Making decisions for retirement can feel like an overwhelming process, as it’s made up of numerous topics and considerations. Most of the time, we think about these considerations in isolation. For example, we ask ourselves:
- “When can I retire?”
- “When should I claim Social Security?”
- “Which pension option is best for me?”
However, it’s important to consider how each item will affect the other and to remember that there’s one looming, rather unanswerable question that remains: “How long will I live?”
When discussing life expectancy with clients there are primarily two schools of thought that we hear: “What if I live longer than X age?” OR “I’m not going to live that long.”
These two very different mindsets can result in two very different baseline approaches to retirement decision-making. While a long life is a benefit to us as individuals, if not adequately prepared for, it can pose a serious risk to our long-term financial health. Longevity, whether expected or unexpected, requires careful planning. While many may believe they will not live to a certain age based on familial history or other circumstances, we think it is important to consider the odds of living longer and the ways to address/mitigate the risk while continuing to maximize your life today.
Genetics certainly play a large role in life expectancy and should be discussed and considered when developing a comprehensive financial plan. While each of us will need to consider details specific to our own situation, reviewing longevity statistics based on the US population is a great starting point when discussing life expectancy. Let’s take a closer look at data that can be used to help predict longevity.
Exhibit 1 highlights life expectancy from birth over different time periods.
This data is a go-to reference point when considering how long one will live, though it is of little relevance for someone reaching retirement. Instead, a better way to evaluate the data for the purposes of retirement planning is to address the question: How long can one expect to live once they reach age 65?
Exhibit 2 illustrates historical data for the remaining life expectancy of individuals reaching age 65 from 1950-2016.
Next, Exhibit 3 illustrates life expectancy based on your current age. Interestingly, as you age, your remaining life expectancy actually increases because you’ve survived many potential causes of death that were included in the initial mortality assumptions. Note: Exhibit 3 is based on 2016 data released by the Social Security Administration.
Finally, Exhibit 4 highlights the probability of a non-smoking, 65-year-old couple of average health living to specified ages. Note that this data is based on the population as a whole and will change based on the health, race, and sex of the individuals that make up the couple. This illustration only includes four inputs, while there are many other factors that affect how long one might live. Decisions should not be based solely on the data below, but rather, considerations that are directly related to you should be incorporated into your plan. Note: All calculations are based on the information provided and the 2016 Social Security Administration mortality table, with future mortality improvement projected using the Society of Actuaries’ MP-2018 scale.
How Can the Risk of Longevity be Mitigated?
As the tables above illustrate, individuals are living longer, and because of that, it is important to prepare for such a possibility yourself. With this in mind, what can be done to address and mitigate longevity risk?
- Maximize fixed income sources: When making decisions around claiming a pension or social security benefits, consider how long you, and if applicable, your spouse are projected to live based on your current age. While investment resources may be depleted over time, having higher fixed income benefits will serve as a nice floor of income should you live longer than expected.
- Remain flexible in your household spending based on portfolio performance: Creating a financial plan provides helpful targets here. Monte Carlo Analysis helps determine the viability of your retirement income strategy and put guardrails in place to adjust in the event of bad market conditions. You may decide to start with a low withdrawal rate but ratchet higher over time. Alternatively, you may start with a higher withdrawal rate if you are willing to adjust down if necessary, to essentially slow withdrawals to allow your portfolio to recover from market losses while increasing equity allocations to take advantage of higher future return potential.
- Consider your retirement income needs while you’re still working: Developing a plan prior to retirement will allow you to obtain a better understanding of the resources that will be available to you in retirement and “stress test” your plan to visualize what adjustments would need to be made if the risk of longevity became realized.
- Begin planning early: Assuming trends continue, the younger a person is currently, the longer they should expect to live. As such, developing a savings plan that helps build wealth, preferably in a tax-advantaged way, will increase flexibility as you approach retirement.
While it is nearly impossible to predict the exact age at which an individual will pass, preparing for the possibility of a prolonged life at an earlier stage is increasingly prudent when developing a financial plan and making decisions around retirement. Doing so can provide increased flexibility in your later years and provide continued peace of mind knowing that the risk of longevity has been addressed.