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Perspective really is everything. For example, in 1930, five years before the legislation creating Social Security was passed, the average life expectancy for citizens of the United States was 59.7 years. Thus, for a program designed to pay workers “a continuing income after retirement” at age 65, the math worked out somewhat favorably. The number of those who could statistically expect to live long enough to actually collect was pretty limited, and the percentage of older persons in the population was somewhat less than 6 percent. Today, on the other hand, those aged 65 and above make up around 12 percent of the US population—and that is expected to increase to 19 percent by the year 2030. In fact, the average life expectancy in the US has gone up to almost 80 years.
Clearly, our perspective on what it means to be “elderly” has undergone a dramatic shift. Indeed, the World Health Organization estimates that a typical 60-year-old today can reasonably expect, not to simply survive for more years, but also to enjoy a healthy, active lifestyle for two decades or more beyond “the big six-oh.” As medical science continues to advance and technology grows apace, we may soon receive a “longevity dividend” of 30 or even 40 years beyond that available to our great-grandparents. Some researchers even suggest that half of the babies born in today’s industrialized countries will live to an age of 100.
When 80 Becomes the New 60: Why You Need a Longevity Risk Plan
Take a few minutes to think about the prospect: the seniors of the future are likely to enjoy two, three, or even four decades of life beyond what we now consider retirement age. Among other things, this means that while we used to plan for retirement income that lasted to age 85 or 90, we now should be thinking more in terms of 95, 100, or even more. Naturally, more years in retirement equals more money needed, and not just for basic household expenses. As retirees age, they will also need to cover increasing healthcare costs; those who opt to age in place will likely need to pay for modifications to the home to accommodate decreased mobility; many will require home-health aides or other means of assistance with long-term care needs that are not covered by Medicare. And we should also mention inflation risk: the “silent thief” that is constantly eroding the purchasing power of each dollar we have.
What all this adds up to is what is sometimes referred to as “longevity risk”: the risk of outliving your money. Because people are living longer than ever (and because it’s unlikely that life is going to get less expensive in the future), a sound retirement plan should include provisions for longevity risk that enable retirees to look forward to their “second act,” with confidence, no matter how long it lasts.
How to Plan for Longevity Risk
Guarding against longevity risk is similar to preparing for most other risks in life: it requires advance planning and involves consideration of several dimensions.
1. Establishing your “income floor.” For most retirees, Social Security provides a valuable foundation with an income stream payable for the life of qualified recipients and, in many cases, a surviving spouse. In addition, many can expect pension income that is also payable for the life of the recipient. Such sources of regular monthly income, while they may not provide 100% of a desired retirement income, can offer a valuable “baseline” that retirees can build on as they create their spending plan for retirement. In addition to Social Security and pensions, annuities can also provide actuarially calculated income designed to be paid for a specified term of years or for the lifetime of the recipient, depending on the option chosen. One of the more important decisions for those entering retirement is making the most advantageous choice about when to begin receiving Social Security, pension, or annuity payments. Generally, waiting until full retirement age (FRA) or beyond will result in the largest monthly benefit.
2. Plan for an extended payout period. Many retirement income models now assume that income will be needed until age 100. As you build your strategy with your financial advisor, it is generally wise to assume that your need for retirement income will extend to at least age 95 and likely beyond.
3. Anticipate sequence-of-returns risk. As we discussed in one of our podcasts, sequence-of-returns risk refers to the impact of experiencing poor market returns in the early years of retirement. When retirees are forced to withdraw funds in a down market during the first few years of retirement, it can have a more long-lasting effect on the ability of retirement savings to provide income for as long as needed. This is because when assets are withdrawn during a period of falling values, it takes more shares to provide the needed amount of income. Further, once prices begin to recover, there are fewer shares available to benefit from increased values. To guard against sequence-of-returns risk early in retirement, then, it is advisable to have enough savings in relatively stable, liquid accounts or from sources like Social Security and pensions to avoid the need for drawing down other investments until the markets have begun to recover. Making adequate provision for sequence-of-returns risk is an important step towards extending the life of your retirement savings.
4. Allocate a portion of investments for growth. Sometimes, as people approach retirement, they think that they should hold most or all of the portfolio in “safe” investments, by which they mean assets less subject to market volatility. The problem is, you never outgrow your need for growth. In order to preserve your retirement purchasing power against the constant drag of inflation, some portion of your portfolio should generally be held in assets like equities (stocks) or equity mutual funds that, while subject to significant price swings, have historically outpaced inflation over time.
5. Anticipate higher healthcare and long-term care costs. As we age, we typically require more attention to various health conditions. So, your retirement budget should allow for higher healthcare expenses during the later years of retirement. This may involve allocating contributions to a healthcare savings account (HSA) prior to enrollment in Medicare; these funds can accumulate tax-free and be withdrawn tax-free in retirement to pay for qualified medical expenses like Medicare Part B premiums, deductibles, and co-pays. And don’t forget about long-term care: research indicates that some 70% of adults currently turning 65 will require assistance with activities of daily living (ADLs; getting into or out of bed, going to the toilet, food preparation, etc.) at some point during their later years. The expense of providing care for these needs is generally not covered by Medicare, which could mean that purchasing a long-term care insurance (LTCI) policy prior to retirement could be a good protection against LTC costs that can run to $6,000 per month or more.
At Aspen Wealth Management, we work with clients to anticipate the likely costs of retirement and build plans that can provide more confidence for maintaining a desired retirement lifestyle. If you are wondering about your retirement planning or some other important financial matter, we’d like to help you find the answers you need.
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