Will I Outlive My Money?
Will I outlive my money? Do I have enough? How much is enough? What if … ? If you are retired or approaching retirement, this is almost certainly the big question for you.
While quality of life has improved by many measures over the last century, retirement planning is an area that has become more difficult of late. This financial challenge comes by way of several confluent factors, to include the following:
- Increased Longevity
Through medical breakthroughs and healthier lifestyles, life expectancy has increased dramatically, from 53 in 1920 … to 70 in 1970 … and now to 79 in 2020.[1] This is a good thing for certain, but it also entails significant financial risk for retirees.
- Low Returns
For much of recent history, high-quality fixed income investments have offered very low investment returns. The .25%, 1-year certificate of deposit (“CD”) was a disaster for risk-averse retirees lacking significant assets.
- Retirement Plan Changes
Defined Benefit retirement programs, the corporate and government-based plans that typically paid retirees a large part of their income until death, have become exceedingly rare,[2] and are becoming rarer still. The average worker is now left to figure it out, with employers remaining at arm’s length in order to avoid liability.
- Increased Healthcare Costs
Healthcare costs have long outstripped broader inflation and healthcare needs peak in retirement, creating an unpredictable and expensive situation for many retirees.[3]
Altogether, these issues have dramatically increased the risk that more retirees will outlive their money.
To avoid this fate, you should begin with a plan. According to a survey from Employee Benefit Research Institute, less than half of Americans have even attempted to calculate how much money they should be saving for retirement. This same study found that those who had calculated their retirement needs had higher savings levels, and higher confidence that they would not outlive their money.
What does this exercise look like? First, one you must calculate the expected length of their retirement. You can begin with the Social Security actuarial tables here: https://www.ssa.gov/oact/population/longevity.html, and then adjust for family longevity history, personal health, and perhaps tack on three-five years as a conservative adjustment. With retirement beginning at the point at which you begin living off of savings (the “withdrawal phase”), you can subtract this retirement age from the expected lifespan to calculate the duration of your retirement. (For example, if you expect to retire and begin drawing on investments at age 67, and then live to 87, your withdrawal phase would be 20 years.)
You should then calculate a retirement spending plan that encompasses your lifestyle preferences, expected inflation, bequest goals, etc. With these inputs, you can plug in your nest egg (existing or expected) and begin drilling down on the investment mix you will need to ensure retirement success – with “success” here defined as your money outlasting you.
This exercise is core financial planning, but you should note just how personal it will be when it is done well. Case in point, do you plan to spend less in retirement[4] or do you plan to travel and tackle an expensive bucket list? Do you want to simply ensure that you never run out of money, or are you in the camp that hopes to achieve solid returns, perhaps as part of a goal to maximize the estate you will leave behind to family and/or charities? A higher allocation to equities will significantly raise the value of your estate in a 50th percentile, base case scenario, but it will increase the variability of outcomes.
For this reason, and many more left out of view here, this is why solid financial planning and management is both art and science. Everything comes back to personal questions: What are you trying to accomplish (prioritized planning goals), and what are you willing to do to achieve those goals (in terms of saving levels, investment portfolio risk, etc.)?
Utilizing these inputs – retirement age, expected longevity, spending plans, investments – there are sophisticated tools available to calculate the “success rate” of various investment approaches/portfolios. To give you an idea of this process, which is typically powered by Monte Carlo simulations[5], here is a simple, free tool available at Vanguard. https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementNestEggCalc.jsf
This tool lacks many bells and whistle, but you could use it by simply subtracting any non-investment-based income streams (for example, Social Security and/or pension) from the annual spending need to get an idea if you are heading toward big gifts for all the grandchildren, or the poor house.
If you don’t have a financial plan that addresses retirement, play with this tool and see how things look. Planning in this area can help you define what you need to do to maximize the likelihood that you will not outlive your money.[6] The best one way to do that is to create a large nest egg by making strong, suitable investments over time, but there are other strategies that merit attention. While it exceeds the scope of this newsletter, admittedly a superficial treatment of an incredibly consequential topic, I will mention three tools and strategies that can prove useful to ensure that retirees do not outlive their money.
- Reverse Mortgage – This allows homeowners to borrow money against their primary residence. With a reverse mortgage, borrowers unlock equity and stay in their home without making new house payments. Would an ideal financial plan include a reverse mortgage ? No. Is it a powerful tool that helps many retirees avoid the poorhouse? Yes.
- Qualified Longevity Annuity Contract – With a QLAC the retiree purchases (by lump sum or payments) an annuity that will create a deferred payment stream. When trying to solve for the problem that enhanced longevity could mean outliving one’s money, these contracts are structured to defer a payment stream such that it begins as late as 85 years of age. By deferring an income stream to a point at which the insurers know you are probably dead or about to die, you can get pretty healthy income payments if you make it to these late years. This can be a powerful tool to increase safety in certain situations. Will a QLAC ensure you don’t outlive your money? In certain situations, it can increase your projected success rate. Would entering into a QLAC translate into leaving behind a smaller estate to heirs? Yes, more often than not.
- Monitoring and flexibility – Like every other facet of life, paying attention to what is taking place and being willing to adjust is key to success. Poor investment returns or unexpected liabilities can mean a retiree needs to adjust spending down or alter investments to keep their projected success rate high. Close monitoring and a commitment to flexibility are the table stakes, and for many retirees this may call for assistance from trusted family members and/or other fiduciaries who are ensuring that things remain in track.
I can’t end this newsletter without citing something Jesus said: “Therefore do not be anxious about tomorrow, for tomorrow will be anxious for itself.” This phrase and His broader teaching here about storing up for tomorrow speak directly to fears such as that fear of outliving one’s money … but people don’t want to hear this from their financial planner … so it wasn’t me that said it.
Keep everything in perspective!
[1] https://www.statista.com/statistics/1040079/life-expectancy-united-states-all-time/
[2] https://www.dol.gov/sites/dolgov/files/ebsa/researchers/statistics/retirement-bulletins/private-pension-plan-bulletin-historical-tables-and-graphs.pdf
[3] According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2022 may need approximately $315,000 saved (after tax) to cover health care expenses in retirement.
[4] One longstanding common rule has called for planning on spending 80% of your pre-retirement spend.
[5] A Monte Carlo simulation is a model used to predict the probability of a variety of outcomes when the potential for random variables is present. These simulations help to explain the impact of risk and uncertainty in prediction and forecasting models.
[6] An alternative is to use the longstanding 4% rule, which says you can safely withdraw 4% of your nest egg each year. This approach has severe limitations but does serve as a valuable comparator.
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