Robert Powell: How to fund a long retirement
You’re saving for retirement. But, like many Americans, you’re probably not sure whether you have (or will have) enough in your nest egg to fund your retirement.
What’s more, you might not be sure how best to manage some of the major risks you’ll likely face in retirement such as longevity, investment, inflation, health and long-term care.
Be unsure no more. In a presentation delivered last week at the Society of Actuaries’ 2017 Living to 100 Symposium, Vickie Bajtelsmit, a professor at Colorado State University and co-author of a new study, outlined the link between life span and the wealth needed to successfully fund retirement, and which strategies can best address some of retirement’s biggest risks.
Longevity risk and life expectancy trends
One challenge to funding retirement is getting a handle your lifespan. And what we know now is this: You and/or your spouse are likely to live a long life. And many households are not planning to live as long as they actually will live, said Bajtelsmit during her presentation.
Consider, for instance, recent life expectancy trends. Average life expectancy for a 65-year-old male rose from 84.7 in 1950 to 87.8 in 2010 and average life expectancy for 65-year-old woman rose from 86.6 in 1950 to 89.7 in 2010.
In essence, you’ll need to save enough – if you want the same standard of living in retirement as you had while working – to fund a much longer retirement than you might have anticipated.
“We are seeing dramatic increases in life expectancy compared to previous generations,” said Bajtelsmit. “My issue, coming from a finance standpoint, is whether people today, who are looking out at that longer period of retirement, that longer lifespan, are financially prepared for that. And on average… they are not.”
One reason why Americans aren’t prepared for funding longer lifespans, according to Bajtelsmit, has to do with the difference between life expectancy at birth and life expectancy at 65, and the point at which people tend to start planning for retirement.
For instance, in 2010, life expectancy at birth for a male was 82.7 but 87.8 for a 65-year-old male. Likewise, in 2010, life expectancy at birth for a female was 86.5 but 89.7 for a 65-year-old female. On average, it’s a difference of about five years, she said.
Now, human nature being what it is, many households don’t start to plan for retirement until late in life. And that means, according to Bajtelsmit, “by the time they do that planning, their life expectancy is actually quite a bit longer on average.”
The oldest old are women
Another challenge is that the oldest old in the U.S. are women. In fact, nearly two-thirds of people over age 85 in the U.S. are single women, and widows and divorced women are more likely to living in poverty than married couples. “We know that women are more often living alone than men in old age,” said Bajtelsmit. “And as a result, they are living on a single income, often on an income that’s been depleted by their former spouse’s last illness and the cost of that or long-term care cost.”
Said Bajtelsmit: “The issues of the very old are primarily women’s’ issues, and how they survive and pay for their expenses in old age.”
Retirement age trends
Retirement age trends are yet another challenge. Yes, there’s been greater longevity. But, on average, the age of retirement has been declining not increasing. “You would think you live longer so you work a little bit longer, not just because you can but because you need to finance your longer lifespan,” she said. “But that’s not actually happening.”
According to Bajtelsmit, that could be the result of several factors. “Sometimes people would like to continue working but they can’t,” she said. “But it’s also because leisure has a lot of value and people would like to have more time in leisure.”
Of course, the downside to this trend, she said, “is that if you live longer and retire earlier you really need to have quite a lot more wealth to fund that period.”
Household risk management
According to Bajtelsmit, the risk of living longer needs to be incorporated in a household’s retirement plan. What’s more, the risks associated with a household’s resources (Social Security, Medicare and insurance for instance) and their expenses (health care, inflation and long-term care) must be incorporated in a household’s retirement plan, as well. “You have to take all those things into consideration, but for the average person that can be a very difficult thing to do,” she said.
No surprise: Living longer costs more
In the study, Bajtelsmit and her co-authors sought to determine, using a simulation model, how much money is needed at the time of retirement to fully fund retirement for households with different longevity at the 50% and 90% confidence levels. They also examined risk management tools that can reduce the risk of cash shortfalls.
And they examined what happens to the oldest old. “So, if you don’t just live the normal lifespan but you are the ones who are luck and live extra long, what products help you the most?” she asked. “How much do you need to have finance that extra longevity.”
