[Insight & Opinion] Risks That Must Be Considered in Retirement Planning

Cash Flow Matters More Than Asset Size
Consider Sequence, Health, and Longevity Risks
Utilize Various Systems Such as Home Pension

"At this point, you must carefully assess how much cash flow you can generate from the assets you currently own."

This is the advice I always give when attending retirement-related seminars or lectures. At the very least, it is advisable to conduct a cash flow-oriented asset reassessment about five years before and after retirement. However, I have rarely met anyone who has actually done this. Most people still tend to focus solely on the size of their assets.

For effective retirement planning, it is essential to shift your management framework from focusing on the size of your assets to prioritizing cash flow. For salaried workers, the value of human capital drops sharply upon retirement. While employed, you can generate cash flow through your salary. Retirement means a complete break from your existing cash flow. After retirement, you must either generate cash flow from your existing assets or obtain a new job to receive a salary. Even if you secure a new job, it is difficult to earn as much as you did in your primary career. Therefore, the cash flow you can generate from your existing assets and pensions becomes even more important.

In addition to volatility risk, you must also consider longevity risk. While you only needed to manage the volatility of your investment assets when you were earning a salary, longevity risk is added to life after retirement. Longevity risk involves two types of uncertainty. First, you cannot choose the timing of your death. Second, you may need more funds for retirement than you originally anticipated. In Japan, which faced an aging society about 20 years ahead of us, the elderly initially worried about dying, but as they grew older, they began to worry more about living too long. The longer you live, the more cash flow you need to support that life. Otherwise, unfortunately, you may face retirement bankruptcy.

You should also consider sequence risk. The dictionary definition of "sequence" is "a series of consecutive events or actions." Sequence risk refers to the impact caused by the order of returns. The reason sequence risk arises is that, after retirement, you need to withdraw money from your assets to cover living expenses. Even if the average return is the same, the outcome can be very different depending on whether there are cash outflows (withdrawals) or not. The returns during the first 10 years after retirement are especially important. According to various studies and simulations, the returns during the first 10 years after retirement determine the cash flow for the entire 30-year period. If you fail to manage returns in the early years of retirement, you may struggle for the next 30 years.

Of course, health issues are also important. More than 50% of the medical expenses you incur in your lifetime are spent after age 75 (late old age). If you do not have sufficient funds for medical expenses, your cash flow in old age can deteriorate severely. To prepare for this, you should make good use of insurance or secure a certain amount of cash flow that includes medical expenses.

The risks mentioned so far are ones that everyone must face in an aging society. Various systems should provide incentives to help people secure cash flow. Good systems such as the home pension scheme are already in place, and discussions about separate taxation for dividend income are gradually beginning in the capital market. When you receive retirement pension as an annuity, you can enjoy a tax-saving effect of 30-40%. In the long term, these incentives need to be further strengthened. If more people are pushed into retirement bankruptcy, eventually, they will have to be rescued through welfare programs. I believe that providing incentives for generating cash flow may, in the long run, be a way to reduce costs.

Lee Sanggeon, Head of Mirae Asset Investment and Pension Center