A Silver Cloud With a Black Lining

Retirement can be the best time of your life.  We often point out it is the time of your life  when you have both the time (unlike when you are working) and the money (unlike when you are growing up) to do the things that are important to you.  In fact, when new clients are starting the retirement income planning process, our early conversations are about all the things they want to accomplish.  After we talk about the fun stuff, we then discuss how to address and protect against the events that may upset this ideal retirement.  As Keith Richards might reply, “What a drag it is getting old.”

There are several risks that could alter your retirement. When reflecting on the risks you face, your first thoughts may center around your savings losing value or getting sick. Another significant risk, and one that doesn’t necessarily leap out, is longevity. Simply put, are you prepared if you are healthier than you think? This isn’t just a “what-if” either, recently the CDC reported life expectancy rose in 2018. It is easy to dismiss longevity risk as a good-problem-to-have, but it is a potential problem nevertheless.

When answering the question “Do I have enough money to retire?”, several assumptions are made, one of which is when you and your spouse will die. As financial planners, we do not phrase it that way; we will talk about “end of plan,” or some other euphemism, but it is an essential assumption that we have to make. The truth is we have no idea when we will reach “end of plan.” An honest assessment of our health and knowing our family history can help us make an educated guess, but it is still a guess. 

So, if we know the age we pick will be wrong, why go through such a morbid exercise? The fact is nearly every major financial decision in retirement is at least in part based on that number. Social Security timing, withdrawal strategies and spending decisions are directly tied to this number. Decisions around insurance, gifting and estate planning will be influenced by the age you choose. So we at least need to make a “best guess” at the number.

Picking an age

Why not just pick a really old age to minimize the chance of living too long?  If you use an age that is too old, then you likely will be, in hindsight, sacrificing needlessly. Simple math dictates the more years you need your savings to last, the less you can spend per year.  The choices we make in retirement should be between things we want to do, and not because we are scared to enjoy life because our “plan” says we cannot afford to spend the money.

Deciding on an age sounds like a lose – lose proposition, but this is why stress PLANNING over A PLAN.  A plan is a snapshot at one point over your entire life.  Planning is ongoing.   As your retirement progresses, assumptions can be changed to reflect what is actually happening in your life.  With the flexibility you can get from “planning”, you have a wider margin of error in deciding on your “end-of-plan” date.

Assuming a too-early death date, however, creates the risk of running out of money, the specter of which concerns nearly everyone who could be enjoying retirement. Because of Social Security and other benefit programs, you will not literally have no money. Still, the exhaustion of your savings will likely result in a dramatic change in your lifestyle.  

For some people, the mere threat of outliving savings is enough to ruin their retirement.  We meet with retirees all time who are too stressed to spend.  They find it difficult to enjoy even the simple things with the specter of financial ruin hanging over them like the sword of Damocles. 

Tools you can use

There are several tools you can use to protect yourself against outliving your savings.  Please note, retirement income planning, like financial planning in general, is specific to your situation and your preferences.  Therefore, you should be careful about adopting any option you learn about without understanding how it addresses YOUR situation.

Frequently annuities are mentioned as a solution to longevity concerns, and they can go a long way to solving the issue.  The trade-off is you lose access to the money, since you give a lump sum to an insurance company in exchange for a guaranteed monthly income.  Moreover, the monthly income does not change with inflation.  What tends to worry most people about annuities is the concern of dying before they “get their money back.”  Some annuities offer options to “get your money back” and to protect against inflation, but in exchange for lower payout rates.

For those of us who wish to maximize the control of our assets, we need to pay attention to withdrawal strategies.  Any planning that depends on drawing down investing accounts needs to understand how long the money can last.  For example, if you pull $100 per year from an account with a $400 balance, that account will only exist for a few years (unless you earn more than 25% per year, every year – good luck with that!)  However, if you are taking the same $100 from a $400,000 account, then that account will likely outlive you.

The “Big Bang” moment in the evolution of the withdrawal strategy concept was in 1994 when the 4% Rule was introduced. The 4% Rule looked back at 50 years of stock and bond market returns to determine how much an investor could withdrawal rate over a 30-year period, without the account value reaching $0.  Since then, other strategies have evolved, each with their own strengths and weaknesses.  Interestingly, even though these strategies may be higher or lower than the 4% Rule, the distribution rates generally are in the mid-single digits, which means a 4% distribution rate is probably a good rule of thumb to use if you are just looking to estimate your income.

The foundation of retirement income planning and probably the single best tool available to protect against longevity is Social Security.  With Social Security you get a monthly income that grows with inflation, from a payer (the US government) with deeper pockets than any insurer – they legally own the printing presses.  Unlike an annuity, the funding of your benefit does not come out of your savings either.  Since it is paid by tax dollars there is no stock market risk.  While some are concerned that Social Security could go bankrupt, we believe that is very unlikely.  When it comes to Social Security you must understand the claiming options and how they could impact your Medicare and other benefits.  You can claim as early as age 62, but if you delay until Full Retirement Age (66-67 depending on when you were born) your benefit increases 5-6% per year [The exact benefit reduction for claiming before your FRA is based on how many months early you collect.]  If you do not collect at FRA, the benefit will increase 8% per year until you hit age 70.  Again, these increases are without investment risk.  In 2020, a risk-free return of 5%-8% is damn hard to beat!

We all hope for a long, enjoyable retirement.  But, without proper planning, you run the risk of outliving your savings which could ruin even the humblest of retirement dreams.  The three tools mentioned here can greatly help you have the income you need, regardless of how long you live.  However, everybody’s situation is different and what works for your neighbor may not work for you.  For you the solution could be a combination of these tools or even some options not covered here.  Moreover, you need to understand that when addressing longevity, or any retirement risk, any individual tool could increase your exposure to other risks.  That is why we encourage you to consult with a retirement income planner, to help you understand when a solution is truly a solution, and not just exchanging one risk for another.

Please contact us today and discover if planning will help you live the best version of your retirement.

Note:  This information is not intended to be a substitute for individualized tax advice or financial advice. Please consult your advisor regarding your specific situation.