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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 that 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 and medical costs that historically have risen faster than general inflation—particularly for long-term care—managing health care costs can be a critical challenge for retirees.

According to Fidelity’s annual retiree health care costs estimate, the average 65-year-old couple retiring in 2014 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: Purchase long-term-care insurance. The cost is based on age, so the earlier you purchase a policy, the lower the annual premiums, though the longer you’ll potentially be paying for them.

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 An HSA offers a triple-tax advantage: You can save pretax dollars, which can grow and be withdrawn state and federal tax free if used for qualified medical expenses—currently or in retirement.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 American 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 And recent data suggest that longevity expectations may continue to increase.

Without some thoughtful planning, you could easily outlive your savings and have to rely solely on Social Security for your income. And with the average Social Security benefit being just over $1,294 a month, it likely won’t cover all your needs.3

Consider: To cover your income needs, particularly your essential expenses, 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.4

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 up 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 also 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, 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 risk and return potential. 

Consider: Create 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 (login required). 

5. Don't withdraw too much from savings.

Spending your savings too rapidly can also put your retirement plan at risk. For this reason, we believe that retirees should consider using conservative withdrawal rates, particularly for any money needed for essential expenses.

A common rule of thumb is to use a withdrawal rate of 4% to 5%. Why? We examined historical inflation-adjusted asset returns for a hypothetical balanced investment portfolio of 50% stocks, 40% bonds, and 10% cash, to determine how long various withdrawal rates would have lasted. The chart to the right shows what we found: In 90% of historical markets, a 4% rate would have lasted for at least 30 years, while in 50% of the historical markets, a 4% rate would have been sustained for more than 40 years.

Consider: Keep 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.

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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. Society of Actuaries IAM 2000 mortality tables, updated to 2013 with Schedule G Adjustments. Figures assume a person is in good health.

3. U.S. Social Security Administration, April 2014.

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

5. For the balanced portfolios, the following indexes were used. For domestic stocks, the IA SBBI S&P 500 TR. For foreign stocks, the MSCI EAFE TR. For bonds, the IA SBBI U.S. Intermediate-Term Government TR. For cash, the IA SBBI U.S. 30-Day Treasury Bill TR. The stock component of each portfolio includes 70% domestic and 30% foreign stock from January 1970 to July 2013. Because MSCI EAFE data are available only from January 1970, the stock component before that time was 100% domestic equity (S&P 500 TR). TR: Total return. Asset class returns reflect the reinvestment of all distributions. Historical inflation rates were derived from the IA SBBI U.S. Inflation Index. Securities indexes are not subject to fees and expenses typically associated with investments in securities. Fees and other expenses will reduce actual investment returns.

Fidelity Portfolio Review, Fidelity Retirement Income Planner and Fidelity Income Strategy Evaluator are educational tools.
The S&P 500® Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. S&P 500 is a registered service mark of Standard & Poor’s Financial Services LLC.
The MSCI® Europe, Australasia, Far East Index (EAFE) is an unmanaged, market capitalization-weighted index designed to represent the performance of developed stock markets outside the United States and Canada.
The IA SBBI U.S. Intermediate-Term Government Bond Index is an unweighted index that measures the performance of five-year-maturity U.S. Treasury bonds. Each year, a one-bond portfolio containing the shortest noncallable bond having a maturity of not less than five years is constructed.
The IA SBBI U.S. 30-Day Treasury Bill Index is an unweighted index that measures the performance of 30-day maturity U.S. Treasury bills. The IA SBBI U.S. Inflation Index tracks U.S. inflation.
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