In the study, Bajtelsmit also accounted for joint life expectancy. “If you are married couple and are looking at the second to die distribution, the joint life expectancy of that married couple is much longer than the life expectancy of either of the two.”
|Characteristics||Median household||75th percentile household|
|Total pre-tax income||$60,000||$105,000|
|Husband (age 62)||H: $42,000||H: $74,000|
|Wife (age 62)||W: $18,000||W: $31,000|
|Base case housing||Home owner||Home owner|
|Mortgage||No mortgage||No mortgage|
|Social Security status (both retire at full retirement age of 66)||H: Fully insured||W: Qualifies on H’s earnings|
|Defined benefit||Base case: none||Base case: none|
|LTC insurance||Base case: none||Base case: none|
|Desires standard of living in retirement||Same as pre-retirement||Same as pre-retirement|
And what did Bajtelsmit and her fellow researchers find? Well, first the caveat. It’s a simulation model and the researchers had to make some assumptions “about every single thing about these households.” (You can read all the assumptions in the report.)
So, here’s what they found: A typical 62-year-old couple in a median household with income of $60,000, savings of $100,000 and home equity of $180,000 would need, assuming they retired and claimed Social Security at age 66, $290,000 in savings to be 50% sure they could fund their retirement, or $430,000 if they wanted to be 90% sure. (Fully funding meant funding without reducing their standard of living.) By contrast, if that same couple retired and claimed Social Security at age 70, they would need only $170,000 in savings to be 50% sure, and $290,000 to be 90% sure.
On the other ahead, if the median household had a long joint life expectancy, they would need $400,000 to be 50% sure, assuming they retired and claimed Social Security at age 66, or $520,000 to be 90% sure. On the other hand, they would need $260,000 to be 50% sure if you retired and claimed Social Security at age 70, and $380,000 to be 90% sure.
Now contrast that with 62-year-old couple in 75th percentile household with income of $105,000, home equity of $315,000 and $250,000 in savings. If that couple retired and claimed Social Security at age 66, they would need $660,000 in savings to be 50% sure of fully funding their retirement or $880,000 to be 90% sure. If that same couple retired and claimed Social Security at age 70, they would need $410,000 to be 50% sure and $610,000 to be 90% sure.
Now, if the wealthy household had long joint life expectancy and claimed Social Security at age 66, they would need $840,000 saved to be 50% sure, or $990,000 to be 90% sure. Likewise, that household if they retired and claimed Social Security at age 70, would need $570,000 to be 50% sure, or $710,000 to be 90% sure.
Delaying retirement to age 70, among other things, reduces how much money you need for retirement at age 66 by increasing the number of years a household has to save and invest. Plus, it reduces the number of years a household has to fund retirement. “If you are going to live longer, retiring a little later helps a lot,” said Bajtelsmit.
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Risk management strategies matter
There are several strategies households can take to manage retirements risks, according to Bajtelsmit. Those include cutting discretionary expenses, downsizing housing, using reverse mortgages and annuities, purchasing long-term care insurance, or using a combination of strategies.
And what she and her fellow researchers found is that reducing expenses helps wealth last longer, but it’s insufficient as a risk management strategy to offset the effects of large shocks such as long-term care or extreme investment events. “I can downsize my expenditures, but if I have a huge long-term care event, I’m going to run out of money,” she said. “So, you have to think about those large risks that can basically bankrupt the household.”
In the research, Bajtelsmit and her colleagues also discovered that securing a reverse mortgage at age 75 with “life annuity income” would be better than downsizing as a way to reduce the amount of money needed to fund retirement, especially in household with long joint life expectancy. “It’s helpful,” she said. “It doesn’t completely solve the problem.”
A combination of risk management strategies, however, can significantly reduce the amount of money a household needs to fund retirement. For instance, the 75th percentile household that delayed retirement to age 70, secured a reverse mortgage at age 75 and purchased on long-term care insurance policy on only the wife needed just $230,000 saved to be 90% sure (it was $610,000 using just the delay-retirement strategy) and households with the longest joint life expectancy needed $340,000 to be 90% sure (it was 710,000 using just the delay-retirement strategy.)
And what’s needed now, according to Bajtelsmit, is better advising about the risks households will face in retirement and the value of risk-management strategies.
We’re living longer. We’re not retiring later. And therefore, said Bajtelsmit, households need to have more saved at retirement to fully fund their needs over the lifespan.
“The people who are predisposed to live longer are really at most risk here,” said Bajtelsmit. “And they don’t necessarily know who they are. But if they haven’t planned for it they may run out of money and be living with our kids when we are will bit older.”
Bottom line: The study shows that risk-mitigation strategies, when used in combination, can really increase the chances of a successful retirement – making it to the end without running out of money
And the key here, said Bajtelsmit, is using some sort of inflation-adjusted life income or benefits, such as long-term care insurance, that will provide for those life events that are very expensive but unexpected.
Robert Powell is editor of Retirement Weekly, published by MarketWatch. Get a 30-day free trial to Retirement Weekly. Follow Bob on Twitter @RJPIII. Got questions about retirement? Get answers. Send Bob an email.