Understanding Longevity Risk

Living a long life is a wonderful prospect. But from a financial perspective, longevity comes with its own set of risks. The longer you live, the more money you'll need. Outliving your savings is one of the biggest concerns for retirees, and it's a challenge that requires careful planning.

Longevity risk refers to the possibility that you'll outlive your savings or your money won't last as long as you do. With life expectancies increasing, retirees are living longer than ever. The average life expectancy for someone reaching age 65 is about 85, but many people will live well into their 90s or beyond.

This extended lifespan is good news in many ways, but it also means retirees must stretch their savings further than previous generations. For example, when Social Security was created, the average lifespan was around 61 years. But today, people often spend 20, 30, or even longer in retirement. That's a long time to depend on your savings, especially if you retire early.

How Do You Plan for Longevity?

Planning for a long retirement requires more than just saving. It's about making intelligent decisions with the money you've accumulated to ensure it can support you through your later years. Here are some of the most effective ways to manage longevity risk:

Create a Sustainable Withdrawal Strategy

One of the most critical aspects of retirement planning is figuring out how much you can safely withdraw each year. Withdraw too much, and you could run out of money too soon. Withdraw too little, and you might miss out on enjoying your retirement.

The classic rule is the 4% rule. This rule suggests that you can withdraw 4% of your savings in the first year of retirement and adjust that amount for inflation each year. This method is designed to help your money last for around 30 years. It's a good starting point but not set in stone. You'll need to adjust based on your circumstances, market conditions, and inflation.

If you're worried about living longer than average, financial advisors increasingly suggest a slightly lower withdrawal rate (perhaps 3% or 3.5%) to give yourself a bigger margin of safety if you live into your 90s or beyond.

Delay Claiming Social Security Benefits

One of the most reliable ways to address longevity risk is by delaying Social Security. Social Security provides a guaranteed, inflation-adjusted income for life, making it a valuable tool for managing longevity risk.

You can start taking Social Security as early as age 62, but if you delay claiming until age 70, your monthly benefits will increase. Every year you delay past your full retirement age, your benefits grow by about 8%. This step can result in a significantly larger monthly check, which can help cover living expenses later in life.

If you're healthy and expect to live a long time, waiting to claim could be a smart move to maximize your income later in retirement. By delaying Social Security, you create a larger, inflation-adjusted source of guaranteed income, which helps protect you against longevity risk.

Consider an Annuity for Guaranteed Income

Annuities often get a bad rap, but they can be useful when it comes to longevity risk. An annuity is a contract with an insurance company where you pay a lump sum, and in return, you get regular payments - typically -for the rest of your life. Think of it like a pension you create for yourself.

There are different types of annuities, but longevity annuities, also known as deferred income annuities, which we also cover in another of this week's articles, are explicitly designed for those concerned about outliving their savings.

Here's how it works: You invest a lump sum into a longevity annuity, and the insurance company begins paying you a guaranteed income starting at a future date, typically around age 80 or 85. This strategy can be particularly useful if you want to ensure that you'll have income in your later years, even if you've exhausted other resources.

That said, annuities can come with fees and restrictions, so they're not for everyone. But for those concerned about longevity risk, it's worth considering. So, do your research and speak with a financial advisor to find the right fit.

Balance Growth and Security in Your Portfolio

Many retirees shift their investments to more conservative assets like bonds as they approach retirement. While reducing risk is essential, it's equally important to maintain some exposure to growth assets like stocks, especially if you expect to live a long time. If your portfolio is too conservative, you may not achieve the growth needed to keep up with inflation and cover rising costs in later years.

Balancing growth and security in your portfolio is key. A diversified portfolio that includes both safer assets (like bonds) and growth-oriented assets (like stocks) can help ensure your savings last while still providing opportunities for long-term growth.

Be Flexible With Spending

Here's a reality check: no retirement plan is set in stone. Your spending habits and needs will likely change over time, and so will market conditions. The best thing you can do is stay flexible.

In years when the market performs well, you might be able to withdraw a little more. In leaner years, you may need to tighten your belt. The key is monitoring your spending and adjusting based on how your portfolio is doing. Flexibility is your friend when it comes to ensuring your money lasts.

Plan for Healthcare Costs

Healthcare is one of the most significant expenses in retirement, and those costs tend to rise as you age. While you may feel healthy now, it's essential to plan for higher healthcare expenses down the road. Medicare will help cover some costs, but it won't cover everything. Long-term care, dental, vision, and hearing care are just a few examples of what you might need to budget for.

Building a healthcare plan into your retirement strategy can help protect your savings. Consider options like long-term care insurance, and make sure you have enough set aside in savings to cover any out-of-pocket costs.

Work Part-Time or Freelance

If you're healthy and willing, working part-time or freelancing can be a great way to supplement your retirement income. Not only does it provide extra money, but it can also help keep you engaged and active.

Many retirees find that working in some capacity gives them a sense of purpose, and the additional income reduces the need to draw from their savings too early. Even working a few hours a week can make a difference over the long haul.

The Takeaway

Longevity risk is a genuine concern, but it's not something to fear. The key is balancing your spending with your investments, safety with growth, and guaranteed income with flexibility.

No one knows precisely how long they'll live, but by planning for a long life, you'll be better equipped to enjoy it without worrying about your finances. After all, retirement is about more than just surviving - it's about thriving.