Beware these risks when planning for retirement
Many people view retirement as the well-deserved culmination of years of dedicated work, offering an opportunity to unwind, enjoy financial independence, and pursue personal interests and family time.
However, Stian de Witt, Executive Head of Financial Planning at advisory firm, NMG Benefits, said that without a solid strategy, retirees can face challenges that may negatively impact their income and quality of life.
He said that ensuring a stable and enjoyable retirement requires thoughtful financial planning to address the potential risks that could threaten your financial security.
De Witt said that five critical risks, namely to do with liquidity, inflation, tax, sequence of returns, as well as fund selection and asset allocation, are crucial to address before reaching retirement.
- Liquidity Risk
“One of the biggest challenges in retirement is maintaining a stable income, especially when markets fluctuate,” said de Witt.
Liquidity risk arises when retirees need cash for daily expenses but find themselves forced to sell investments at a loss during market downturns.
De Witt said that to avoid this, “it’s important to maintain a portfolio with a Money Market or Income Fund that can weather temporary market dips without affecting long-term investments.”
- Inflation Risk
Over time, inflation diminishes purchasing power, making it vital for retirement income to grow faster than inflation, especially when considering taxes and fees.
A lot of retirees view Money Market funds as a secure choice because they ensure the safety of their principal investment.
“However, after adjusting for inflation and taxes, these funds might barely keep pace or even lag, reducing retirees’ real income,” said de Witt.
- Tax Risk
The financal planning expert explained that high tax rates can seriously reduce the value of retirement income.
“For instance, a 10% return reduced by a 45% tax rate leaves only a 5.5% after-tax return. Many retirees overlook tax-efficient investment options, missing opportunities for substantial savings,” said de Witt.
However, retirees can benefit from tax exemptions and deductions by utilizing different investment vehicles and asset classes.
He said that working with a Certified Financial Planner can help retirees save as much as 20% in taxes, potentially adding an extra two to four years of retirement income.
- Sequence of Returns Risk
“Research shows that if markets take a significant hit in the first two years of retirement, it could reduce a retiree’s portfolio longevity by up to seven years,” said de Witt.
“Entering retirement during a market downturn can have lasting effects.
“Managing the sequence of returns risk involves diversifying investments and potentially adjusting withdrawal rates to avoid depleting the portfolio during early retirement market declines,” he added.
- Fund Selection and Asset Allocation Risk
South Africa has over 1,700-unit trusts, each with different fees, performance histories, and growth potential.
“Choosing the wrong fund, especially one with high fees (over 2% per year), can significantly reduce portfolio growth,” said de Wit.
He said that low-growth funds or high-fee structures can cut a retirement portfolio’s lifespan by one to two years but carefully selected portfolio, with attention to costs and performance, can support long-term growth.
Going forward
The financial planning expert said that a well-suited financial advisor who considers all five risks, can make a significant difference to your retirement portfolio’s longevity.
“The stakes are high, but with the right planning, retirees can secure their financial freedom, reduce unnecessary risks, and enjoy peace of mind throughout their retirement years,” said de Witt.
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