Creating confident clients with longevity planning
by William J. Rossi, III CFP, ChFCMr. Rossi is a Partner at Koss Olinger, a Florida-based financial group with over 150 years of combined financial advisory experience. His areas of expertise include investment management, estate planning and creating income distribution strategies during retirement. He is a 13-year member of MDRT and has received 11 Court of the Table and 10 Top of the Table qualifications. Visit http://www.kossolinger.com/
How old is the oldest person you know? Believe it or not, there was a time when any American over the age of 65 was considered “old.” But today, that number is much higher as more and more people are living longer lives. In fact, according to the U.S. Census Bureau projections, by 2050 at least 400,000 people will be 100 or older.1
Anticipating this kind of longevity has led financial advisors to shift their focus towards helping clients maintain a suitable standard of living by treating longevity as the fundamental risk facing all retirees. However, living longer than expected can increase the likelihood of other risks occurring.
To help safeguard a retirement portfolio, here are some of the most common risks associated with longevity planning for which to prepare and manage.
Market and Investment Risks
During retirement, there are many risks that are beyond an individual’s control including investment volatility, fluctuations in interest rates and high stock and bond valuations. Public policy is also a concern, as unexpected increases in taxes, reduced Social Security benefits or increased Medicare costs can all serve to increase pressures on a spending plan.
Another risk retirees must face is heightened vulnerability to sequence-of-returns risk once they are spending from their investment portfolio. Poor returns early in retirement can push the sustainable withdraw rate below what is implied by long-term average market returns. It is not just the average return which matters, but also the order of the returns. Entering retirement during a time of positive market performance increases the chances that retirement savings will last a lifetime. Alternatively, negative market returns in the early years of retirement require a retiree to liquidate more investments in order to provide the income they need, increasing the likelihood of depleting a retirement savings sooner.
People generally want to continue the same lifestyle that they enjoyed before retirement once they actually do retire. However, the first stage of retirement is when spending is more likely to surpass pre-retirement lifestyles due to activities including traveling and taking up new hobbies.
Estimating how much savings is needed during retirement can be complicated, especially when you factor in inflation. While inflation typically only slightly increases the cost of goods from year to year, it represents a serious risk and challenge for retirement income planning. Rising prices erode cash value and purchasing power over time. Typically, the annual inflation rate is somewhere around three percent, which might not sound too bad. But at this rate, the cost-of-living will double every 24 years.2
Among older Americans, average annual expenditures peaked at about $61,000 for those in the 45-54 year age range, according to the latest data from the Consumer Expenditures Survey. By ages 55-64, spending dipped to $56,000, and down again to $46,000 between ages 65-74. At 75 years and older, average spending was only $34,000, though health care expenses may spike up for many.3
For many retirees on a fixed income, potential medical costs remain a top concern. According to a Fidelity Investments study, a 65 year old couple can now expect to spend an estimated $245,000 on health care throughout retirement, not including skilled nursing care or long-term care4. Long-term care insurance can cover a major portion or even all of the long-term care costs that are not generally covered by health insurance policies and Medicare. Because long-term care costs have historically risen faster than the rate of ordinary inflation, an important feature to consider for any policy is an inflation rider.
Other issues related to personal spending risks include the unexpected need to support other family members such as adult children or grandchildren, divorce, changing housing needs, etc. The death of a spouse is also a relevant consideration, as Social Security benefits will decrease by a third to a half and taxes will increase as there are fewer exemptions. Aging retirees are also vulnerable to financial fraud and theft as predators seek to exploit those with reduced cognitive abilities.
It is important that retirees preserve their flexibility and liquidity in order to effectively manage unplanned expenses over an extending retirement period.
Longevity Planning Ideas
Longevity risk combined with an uncertain length of retirement make income planning difficult to do. It requires having income to meet an uncertain amount of expenditures over an uncertain time period. While these risks cannot be completely eliminated, here are a few strategies to help plan for and manage the risks associated with longevity planning:
- Consider delaying taking Social Security benefits
An individual can elect to take benefits as early as age 62, or wait as late as 70. While waiting to receive a larger benefit, the income will have to be replaced by withdrawing more from retirement savings. This will result in a loss of investment earnings potential on one’s savings in the short-run, but withdrawals will be reduced once bigger Social Security payments begin. For retirees who withdraw from their portfolio, it is important to carefully consider how much can be withdrawn each year, while ensuring the portfolio lasts a lifetime.
- Consider converting retirement funds into a life annuity
A life annuity provides a series of payments at fixed intervals, paid for the remainder of the purchaser’s life. This option makes it easier for clients to stay on budget, and helps to ensure basic needs such as food, housing and healthcare are covered. Life annuities can be purchased at retirement or layered over time, which adds flexibility.
- Consider purchasing a deferred annuity
A deferred annuity delays payments of income until the purchaser elects to receive them. This option is ideal for retirees who want to purchase lifetime income prior to retirement or want to buy an annuity that begins later in life, which can be a cost effective way to protect against longevity risk.
- Consider purchasing a life insurance policy
Life insurance provides economic protection to loved ones if they die before their financial obligations to them are met.
- Establish a contingency fund
Also known as an emergency fund, this isn’t your traditional savings account. Instead, they are funds set aside to address longevity concerns as well as other retirement risks. These funds should not be included in a plan’s projections of how much you can spend for normal living expenses.
Retirement planning is one of the most important guarantees an individual can make towards ensuring their satisfaction with their retirement lifestyle. However, as the retirement landscape continues to shift, and life expectancy continues to increase, advisors will need to prepare themselves to deal with new products and services for longevity planning.
When helping a client figure out how much to save for retirement, the biggest challenge is not knowing exactly how long they are going to live. For example, if you build a client’s retirement plan and assume they will live to age 80, but they live to be 90, how are they going to make their money last an additional 10 years? How can you help them plan for this type of uncertainty?
As longevity planning remains one of the most important financial planning topics, advisors need to focus on having a greater understanding of its related implications to clients. ◊
Securities Offered Through ValMark Securities, Inc. Member FINRA/SIPC. ValMark and Koss Olinger are separate entities. Advisory Services offered through Koss-Olinger Consulting, LLC., An SEC Registered Investment Advisor
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1. Pew Research Center, Living to 120 and Beyond, August 6, 2016
2. The Wall Street Journal Guide to Understand Money & Investing, 2004
3. Bureau of Labor Statistics, Consumer Expenditure Survey, 2015
4. Fidelity, Health Care Costs for Couples in Retirement, 2015