The whole point of planning for retirement is ensuring that your money lasts for the rest of your life. But, when you’re setting up your financial plan, how long should you expect to live? Today, we’ll revisit our old friend, Chef Steve, to understand why retirees need to plan to live longer than they expect when creating their financial plans.
Life Expectancy Increases as You Age
The older you get, the longer you can expect to live. This can be counter-intuitive to a lot of people. According to the Social Security Administration, life expectancy at birth in 2019 was 76.2 years for men and 81.3 years for women. Upon first glance, it would stand to reason that these would be perfectly acceptable life expectancy numbers to use in a financial plan.
But, that’s not true. When we look further into the data, we find that, for the average American who has already reached age 65, life expectancy increases to age 83.1 for men and age 85.7 for women. That’s an increase of almost 7 years and 4-1/2 years, respectively.
But what happens to the life expectancy of an average American if they reach their 83rd birthday? At that point, life expectancy jumps to 89.9 years for men and 91 years for women.
As it turns out, the longer you live, the more your life expectancy increases.
It goes without saying that we want a long and happy life. But for financial planning, a long life is the most difficult scenario to plan. The difference between life expectancy at birth and the life expectancy of a 65-year-old means that someone who retires at that age will likely need their investments to support them for another 4 to 7 years. If they live into their early 90s, their portfolio will need to support them for another ten to fourteen years.
Those extra years could put a lot of stress on their retirement savings. This stress on their investments is what is known as “longevity risk”. Who knew that having the good fortune to live a long life would be considered a “risk”?
So, even though someone may not believe that they’ll make it to their early 90s, there’s still a good chance they do.
How Much Does Longevity Affect a Financial Plan?
To see how different life expectancy assumptions affect a financial plan, we’ll revisit our old friend from prior blog posts, Chef Steve. Chef Steve and his wife, Suzie, have $1 million in savings and expect to spend $6,000 per month when they retire at age 62. Steve’s Social Security retirement benefits his Full Retirement Age of 67 are $2,304 per month. Suzie plans to take spousal benefits at that time.
If we plan for Chef Steve and Suzie to live to their average life expectancy at birth, their Monte Carlo probability of retirement success comes in at a very comfortable 97%.
However, they weren’t born yesterday; they’re both about to turn 62. According to Social Security’s data, their life expectancy at retirement is age 82 for Steve and age 85 for Suzie. When we re-run their financial plan with these numbers, their Monte Carlo probability of retirement success drops from 97% to 93%. That’s still a very comfortable retirement. With these odds, I may encourage them to consider spending more money in retirement to enjoy the savings that they’ve worked so hard to accumulate.
But, Steve and Suzie are very healthy and have family histories of longevity. Neither would be surprised if they lived into their 90s. When we re-run their financial plan with life expectancies of ages 90 and 92, respectively, we find that their Monte Carlo probability of retirement success drops to 74%. This is a perfectly fine number, but it’s almost 20% lower than the scenario we started with.
If you were Steve and Suzie, which scenario would you want to include in your plan? What would happen if their plan supported them to live into their mid-80s, but they ended up living much longer?
Retirees May Want to Plan to Live Longer
This is where retirement planning gets tricky. There always exists tension between planning for the future and enjoying the present. Whether you lean toward one or the other is completely subjective. However, moving to either extreme isn’t healthy.
Adding a scenario to your financial plan that includes longer life expectancies, at the very least, will allow you to understand how longevity risk will affect your plan. There’s a decent chance you’ll live longer than you expect.
Given these opposing goals of enjoying the present and planning for the future, there’s a chance that, despite our best efforts, something won’t go according to plan. That’s why consistently updating your financial plan is essential, before and during retirement, to ensure you stay on a good trajectory, even if you may need to course-correct from time to time.
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As a fee-only financial advisor in Atlanta, we can (and do) work virtually with clients all across the U.S. and we’re here to help you when you’re ready.