With the decline of defined-benefit pension plans, most people plan to self-fund their retirement using a combination of Roth IRA and 401(k) plans, as well as Social Security benefits. These investments fluctuate with the market. Market volatility five to ten years before or after retirement can have the greatest impact on retirement savings. This critical period is referred to as the retirement risk zone.
What is the retirement risk zone?
The retirement risk zone is a critical period right before and after you retire. During this period, your retirement savings are typically at their highest, and any significant changes to the market are most likely to have a greater impact because your accounts have less time to recover from a market downturn.
Retirement marks a transition from depositing funds into retirement accounts to withdrawing them. The effects of market downturns may intensify as you start to withdraw funds from your accounts because it takes longer to recover from a market loss than the time it took to cause it, and you have less money in your account. Poor investment returns early in your retirement, combined with withdrawals, can deplete your accounts faster than you might expect.
Fee-only financial planning can help you evaluate your investment strategy as you approach retirement and transition from one class of assets to another based on your risk tolerance.
Adjust Asset Allocation
Typically, greater market risk means greater returns on investment. A higher-risk portfolio can grow more quickly and outpace inflation. However, it comes with a higher risk, and this risk is compounded during the retirement risk zone. If you are several years from retirement, your portfolio has more time to recover.
Most people choose passive portfolio management and take a percentage from each investment for retirement distributions. Another option is to take withdrawals from assets that are performing well in the market, which gives funds that are currently in a downturn time to rebound.
A financial advisor can help you determine how much money you need to save for retirement, your monthly distributions, and how much risk you can tolerate to achieve your retirement financial goals. Depending on how much time your investments have to rebound from a market downturn will determine how best to allocate them.
Evaluate Social Security Claiming Strategies
For most people, the full retirement age is 66 or 67. However, you can start collecting your benefits as early as age 62 or as late as age 70. Taking social security early will reduce your monthly benefits.
Consider factors such as your overall health, your ability to work part- or full-time, and how much Social Security will contribute to your retirement income when determining the best time to collect benefits. Your age when you started receiving benefits, as well as the total amount you contributed to the Social Security system over your lifetime, will determine your monthly Social Security benefits.
There are pros and cons to taking Social Security on time, early or late. Your financial advisor can help you calculate your breakeven age. It typically takes 12 to 14 years beyond your claim date to receive the same number of dollars as you would if you started claiming at age 62.
Create a Cash Buffer
If possible, maintain a cash buffer that you can use to avoid selling assets during a market downturn. Cash savings accounts, short-term certificates of deposit (CDs), money market accounts, and short-term U.S. Treasury bills, along with your Social Security and pension benefits, should be readily available to meet your immediate financial needs.
Consider your living expenses and a financial cushion for emergencies when determining what percentage of your investments should make up your cash buffer.
Consider Roth Conversions
Funds converted to a Roth IRA can grow tax-free and be withdrawn tax-free during retirement. Roth IRAs offer several benefits, including no minimum required distributions during retirement, flexibility in retirement planning, and the ability to transfer wealth to beneficiaries tax-free, subject to certain conditions.
Converting traditional IRAs to Roth IRAs in years when your taxable income is lower, such as early in retirement before you are eligible for Social Security benefits, can lead to lower federal taxes owed on your investment.
Roth conversions are not the best option for everyone. You will need to pay taxes on your Roth conversions, so it is important to consider your current cash flow before converting. Be aware that you cannot access the funds in converted Roth IRAs tax-free for five years, even if you are over 59½.
Review Insurance Needs
If you plan to retire before age 65, you will need to evaluate healthcare costs. Medical expenses can significantly impact your retirement savings. According to a Fidelity Retiree Health Care Cost Estimate, a single 65-year-old in 2023 may need to save $157,500 (after taxes) to cover their healthcare costs after retirement. A married couple (age 65 in 2023) will need to save approximately $315,000.
Even when you qualify for Medicare, the 2024 Medicare Part B premium costs an average of $174.70 per month. The annual deductible is $240, after which most plans require you to pay 20% of all Medicare Part-B expenses. The 2024 Medicare Part A deductible is $1,632. However, most people are exempt from Medicare Part A deductibles if they pay taxes during their working years.
There is no one-size-fits-all guide to investment, but there are effective strategies to help manage market volatility during retirement. Working with a wealth manager who uses a fee-only financial planning structure can ensure you make the best financial decisions for yourself and your loved ones.
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