Financial security in retirement depends on understanding a series of risks that can erode even significant life savings. These risks may seem daunting, but each can be met, and potentially overcome, provided you understand them and take action by creating a sound retirement income plan.

To illustrate how this works, let’s take a look at two very different retirees who have gone through the income planning process and, in doing so, have identified the risks most pertinent to their individual circumstances.

Meet Charlie Charlie is 70 years old. He and his wife, Marie, have two children and five grandchildren. They enjoy spending time with family, traveling to Europe to learn new cultures and languages, and taking long drives around New England.

Charlie’s main goal is to stay healthy so he can continue to enjoy his retirement, but he’s concerned about having enough income to maintain their new lifestyle. During his years of hard work as an insurance executive, he lived modestly and focused on covering day-to-day expenses. Now, he and Marie seem to have developed a taste for adventure. In the mean-time, his retirement savings, which are invested predominately in equities, have been affected by market volatility. Although his retirement package seemed generous at the time, he sees his assets diminishing faster than expected and realizes that he needs to have a secure plan in place to sustain him and Marie for a lifetime.

Charlie’s first step toward developing a realistic retirement income plan is to identify the risks that he is most susceptible to.

Longevity risk: At the ages of 70 and 68, respectively, Charlie and Marie are in good health and view wellness

as a top priority. This, combined with today’s longer life expectancies, makes them susceptible to the risk of longevity, given that they may live well into their 90s. In fact, there’s a 25% chance that at least one of them will live to celebrate their 97th birthday. That means their retirement savings will need to sustain them for another 25 to 30 years to ensure they do not outlive their income.

Withdrawal rate risk: Because of Charlie’s desired retirement lifestyle, he is more susceptible to the withdrawal rate risk, or the risk of withdrawing too much too fast. The percentage of assets Charlie withdraws each year can have an enormous effect on whether his money lasts through his — and Marie’s — lifetime. Charlie’s withdrawal rate will most likely need to be reduced if he is to succeed at his goal.

Asset allocation risk: Although Charlie’s long-time horizon requires that he allocate a significant portion of his assets to equities, he still needs to be careful to have a balanced portfolio — neither all stock, which can make a person too exposed to bear market risk, nor all bonds and cash, which have little potential for upside appreciation. As part of his revised retirement income plan, Charlie will need to reallocate assets to reduce his exposure to equities, if he wants to be less susceptible to market downturns.

Planning for Retirement Income:Case Studies

Meet Kitty Kitty is 60 years old. She is divorced with three children and two grandchildren. She is admit-tedly frugal with her money, except when it comes to her grandchildren — she enjoys spoiling them with gifts, and spending her free time with them.

Kitty has decided she would like to retire from her 30-year career as a schoolteacher. She feels the time is right. Not only would she like to spend more time with the kids, but lately she has been experiencing extreme joint pain due to arthritis. This has made it increasingly difficult for her to manage a full day in the classroom.

Ideally, she’d like to leave within the next 9 to 12 months, but she’s worried about whether she is ready financially. Kitty has never put together a formal retirement plan. In fact, she has thought very little about an overall retirement strategy, since her inclination has always been to put all of her assets into what she felt were “safe” investments, like bonds, where she feels she isn’t risking her principal. But now she realizes that her assets will need to work harder if they’re going to be able to carry her through her life-time — possibly another 35 years. Before Kitty can develop a realistic retirement income plan, she too will want to identify the risks that she is most susceptible to.

Health care expense risk: All retirees face this risk to some degree, but Kitty’s worsening arthritis could be seen as a red flag for excessive health-related costs down the road. To meet these potential costs, Kitty should maximize savings specifically intended for health care. She may also want to consider funding long-term care insurance, since purchasing a policy now when she’s 60 would be significantly less costly than waiting till later in life.

Asset allocation risk: Like Charlie, Kitty is susceptible to this risk, but at the other end of the spectrum. While Charlie’s portfolio is too heavily weighted in stocks, Kitty clearly has too much of her portfolio concentrated in fixed-income investments. This ultra-conservative strategy can make it unlikely that her assets will be able to provide income for another 30+ years, since she lacks the upside potential of equities.

Inflation risk:Investing too conservatively also exposes Kitty to inflation risk — the risk that her income won’t grow to keep pace with rising costs. This is especially a concern considering the rising cost of health care, which in many cases has been rising at double the rate of inflation. For example, according to a study by Families USA, prices for 50 of the most commonly prescribed drugs for older Americans rose 25.2% from 1994 to 1999 — nearly twice the 12.8% overall inflation rate for the same five-year period.

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Hypothetical case studies are for illustrative purposes only and not based on actual people.

Asset allocation does not ensure a profit or guarantee against loss. Guidance is provided by Fidelity Representatives through the use of Retirement Income Planner. This is an educational tool not intended to serve as the primary or sole basis for your investment or tax-planning decisions. It was developed by and offered for use by Strategic Advisers, Inc., a registered investment adviser and a Fidelity Investments company.

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