How to fortify your retirement against a financial shock

If you've made careful plans to develop a retirement income portfolio that covers your expected living expenses and lasts the rest of your life, congratulate yourself!

Still, you're not yet finished with your retirement tasks. Common financial shocks can disrupt your careful plans, as recently determined by the Boston College Center for Retirement Research (CRR) in a brief titled "Will the Financial Fragility of Retirees Increase?"

The CRR brief analyzed two common retirement shocks: a drop in income due to widowhood and a spike in medical expenses. Both are serious but can be addressed with careful planning.

The CRR brief cites one study that found that roughly 80 percent of a typical retiree's budget consists of money spent on basic needs, including housing, health care, food, clothing and transportation. The rest of the budget consists of money spent on nonessentials, such as entertainment, gifts and other costs such as cable TV or a cellphone (although you could argue that a cellphone is a basic need in today's world).

These figures suggest that a typical retiree's household has a margin of about 20 percent of total income that could be reduced in the event of an unexpected shock. This margin could be less, however, for retirees who are single, live in lower-income households and rent or are still paying a mortgage.

Plan to take care of your spouse after you're gone

For married couples, it's almost certain that one spouse will die before the other. Often, it's the husband who dies first. Women typically outlive men by a few years, and men tend to marry women a few years younger than themselves, so it's not hard to imagine that a woman might face a five- to 10-year period of widowhood at the end of her life.

The CRR brief cites studies that estimate a widow needs about 75 percent to 79 percent of the income she and her spouse or partner had while they were both alive in order to maintain her standard of living as a widow. 

But another study estimated that women who will become widowed over the next quarter-century will receive about 62 percent or less of the couple's income while both were alive, and one in four widows will receive 55 percent or less. Neither of these figures is close to the 75 percent to 79 percent estimated need. Clearly, widowhood represents a threat to the financial security of the surviving spouse.

Here are steps you can take to help protect your spouse after you pass away:

  • If you're the primary wage-earner, a careful strategy to delay your Social Security benefit can help maximize Social Security's benefit for the surviving spouse.
  • If you're lucky enough to participate in a defined-benefit pension plan, elect a joint and survivor annuity that continues 100 percent of the income to the spouse after you pass away. Resist the temptation to elect a lump sum payout or buyout, if you're offered that choice.
  • If you're using your retirement savings to generate a retirement paycheck, set the paycheck up to continue intact to your surviving spouse. You can also use a portion of your savings to purchase a joint and survivor annuity.
  • Consider paying off the mortgage on your house to reduce basic living expenses in retirement.

Protect yourself from medical shocks

The CRR brief cites another study indicating that declines in health were a clear predictor of financial hardship. Not only does spending on medical needs increase as people age, but other costs increase as well when retirees are less able to fend for themselves. These costs include money spent on home maintenance, food preparation and transportation.

Here are ways you can protect yourself against medical shocks:

  • Carefully select a Medicare supplement plan or Medicare Advantage plan that ensures most of your medical costs will be covered.
  • Keep some margin in your budget for living expenses, so that when your health declines, you can pay for medical plan deductibles, co-payments, and nonmedical costs that might increase.
  • Consider investing in a Health Savings Account so that you have a pool of money to pay for medical expenses.
  • Develop a strategy to pay for high long-term care expenses that have the potential to disrupt your retirement finances.

There's a lot to think about when planning a retirement that could last for 20 or 30 years. Clearly, it's worth spending the time it takes to prepare careful plans now to address these future shocks before they strike.

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    Steve Vernon helped large employers design and manage their retirement programs for more than 35 years as a consulting actuary. Now he's a research scholar for the Stanford Center on Longevity, where he helps collect, direct and disseminate research that will improve the financial security of seniors. He's also president of Rest-of-Life Communications, delivers retirement planning workshops and authored Money for Life: Turn Your IRA and 401(k) Into a Lifetime Retirement Paycheck and Recession-Proof Your Retirement Years.