Ready to live a long, long life?
Retirement is, love it or hate it, a financial milestone that all of us want to reach. It’s a time when we can theoretically relax, enjoy what we built through hard work and sacrifice, and pursue the activities we love instead of the ones forced on us. However, with increasing odds that you could live twenty or thirty years after leaving the workplace, there are understandable concerns about longevity risk.
As you live longer, the prospect of outliving your savings looms large.
In this article, I will explore why I feel longevity is a significant issue when planning for retirement, discuss why the traditional 4% rule may no longer suffice, and suggest some products and strategies to overcome the challenges of longevity risk.
The hidden dangers of a longer lifespan
The increased life expectancy of individuals is a remarkable achievement of modern science, improved health care, better nutrition, and improved living conditions. Yet, from a financial perspective, longevity presents a challenge. That’s because many retirement plans are created on the somewhat outdated assumption that people will retire around age 65 and live comfortably for 15-20 years. But what happens to retirees when their golden years stretch to 25, 30, or even 35? It makes sense that the longer you live, the more income you’ll need to finance your retirement lifestyle.
Outliving savings is a realistic concern.
One of the most troubling issues related to longevity is the risk of outliving your savings. Outliving your retirement accounts happens when you spend down your nest egg too quickly, leaving you with inadequate funds to cover living expenses in your later years. With healthcare costs for seniors rising and inflation nibbling away at your cash, the design of your financial plan must support a lengthy retirement. You may also need to let go of traditional planning rules that never anticipated you living 25 or 30 years after retiring.
One rule I suggest you rethink is the so-called “4% Role.” This commonly used guideline forms the basis of many retirement plans, meaning that retirees withdraw up to 4% from their initial portfolio balance in the first year of retirement. Adjusted for annual inflation, the 4% rule posits that withdrawing 4% will give you enough money to live comfortably for the next 25-30 years. However, advisors formulated the 4% rule when inflation was well-managed, and life expectancies were significantly lower. Many modern retirement and income planners have begun moving away from the 4% rule and adjusting for today’s unstable economic conditions.
How can you mitigate longevity risk?
I think a lot of retirement planning seems like it’s been rolled off an assembly line. Some so-called planning is little more than plugging in the client’s name, adding a few values, and then a plan for the financial future magically appears. Creating a truly “airtight” retirement blueprint requires assessing your attitudes toward money, risk tolerance, and core values. Only when a detailed and specific profile emerges will you know if the plan you’ve created will achieve your goals.
After creating a deep client profile, experienced retirement planners often suggest different products and strategies to address longevity risk.
These include:
- Adding annuities: Annuities are financial products that create streams of predictable lifetime income. Immediate annuities, for instance, can be particularly beneficial in making an additional source of stable income in retirement.
- Purchasing longevity Insurance: Longevity insurance is a type of insurance that provides a lump-sum payout at a specified age (e.g., 85 or 90). This lump sum helps protect against the risk of outliving your savings and serves as a financial safety net for your later years.
- Balancing and diversifying your portfolio: Balancing your portfolio by diversifying your investments and adjusting your asset allocation as you age can help manage risk. A diversified basket of assets can help ensure your portfolio will last as long as you need it to last.
- Increasing savings by working longer: Delaying retirement or working part-time during retirement can increase your income. Working later reduces the years you’ll need to rely on your savings.
- Partnering with a trusted advisor: Periodically review and adjust your retirement plan with the help of a qualified advisor. You and your advisor can work together to adjust for changes in your financial situation, health, and money goals.
Living longer is the positive result of technological advancements, healthcare, nutrition, and overall improvements in the quality of life. However, longevity also poses a considerable financial challenge for retirees. The 4% rule, once a reliable rule of thumb for retirement spend-down, may no longer be adequate in an era of unchecked inflation, increased healthcare costs and longer life spans. The same goes for other conventional planning rules of thumb. Ensuring a financially secure retirement means exploring alternative strategies and products to address longevity risk. Doing so lets you enjoy a more comfortable and worry-free retirement, regardless of how many candles are on your birthday cake.
