneficiaries.

But, not just any permanent life insurance policy will work for this strategy. So, it is vital that you work with a financial professional when setting up this type of plan.

While many of the above concerns – including inflation and high health care costs – can lead to depletion of assets, there are other factors that can contribute, too, such as a volatile stock market and low interest rates.

Still others, such as sequence or order of returns must also be considered. While this is a little-known risk factor, it can be detrimental to how long your portfolio lasts. Sequence of returns refers to the year-over-year investment returns that are experienced in a portfolio.

In this case, the order (or sequence) of when such returns are received can have a significant impact on the value of the portfolio – as well as make a big difference is how long the portfolio remains intact.

As an example, Investor No. 1 and Investor No. 2 both have a portfolio that is valued at $100,000. Both of these investors decide to withdraw 9% per year from their portfolio, while allowing the remainder of the funds to keep growing over time.

Over the first three years, both of these investors generate a 7% average return. In fact, they both received the very same returns over a three-year period, but just in a different order. In this case, Investor No. 1 had a negative 13% in Year 2, whereas Investor No. 2 generated a negative 13% in Year 3.

Yet even though both investors ended up with a +7% average return over the initial three-year time period, because Investor No. 1 received the negative return earlier, it caused his portfolio to be depleted a full six years before Investor NO. 2’s portfolio ran dry. This is why sequence of return matters, and it must be addressed when planning for retirement.

Sequence of Returns Example

Working with a financial professional can help you to plan ahead for risks like stock market downturns, drops in interest rates, and sequence of returns. Preparing for these risks ahead of time won’t make the dangers disappear. But it can put you in a position to defend your portfolio – and your ongoing retirement income – before the risks occur.

One of the other key concerns that those who are approaching retirement frequently face is leaving a legacy for their loved ones. There are many people who wish to leave something behind for their family and friends, and/or for organizations and entities (like charities) that are important to them.

While tangible assets like property, artwork, and personal effects are oftentimes specifically left to loved ones in a will, there are other ways to provide for those who are left behind. One way to leave money income-tax free is with life insurance.

Because the beneficiary of life insurance death benefits won’t have to pay income tax on these inherited funds, they can often make use of 100% of the proceeds. But this isn’t the only thing that makes life insurance so attractive as a legacy strategy.

It can also allow you to make use of 100% of your portfolio for other needs and wants. For instance, by not having to earmark a significant amount of cash or investments to leave as an inheritance or legacy, you can leverage a substantial – and guaranteed – amount of money for those you love simply by paying the life insurance policy’s premium.

Annuities can also oftentimes be used as part of a legacy strategy. In this case, on top of generating an income that cannot be outlived, many annuities include a death benefit whereby if the annuitant (i.e., the income recipient) dies before receiving all of the allotted income that is due to them, the remainder is either paid out as a lump sum death benefit or as continued payments to the named beneficiaries over time.

The legacy strategy that you use will depend on a number of factors, including what you plan to leave, how (and when) you would like it to be paid out, and whether or not there are any stipulations on how the inheritance may (or may not) be used. This is why it is recommended that you work with a retirement planning specialist when creating and implementing your desires.