- In your retirement years, it’s important to reduce your exposure to risk
- Retirees face different and often more significant inflationary pressures
- Tax-friendly withdrawal strategies can help preserve retirement income
If you’re already in retirement, you’re likely well aware that your investing risk tolerance has changed. While a few years of negative returns can erode decades of savings, having a financial plan with retirement income strategies in place can help ensure you still generate enough returns from assets to last a lifetime.
“It’s an intellectual as well as an emotional change as we move from building wealth to living on it,” says Mike Greene, Senior Vice President of Financial Advice at Ameriprise. “We’ve become wired in the way we think, so we need to ‘retrain’ our brains from seeing a portfolio as designed for growth to one designed for income.”
It’s particularly important to focus on reducing risk in the 10 years before and after you retire, often referred to as the “retirement red zone.” This means addressing three potential retirement derailers: market downturns, inflation and taxes. Here’s how.
1. Risk management implementation
A market downturn in retirement could significantly impact your portfolio and, ultimately, the ability to maintain your post-work lifestyle. This concept is also known as the “sequence of returns risk” — or the potential for investments to generate lower returns or lose value just prior to or after retirement distributions begin.
“When we’re saving toward retirement, we don’t worry about sequence of returns very much because we have time on our side to come back from down markets,” Greene says. “But if we have to sell when prices are low, those shares are no longer there to grow.”
One way to protect wealth in retirement is by reducing your exposure to the often more volatile stock market and allocating more to fixed income during the retirement red zone. Bonds tend to be much less volatile than stocks and haven’t experienced a decline of 10% or more in any calendar year since 1926.
A robust cash reserve is also crucial. “For workers, we recommend a minimum cash reserve of at least 90 days, but in retirement, we’re aiming for a longer time frame because we don’t want to have to sell when prices are low,” Greene says. “As you make that transition into retirement, it’s a good idea to establish a minimum of one year’s worth of essential expenses in cash-type investments so you can ride out a down market.”
2. Inflation-fighting investments
Those in retirement generally contend with different and often more significant inflationary pressures. Costs for goods and services that are more prominent in a retiree’s budget, such as health care, have tended to rise faster than the broader inflation rate.
This is why it’s important to appropriately position portfolios to help protect purchasing power over the course of retirement. “Inflation is historically low today, but we don’t know how long that will last. Even low levels of inflation over long periods of time — such as 20–30 years in retirement — can really add up,” Greene says.
Should inflation become a more serious concern than it has been in recent years, expanding your portfolio to include real estate, commodities and Treasury Inflation-Protected Securities (TIPS) could provide some level of risk mitigation. These assets have historically performed well during periods of high inflation and provide additional diversification.
3. Tax-efficient withdrawal strategies
Even after you’ve stopped taking home a paycheck, taxes can take a substantial bite out of your savings. Having tax-advantaged withdrawal strategies in place may positively impact your lifestyle in retirement.
“We’ve all heard about asset allocation, but tax diversification is something not a lot of people think about,” Greene says. “When planning your income for the year, your advisor can help optimize withdrawal strategies while considering your tax liability.”
Stay in touch
If you’re in or approaching the retirement red zone, be sure to check in with your advisor regularly to continue to fine-tune your investment strategy within these three key areas of concern. “Using our exclusive Confident Retirement® approach, your advisor can address the issues of risk, inflation and tax efficiency more holistically, within an ongoing planning relationship, to help preserve your retirement income for a lifetime,” Greene says.