Making retirement money last as long as they do is the focus of most retirees. This “longevity risk” is faced when moving from “accumulating” to “spending” and many financial plans fall short in addressing it. For a couple now aged 65 there is a fifty percent chance one spouse will be alive at 92 and a twenty-five percent chance one will reach 97; thus, retirement plans must deal with living longer. Strategies to cope could include delaying Social Security to boost lifetime benefits, working longer to lengthen accumulation years and/or securing a guaranteed lifetime income from an annuity. No strategy for longevity risk says you have more than needed for retirement or whatever else!

There are several other retirement hazards that fuel longevity risk. The most common is the unpredictable whims of the market. A market investment strategy may be appropriate during the working years but when you’re “selling” to “spend”, major market meltdowns like 2000-02 or 2007-09 could mean disaster. The highly touted “4% Rule for Retirement Withdrawals” is flawed when markets are volatile or falling because (a) reduced values mean 4% is not enough and (b) your money is depleted faster. Japan’s Nikkei Index has fallen from roughly 40,000 to 9,000 since 1990, proving that “long term” markets are still risky. Don’t be fooled by sophisticated “Monte Carlo simulations” predicting you’ll have enough money because “theory” doesn’t always match reality. A renowned economist once said “markets can fall longer than you can stay solvent”; therefore, longevity risk will always threaten retirement.

Since lifespans are increasing and medical care is improving, health care costs are likely to continue outpacing inflation. This trend is further fueled by two additional facts that will raise demand for medical care: (1) seventy-eight million baby boomer now entering the “medical risk zone” and (2) recently mandated universal health care for all citizens. Average medical care costs for a couple are estimated to total over $200,000 between ages 65 and 80, rise to almost $450,000 by age 90 and reach over $750,000 by age 100.

Inflation and taxes add to longevity risk by eroding retirement money’s purchasing power. Historically it was difficult to hedge against inflation without having risk of loss; however, inflation-adjusted lifetime income is now available from annuities offered by some insurance companies. While Social Security is annually adjusted for inflation it faces other challenges: no inflation adjustments of tax thresholds will erode benefits and questionable financial solvency could impact benefits. Taxes can be better managed by relying on tax-deferral, tax-free Roth IRAs, timing of withdrawals from retirement accounts and other moderate risk strategies financial advisors offer.

Longevity risk management is often underestimated or overlooked in retirement planning even though outliving your retirement money would be a horrible experience. Fortunately, insurance companies assume and manage your longevity risk by offering guaranteed lifetime income as well as long-term care coverage. Such protection works by spreading risk over many policyholders – the same as insurance that safeguards your home, health, life, car, business, etc. The small premium payments deliver valuable peace of mind. If your retirement fear is living longer than your money, talk to your financial advisor or your insurance agent about “longevity insurance”. If you’re neglecting longevity risk in retirement you’re betting against reaching the older ages that medical professionals are working hard to assure.

Shelby J. Smith, Ph.D.
July 2012

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