Illustration by Lynne Carty / Barron’s
If you’re using life expectancy calculations to plan your retirement budget, you could run out of money.
Consider a husband and wife, both 63 years old, who plan to retire at age 65. They have saved up enough money for a 25-year retirement. According to the Social Security Administration’s actuarial life table, the man can expect to live another 18 years after retiring while the woman can expect to live almost 21 years. It sounds as if they have saved up plenty.
What are the odds one of them will outlive their 25 years of saving? More than 60%, according to this calculator from the American Academy of Actuaries and the Society of Actuaries. The calculator uses the same Social Security data with a few basic health questions mixed in.
Looking at averages isn’t a foolproof way of determining how long you can expect to live. People die at a variety of ages over a period of decades. According to the actuaries’ calculator, a 65-year-old man in excellent health who doesn’t smoke has a 95% chance of living to age 70, a 79% chance of living to 80, a 43% chance to 90, and an 8% chance to 100.
“It’s a challenge,” says Richard Faw, a Philadelphia-based financial advisor and actuary. “We never set a financial plan to be based on life expectancy.”
For married couples, the math gets even more daunting. If that 65-year-old man is married to a 65-year-old nonsmoking woman in identical health, there is a 10% chance one of them will be alive at age 103.
“These retirement periods are a lot longer than people plan for,” says Linda K. Stone, the senior pension fellow at the American Academy of Actuaries. Further complicating things, it’s common for one spouse to live another 10 or 15 years after the first spouse has died, she notes.
The variability in life spans presents a big financial planning challenge. Spend too much and you will run out of money long before you die. Spend too little and you unnecessarily crimp your golden years.
But there are steps you can take to make sure you have enough money no matter how long you live. They include using an actuarial calculator to obtain a more realistic appraisal of your likely life span and then creating a base of regular income from Social Security, pensions, annuities, and other secure sources to cover essential expenses. If you have taken those two key steps, you have a lot more flexibility in what you do with the rest of your money.
Here is a guidebook to how to properly plan for longevity.
Take Your Calculations a Step Further
Start with this longevity calculator from the actuaries. It demands five pieces of information: date of birth; gender; retirement age; whether you smoke; and whether you assess your general health as poor, average, or excellent. “We tried to keep this simple with the factors that make the most difference,” says Stone of the Academy of Actuaries.
Smoking, of course, has a big effect on your life span. A 70-year-old woman smoker in average health has a 50% chance of living 12 more years. If she doesn’t smoke, her life expectancy rises to 18 years. General health is another key. Consider the 70-year-old female nonsmoker. If she assesses her health as poor, she has a 50% chance of living 16 more years; if she assesses it as excellent, it rises to 20 years.
How good are we at knowing our own health? “People have a better sense of their health than of their longevity,” says David Blanchett, head of retirement research for the PGIM unit of Prudential Financial.
Instead of a single life expectancy number, the calculator gives you probabilities at various ages. If you aren’t overly worried about outliving your money, use the age at which the calculator says you have a 25% chance of being alive, says financial author Wade Pfau, who wrote Retirement Planning Guidebook. To be even more cautious, pick the age at which you have a 10% chance of being alive, Pfau adds.
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People have a better sense of their health than of their longevity.
Make a Plan to Cover Essential Expenses
The first step is waiting as long as possible to claim Social Security, the only current major annuity that is adjusted for inflation. Your monthly benefit will rise by at least 76% if you claim at 70 instead of 62.
If Social Security and any other pensions you receive are enough to cover essential expenses such as housing, food, and health spending—tips on how to do that here—then you’re all set. If not, there are other steps you can take to boost your safe income.
One option is buying a life income annuity. Currently, annuities for a 70-year-old man have annual payouts up to 8.42% from a top-rated insurer, according to Annuities.com, a website that sells annuities from various insurers. Fees are fairly minimal on these basic annuities, though commissions and surrender fees can be sizable on other more complex annuities so be careful to understand what you’re buying.
Another option is creating a ladder of Treasury inflation-protected securities, or TIPS, to cover your retirement. Rising real interest rates have made TIPS more attractive. If you put $1 million in a series of TIPS maturing over the next 30 years, you could get around $41,600, adjusted annually for inflation, Pfau calculates.
The advantage of a ladder is that you retain control of your money. If in two years, you decide to give your money to charity and join a monastery, you can do that with a bond ladder. You can’t do it with an income annuity. On the other hand, the annuity will keep paying out even if your retirement lasts more than 30 years.
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Your monthly benefit will rise by at least 76% if you claim at 70 instead of 62.
Be Flexible With Your Spending
The 4% rule, devised by advisor William Bengen in the 1990s, says a retiree can safely withdraw that percentage each year, adjusted annually for inflation, from a portfolio of stocks and bonds for 30 years. It remains a handy rule of thumb for evaluating the viability of your drawdown strategy.
But if you’re willing to be more flexible, you can withdraw more money than 4% in periods of good returns from a portfolio of stocks and bonds, and you will never run out of money even if your retirement lasts longer than 30 years.
The simplest approach is to use the table that the government has for required minimum distributions from tax-deferred accounts. For a 73- year-old, the RMD is 3.77% of assets. Each year, the required percentage rises as your life expectancy declines. By age 90, your RMD will be 8.2%
The RMD approach automatically adjusts for down markets. If your portfolio fell 15% last year, your RMD will decline almost 15%.
That means your discretionary spending will fall during down markets, and you have to be ready for it. That vacation to Naples, Italy, may turn into a vacation to Naples, Fla., but you’ll find some great restaurants in Florida as well.
Many financial experts see the RMD percentages as overly conservative. Pfau advises multiplying all of the percentages by around 1.5. This has the effect of permitting more spending early in retirement, and less late in retirement when spending tends to fall anyway. Even with this adjustment, you won’t run out of money.
Make Adjustments Along the Way
You might think your chances of reaching 95 are minimal, but if you live to 90, they are actually good.
If you end up living longer than you planned, you can decide to trim your discretionary spending. Another option is to buy a lifetime income annuity to avoid running out of money. Because of your age, you will get a stunning payout.
A 90-year-old plunking down $100,000 for an annuity could currently get a 21.46% payout from an insurance company with a top credit rating. The insurer will come out ahead if the retiree dies in the next two or three years. But suppose the retiree lives on for another decade. He would get $21,460 a year from the annuity, and he wouldn’t have to fret about running out of money.
Another approach is to keep an emergency fund that you only tap after you have spent all your money. Susan Elser, a financial advisor in Indianapolis, says many of her clients have tax-free Roth IRAs. Because this is the most tax-efficient vehicle, they are typically the best way of leaving wealth to children. But if her clients run short of money in retirement, they can crack open the Roth IRAs.
“The longer you live, the better your Roth IRA looks,” she says.
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The longer you live, the better your Roth IRA looks.
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Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2021.