Those of us who believe financial planning is the cornerstone of financial confidence and well-being — both advisors and investors — are constantly aware of any risks that could potentially affect our net worth. We keep a close eye on the markets, the economy, inflation, interest rates and other key factors.
However, a risk that’s just as important, but rarely discussed, has affected many retirees negatively when not planned for appropriately: the risk of living longer than expected. It’s called longevity risk. By being aware of how long you might live, you can work with your financial advisor to make smarter decisions about your finances, from choosing the right life insurance policy to planning your retirement.
How life expectancy is calculated
Life expectancy is the statistical age at which a person is expected to live.
Several factors influence life expectancy, including mortality rates, gender, race, ethnicity, family medical history, lifestyle choices such as smoking and access to health care. These factors, and others, contribute to the variations in life expectancy across different groups and regions. Insurance companies use actuarial tables, which are mathematical models, to assess the risk associated with insuring individuals. This helps them minimize liability risks and set appropriate premiums for policyholders.
People are living longer and need more money in retirement
Someone who is 65 right now and lives to be 95 will spend 30 years in retirement. And that number could easily increase because every year, life expectancy continues to increase. People are living longer than ever. That means we need to save more money to live on during retirement.
People living in prehistoric times could expect to live to the age of 30, and by 1900, life expectancy had increased to around 47 years. Today, the average life expectancy for someone living in the United States is approximately 78 years.
In the charts below are some predictions of life expectancy based on historical guidelines.
For example, a 65-year-old woman who is a healthy nonsmoker, on average, has a 72 percent chance of living to the age of 85. A 65-year-old man who is a healthy nonsmoker has a 63 percent chance of reaching age 85. Married couples with the same characteristics have a 90 percent chance of living to the age of 85, and there is a 50/50 chance that at least one spouse will live to be 95.
Source (chart): Social Security Administration, Period Life Table, 2020 (published in the 2023 OASDI Trustees Report); American Academy of Actuaries and Society of Actuaries, Actuaries Longevity Illustrator, http://www.longevityillustrator.org/ (accessed January 2024), J.P. Morgan Asset Management.
Overreacting in the short term negatively impacts the long term
In November, we got our first snowstorm, and, as usual with the first snowfall of every year, there have been quite a few accidents because drivers overreact. They aren’t used to driving in the snow. When they feel their vehicles losing traction, many people tend to oversteer or brake too suddenly, which causes them to spin out in the middle of the road.
Fear and uncertainty cause them to react in the short term instead of planning more thoroughly and allowing more time to arrive at their destinations.
It’s the same with planning for your financial future. I don’t want anyone to overreact about the uncertainty of their life span — or any other risk. Overreacting in the short term can cause people to make knee-jerk decisions, such as bailing out of the stock market during a downturn, that can impact their long-term needs. Investing for the future is a long-term game, and the best course of action is always to stay the course.
How to mitigate longevity risk
If you’re still working and haven’t set your retirement date yet, work with your advisor to determine how to set up a savings plan that will support your estimated life expectancy. Here are six strategies that can help you manage longevity risk.
1. Save more money and/or work longer
Saving more money and/or working longer can help you build a cushion against the risk of having more life left than money. There are two major benefits to working longer: it increases the amount you can save and reduces the amount of time you will need your money to last.
2. Wait until age 70 to collect Social Security
Waiting as long as possible to collect your Social Security benefits can help you as well — ideally until age 70. Beginning your benefits at age 70, as opposed to age 62, can boost the monthly payout by up to 8 percent per year, resulting in a benefit that’s 76 to 77 percent higher at age 70. With very few exceptions, financial modeling indicates that delayed filing for Social Security is the preferred strategy for managing the longevity risk in retirement.
3. Plan for your health-care needs
Health issues in retirement can have a significant impact on your savings. According to the U.S. Department of Health and Human Services, Americans have a 70 percent chance of needing long-term care after age 65. It’s wise to plan ahead.
Long-term care is expensive, and Medicare generally does not cover it. Relying on personal savings or family support can be challenging when the national median cost for a semi-private nursing-home room is $8,669 per month, according to the Genworth Cost of Care Survey. Medicaid is an option, yet you are required to deplete most of your assets to qualify, and the coverage might fall short of your needs.
Talk with your advisor about getting long-term care insurance or a hybrid life insurance policy. Traditional plans offer benefits for yearly premiums, but these can increase, and unused benefits leave nothing for heirs. Hybrid policies provide a growing pool of benefits without premium increases and can include a death benefit if you end up not needing such care. Some life insurance policies also allow you to use a portion of the death benefit for care, offering a “living benefit” while still leaving something for beneficiaries.
4. Minimize your housing expense
Housing costs make up a major portion of most people’s expenses. As you approach retirement, work with your advisor to determine how you can minimize this cost. This might mean paying off your mortgage before you retire, downsizing to a smaller home and using the equity to fund your retirement or looking into a reverse mortgage. Everyone’s situation is different, so what’s right for someone else might not be right for you. We will figure this out for you.
5. Manage your tax burden
Here at FORM Wealth, one of the most important ways we bring value to our clients is by helping them manage their tax burden. As you look to retire, we will set up tax-efficient withdrawal strategies to minimize how much you pay in income taxes so your money can last longer. Depending on your situation, we might recommend a Roth conversion or suggest that you withdraw from pre-tax retirement accounts in lower-income years.
In many cases, a significant portion of a retiree’s 401(k) balance goes toward taxes instead of living expenses. Also, a lot of retirees who have large pre-tax 401(k) balances end up paying higher tax rates later in retirement due to rising required minimum distributions (RMDs). We will work with you to minimize the amount of taxes you pay, using perfectly legal strategies. Managing taxes is a complex process, and we do not recommend a DIY approach!
6. Make sure your assets are allocated appropriately
Asset allocation among various types of investments is an important way to balance your need for regular income with the long-term performance of stocks. Although stocks can be more volatile, they tend to generate returns above inflation over long periods of time. Bonds and annuities can help you avoid outliving your savings. Work with your advisor to ensure your asset allocation is appropriate at each stage of your life. This requires regular review and adjustment.
Proper asset allocation in retirement can help you balance potential returns with risks as you withdraw money from your savings.
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Our job as your advisors is to bring you perspective — not only to what your needs and your concerns are now, but what they’re going to be in your future. As we move into 2025, know that the financial plan we have built for you is designed to protect you against many different types of risk. We worry about those potential risks so you don’t have to.
Once we build your customized financial plan, we will adjust it regularly to make sure it always meets your needs — regardless of how long you live.
