Planning for a journey of unknown duration

Q – We’re considering the financial impact of using some of our retirement resources now, while we are still active, versus sacrificing now to be more certain we will be OK later.  How should we handle the tradeoff?

A – One of the biggest challenges facing those planning their retirement is making sure they have adequate capital to last for an unknown period of time. Unfortunately, there is no way to predict how long the retirement journey will last. That’s why longevity risk – the risk of outliving one’s assets – is a very real risk facing those planning for retirement.

For those reaching retirement age now, the average life expectancy for males is 84, and for females is 86. That means that half of retirees are living longer than those ages. As of 2014, there were 72,197 Americans 100 years old or older, a 44 percent increase since 2000. Now, more than ever, it is vital for those planning for retirement to take into account longevity risk and make adjustments where necessary.

Different people have different tolerances for longevity risk. Some may want to be living in their home and in great financial shape at 95; others may want to use some extra play money while they are still active, then scale back their lifestyle later. With appropriate planning, the 95-year-old can be protected while also allowing the 65-year-old to have a little fun. Here are five “tools” that those planning for retirement can use to help achieve these dual goals.

Delay the start date of Social Security benefits. Starting to receive monthly Social Security payouts as soon as eligible is rarely the best move. Waiting to receive Social Security increases the monthly payout. For someone born between 1943 and 1954, “full retirement age” is 66. But waiting to begin receiving benefits until age 67 increases the payout by 8 percent, and waiting until age 70 increases it by 32 percent.

Work past the age of 65. Working longer is a good idea to increase funds available in retirement. However, it may not be a practical option. Research shows that half of workers expect to work past age 65, but less than 15 percent actually do. In fact, 50 percent of retirees leave the workforce earlier than they planned due to layoffs or health issues.  However, new research shows that postponing retirement by 6 to 12 months might have the same impact on your retirement as saving and additional 1% over a 30-year period.

Use a Home Equity Conversion Mortgage (HECM) to supplement monthly income. A HECM is a reverse mortgage insured by the U.S. Federal Government and is only available through an FHA approved lender.  The loan allows homeowners over the age of 62 to turn their home equity into an income stream or lump sum with no monthly payments due thereafter. These loans are becoming a popular way to stay in a home while having access to money for repairs, emergency expenses and long-term care expenses. However, it does mean putting a new mortgage on the home, which will affect the borrower’s estate. Your heirs will have to repay the loan to keep the home.

Buy an annuity that guarantees income for a certain period or for a lifetime. Annuities are insurance plans that, in exchange for an investment, guarantee a regular income stream for a specified period or until death. An annuity can help mitigate longevity risk, but the regular income provided could be eroded over time by inflation.

Choose investments that offer inflation protection over time. Just like having a diverse portfolio helps when accumulating retirement assets, a diverse income strategy post-retirement helps when decumulating retirement assets. A popular investment to protect against inflation is Treasury Inflation Protection Securities. These securities are pegged directly to the Consumer Price Index, so as it rises, so does their value.  Stocks have also given investors inflation protection over the long-term.

Retirement planning is challenging for everyone. But addressing longevity risk is critical to ensuring a well-planned retirement.

Article Sources:

CFA Digest: Longevity Risk, Retirement Savings, and Financial Innovation (Digest Summary)
CFA Digest: Longevity Risk and Retirement Income Planning
CNBC: The dangers of planning on working longer
Financial Advisor: When Longevity and Portfolio Risk Clash, Can Annuities Help?
Forbes: Retirement Risks: It All Starts With Longevity
HUD.gov: Frequently Asked Questions about HUD’s Reverse Mortgages
Investment News: The Longevity Paradox
Investopedia: How to Plan for the Longevity Risk in Retirement
Smithsonian: There Are Now More Americans Over Age 100 and They’re Living Longer Than SSA: Delayed Retirement: If You Were Born Between 1943 and 1954
Wealth Management: Understanding and Communicating Longevity Risk