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Five ways to protect your retirement income

Five rules of thumb to help protect your savings and income—now and in the future.

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If you’re nearing or in retirement, it’s important to think about protecting what you've saved and ensuring your income needs are met now and in the future. Here are five rules of thumb to help manage the risks to your retirement income.

1. Plan for health care costs.

With longer life spans, medical costs that are rising faster than general inflation, declining retiree medical coverage by private employers, and possible funding shortfalls ahead for Medicare and Medicaid, managing health care costs can be a critical challenge for retirees.

According to Fidelity’s annual retiree health care costs estimate, a 65-year-old couple retiring in 2013 will need an estimated $220,000 to cover health care costs during their retirement, and that is just using average life expectancy data.1 Many people will live longer and have higher costs. And that cost doesn’t include long-term-care (LTC) expenses. 

According to the U.S. Department of Health and Human Services, about 70% of those age 65 and older will require some type of LTC services—either at home, in adult day care, in an assisted living facility, or in a traditional nursing home. The average private-pay cost of a nursing home is about $90,000 per year according to MetLife, and exceeds $100,000 in some states. Assisted-living facilities average $3,477 per month. Hourly home care agency rates average $46 for a Medicare-certified home health aide and $19 for a licensed non-Medicare-certified home health aide. 

Consider: Purchasing long-term-care insurance. The cost is based on age, so the earlier you purchase a policy, the lower the annual premiums.

If you are still working and your employer offers a health savings account (HSA), you may want to take advantage of it. An HSA offers a triple-tax advantage: you can save pretax dollars, which can grow and be withdrawn state and federal tax free if used for qualified medical expenses—currently or in retirement.

2. Expect to live longer.

As medical advances continue, it's quite likely that today’s healthy 65-year-olds will live well into their 80s or even 90s. This means there's a real possibility that you may need 30 or more years of retirement income.

An American man who’s reached age 65 in good health has a 50% chance of living 20 more years to age 85, and a 25% chance of living to 92. For a 65-year-old woman, those odds rise to a 50% chance of living to age 88 and a one-in-four chance of living to 94. The odds that at least one member of a 65-year-old couple will live to 92 are 50%, and there’s a 25% chance at least one of them will reach age 97.2

Without some thoughtful planning, you could easily outlive your savings and have to rely solely on Social Security for your income. Chances are, like many people, you don’t have a company pension to rely on—only 30% of Americans today have one.3 And with the average Social Security benefit being just over $1,230 a month, it likely won’t cover all your needs.4

Consider: To cover your income needs, you may want to use some of your retirement savings to purchase an annuity. It will help you create a simple and efficient stream of income payments that are guaranteed for as long as you (or you and your spouse) live.5

3. Be prepared for inflation.

Inflation can eat away at the purchasing power of your money over time. This affects your retirement income by increasing the future costs of goods and services, thereby reducing the purchasing power of your income. Even a relatively low inflation rate can have a significant impact on a retiree’s purchasing power. Our hypothetical example below shows that $50,000 today would be worth only $30,477 in 25 years, even with a relatively low (2%) inflation rate.

Consider: While many fixed income investments and retirement income sources will not keep pace with inflation, some sources, such as Social Security, and certain pensions and annuities can help you contend with inflation automatically through annual cost-of-living adjustments or market-related performance. Investing in inflation-fighting securities, such as growth-oriented investments (e.g., individual stocks or stock mutual funds), Treasury Inflation-Protected Securities (TIPS), and commodities, may make sense.

4. Position investments for growth.

A too-conservative investment strategy can be just as dangerous as a too-aggressive one. It exposes your portfolio to the erosive effects of inflation and limits the long-term upside potential that diversified stock investments can offer, and can diminish how long your money may last. On the other hand, being too aggressive can mean undue risk in down or volatile markets. A strategy that seeks to keep the growth potential for your investments without too much risk may be the answer.

