As you plan for retirement, it is important to make sure you have enough retirement savings and other income sources to last a lifetime. One great way to assess your level of retirement readiness is by stress testing your retirement plan. Doing so involves assessing your plan’s resilience against multiple risks and unexpected scenarios to help ensure it is strong enough to weather whatever uncertainties you may face throughout your retirement years.
To stress test your retirement plan, consider taking the following steps.
Step #1 – Understand your current spending and how it may change in retirement.
Taking time to understand your current spending can help you establish realistic retirement income goals. Review three to six months’ worth of bank statements, credit card statements and bills to understand where your money is going.
Once you have an idea of your current monthly spending, estimate your potential retirement spending needs. Consider which expenses are likely to increase in retirement, such as entertainment, travel hobbies, etc., and which expenses are likely to decrease, such as commuting and other work-related expenditures.
This insight serves as a baseline you can refer back to as you complete the stress test process.
Step #2 – Make a list of retirement income sources.
Consider what income may be available to cover your expenses in retirement. Estimate the amount of income available from all sources of retirement savings, Social Security, pensions, annuities, rental income, etc.
Step #3 – Identify potential risks.
Once you have an idea of how your potential retirement income compares to your anticipated retirement expenses, consider what risks have the potential to derail your plans. Potential risks include:
- Market volatility – Fluctuations in investment value could harm your retirement savings.
- Sequence of returns risk – A market drop early in retirement could permanently and irreparably reduce your retirement savings’ growth potential.
- Longevity risk – You could outlive your retirement savings.
- Unexpected expenses – Unexpected or emergency expenses could derail your retirement income potential.
- A healthcare emergency – A healthcare emergency, including the need for long-term care, could deplete your retirement savings.
- Elevated inflation – An unexpected spike in inflation could negatively impact your purchasing power.
- Job loss –You may be forced to retire sooner than anticipated, leading to less retirement savings than anticipated.
Step #4 – Test various scenarios.
Now that you have an idea of potential risks to your retirement income, it is important to test how these risks may impact the resiliency of your portfolio and savings strategies.
A great way to test various scenarios is by using financial modeling software. Your United Capital advisor has access to powerful software that can help you visualize how risks may impact your chances of financial success. This software allows you to modify various inputs to quickly assess the potential impact of various risks.
For example, to assess the potential long-term impact of market volatility and sequence of returns risk, use the modeling software to simulate a 20% to 30% market drop early in retirement. How does this change impact your monthly retirement income? Will you still have enough assets to support your lifestyle throughout retirement? If not, what adjustments can you make today to help mitigate the risk of market volatility and sequence of returns risk?
Step #5 – Make adjustments.
Based on the results of your retirement stress test, you may need to make adjustments to give yourself a better chance of success, including potentially:
- Finding additional sources of income, such as a part-time job or rental income
- Increasing your current level of retirement savings
- Finding ways to reduce potential retirement expenses
- Establishing a source of emergency savings to cover at least six to 12 months’ worth of living expenses in retirement
- Making adjustments to your investment portfolio to provide current income as well as growth to protect assets from inflation
Step #6 – Regularly reevaluate your strategies.
Your situation, goals and financial situation evolve over time, which is why it is important to regularly reevaluate your retirement strategies and their potential outcomes. I recommend working with your advisor to stress test your retirement at least once a year or anytime you experience a major life change, such as experiencing health issues, getting married or divorced, etc. It can also be helpful to run a new stress test when the market shifts or you establish new goals.
If you could use some help stress testing your retirement plan, we would love to have a conversation. Please schedule a call with United Capital Financial Advisors to learn more.