The sample target asset mixes below show some asset allocation strategies that blend stocks, bonds, and short-term investments to achieve different levels of risk and return potential. With retirement likely to span 30 years or so, you’ll want to find a balance between growth and preservation. 

Consider: Creating a diversified portfolio that includes a mix of stocks, bonds, and short-term investments, according to your risk tolerance, overall financial situation, and investment time horizon. Doing so may help you seek the growth you need without taking on more risk than you are comfortable with. Diversification and asset allocation do not ensure a profit or guarantee against loss.  Get help creating an appropriate investment strategy with Portfolio Review

5. Don't withdraw too much from savings.

Spending your savings too rapidly can also put your retirement plan at risk. This risk can be magnified further if a sustained market downturn—similar to the one from 2007 to 2009—occurs early in your retirement. For this reason, we believe that retirees should consider using conservative withdrawal rates, particularly for any money needed for essential expenses.

The sample chart below shows the impact that a range of inflation-adjusted withdrawal rates could have had on a hypothetical balanced portfolio of 50% stocks, 40% bonds, and 10% short-term investments from January 1972 to December 2012. We chose this time period because 1972 was considered one of the worst times to retire because of rampant inflation and low returns from stocks. It also includes a wide spectrum of market and economic cycles including the bull market of 1982 to 2000, three bear markets, six recessions, and the rampant inflation and tight monetary policy of the late 1970s. It uses the actual, historical returns over this period.

If funds were drawn down at a 6% rate (inflation adjusted), the initial $500,000 would have been exhausted by the late 1980s. So, a 65-year-old couple who retired in 1972 with this portfolio would face more than a 90% probability of having one member survive to see those assets completely drained away.

A more-modest 5% withdrawal rate could have extended income from the portfolio for nearly 25 years, but it still would have run out if there was a more than 63% chance of one member of the couple surviving.

In our hypothetical example, only a 4% withdrawal rate would have left enough assets intact to catch the full tailwind of the long bull market that began in 1982. (Past performance is no guarantee of future results.) This isn’t to say that a 4% withdrawal rate guarantees your money will last as long as you need it; it would also depend on the performance of your investments, your asset allocation, and your time horizon.

As our hypothetical example shows, withdrawing more than 5% of your savings may increase the risk of your retirement income plan falling short. Fortunately, you have control over how much you withdraw and can adjust it based on circumstances.

Consider: Keeping your withdrawals as conservative as you can. Later on, if your expenses drop or your investment portfolio grows, you may be able to raise that rate.

In conclusion

After spending years building your retirement savings, switching to spending that money can be stressful. But it doesn't have to be that way, if you take steps leading up to and during retirement to manage these five key risks to your retirement income, as outlined above.

Learn more

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Investing involves risk, including risk of loss.
1. Source: Fidelity Benefits Consulting, 2013. Based on a hypothetical couple retiring in 2012, 65 years or older, with average (82 male, 85 female) life expectancies. Estimates are calculated for "average" retirees but may be more or less depending on actual health status, area of residence, and longevity. Assumes individuals do not have employer‐provided retiree health care coverage but do qualify for Medicare. The calculation takes into account cost- sharing provisions (such as deductibles and coinsurance) associated with Medicare Part A and Part B (inpatient and outpatient medical insurance). It also considers Medicare Part D (prescription drug coverage) premiums and out‐of‐pocket costs, as well as certain services excluded by Medicare. The estimate does not include other health‐related expenses, such as over‐the‐counter medications, most dental services, and long‐term care.

2. Annuity 2000 Mortality Table; Society of Actuaries. Figures assume a person is in good health.

3. Bureau of Labor Statistics.

4. U.S. Social Security Administration, June 2012.

5. Guaranteed lifetime income is subject to the claims-paying ability of the issuing insurance company.

6. Fidelity Retirement Income Planner is an educational tool developed and offered for use by Strategic Advisers, Inc., a registered investment adviser and a Fidelity Investments company.

7. Fidelity Income Strategy Evaluator is an educational tool.
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