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Longevity Risk: How to Prepare Your Finances for a Longer Life Expectancy

Finances for a Longer Life Expectancy

When it comes to retirement planning, much of the focus usually rests on the actions you have to take to prepare a nest egg for your golden years. But what if your retirement savings run out before you do? This is where the concept of longevity risk comes into play.

Longevity risk is a growing concern as life expectancies in certain countries and regions continue to rise. Let’s explore the idea that you may outlive your retirement savings, why that matters, and how it can impact your ongoing attempts at building a retirement plan. Most importantly, we’ll discuss various strategies and solutions you can use to manage the risk and create a secure retirement even if you live to 100.

What is Longevity Risk and Why Should You Care?

Longevity risk refers to the possibility that your retirement funds may not be sufficient to cover all the years you live. Government data shows that residents of several U.S. states are living well into their late 70s and early 80s on average. Considering that most people retire around their mid-60s, that’s quite a few years to pay for.

Understanding Longevity Risk

When looking at this kind of risk, it’s important to take into account several factors;

  • Average life expectancy: With advancements in healthcare and living conditions, people enjoy longer lives. In the United States, the average life expectancy is 78 years.
  • Mortality rates reflect the chances of passing away at different points in life. As mortality rates decline, more individuals are reaching retirement age, extending their lifespan during retirement.
  • Number of individuals entering retirement: As the baby boomer generation transitions into retirement, a growing population of retirees rely on their savings.

The Importance of Planning for a Long Life

You have to account for longer years as you plan for retirement. Otherwise, you won’t be able to live a more comfortable life when you reach the end of your career. Having to depend on family for support, downsizing extensively, or running out of money altogether could become real possibilities.

Pension funds and life insurance companies use mortality tables to estimate future longevity and manage risk exposure. Such tables help them determine how much they must set aside to meet their future obligations. You can follow in their footsteps. Use similar tools and strategies to get a feel for your risk. Then, create a retirement plan that accounts for the possibility of living longer than expected. This will help you stay financially secure as you age, even if it’s longer than you thought.

How Can Longevity Risk Affect Your Retirement Plan?

Longevity risk can be particularly significant for retirees who rely on a fixed income stream, such as pension or annuity payments.

Know the Limitations of Fixed Income Streams

Defined benefit pension plans and annuities may offer a monthly income for life, but they might not adjust for inflation or cover unforeseen costs. Depending on these sources of income could leave you financially exposed, mainly if you live longer than expected.

Mitigate this risk by diversifying your retirement income. Consider combining Social Security benefits, personal savings, and investments with pension or annuity payments. By having variable sources of income, you can build a more robust retirement strategy that is better equipped to handle the challenges of a more extended retirement period.

Withdrawals for a Longer Retirement

To avoid running out of money in retirement, planning for a longer lifespan is more crucial than you might expect. This means saving more during your working years and being strategic about how you withdraw retirement savings.

One way to start is by following the “4% rule,” which advises withdrawing no more than 4% of your retirement funds annually to reduce the chances of depleting your savings. However, only use this rule if your specific circumstances, such as age, health, or lifestyle, warrant it.

Top Longevity Solutions You Can Try

If you need some strategies to build a nest egg that can handle a long retirement, here are some ideas:

  1. Reverse Mortgages: With a reverse mortgage, individuals who are 62 years old or older can convert some of their home equity into cash. It’s a way to generate income during retirement without selling your home or handling mortgage payments. However, knowing the costs and consequences of a reverse mortgage is crucial before making this choice.
  2. Long-Term Care Coverage: Long-term care insurance aims to help cover the costs linked to services such as assisted living or nursing home care, which can be substantial in retirement. Opting for an insurance plan can protect your retirement funds from being drained by these costs while guaranteeing you still receive the necessary care.
  3. Investment Approaches for Longevity: Some financial advisors offer investment strategies tailored to address the risk of living longer. These strategies may involve a combination of assets such as stocks, bonds, and real estate, focusing on generating income and preserving capital over an extended retirement period.
  4. Longevity Swaps: Pension funds and insurance companies can use longevity swaps to transfer longevity risk to a third party, such as a reinsurance company. By transferring the risk, they can better manage their exposure and ensure their ability to meet future obligations.

Incorporating these solutions into your retirement plan, alongside a well-diversified portfolio and a comprehensive retirement income strategy, can help provide greater financial security as you age.

How Can a Financial Advisor Help You Manage Longevity Risk?

A financial consultant can be your trusted ally as you tackle the challenges arising from a longer lifespan. In addition to evaluating your risk tolerance as it relates to your life expectancy, a knowledgeable advisor can assist you in developing a retirement strategy that adjusts to evolving circumstances.

Envision having a retirement income plan that includes strategies for longevity, such as annuities, to ensure a stream of income for the rest of your life. Your consultant can help you blend this with an optimized investment portfolio tailored to achieve growth while managing risks. They will steer you through market changes and life transitions, ensuring your strategy remains on course.

An exceptional advisor goes beyond number crunching, however. They invest time in knowing your objectives, concerns, and dreams, shaping a strategy that reflects your principles. With their expertise and encouragement, you can feel assured and empowered as you navigate the complexities and possibilities of outliving your savings.

What Role Do Annuities Play in Addressing Longevity Risk?

An annuity involves an agreement between an individual and an insurance company, where the person makes payments in return for an income flow typically throughout their retirement years. Annuities can be valuable for managing longevity risk, especially for older retirees with even more years under their belt. Here are some of the most popular options.

Single Premium Immediate Annuities (SPIAs)

SPIAs enable you to transform a lump sum into a stream of income that begins immediately and continues for the rest of your lifetime. This can offer reassurance, knowing that you have a flow of funds to meet your essential needs.

Deferred Income Annuities (DIAs)

Also known as longevity annuities, DIAs allow you to secure income for the later stages of life. By postponing payments until you are 80 or 85 years old, you can ensure an income stream when it is most needed while also reducing the initial cost of the annuity.

Variable Annuities with Living Benefits

Variable annuities with living benefits have the potential to grow with the market and provide a guaranteed minimum income stream. This can help keep pace with inflation and preserve one’s ability to make purchases throughout a lengthier retirement period.

By integrating annuities into your retirement strategy, you can establish a reliable base of assured income that will endure for as long as you do.

How Does Increasing Life Expectancy Fit into Your Financial Plan?

Even if you don’t feel like you’re in great shape or in the best health, it’s still wise to incorporate longevity risk into your financial planning. First thing first — estimate your life expectancy using tools like a life expectancy calculator at the Social Security Administration website. Consider factors such as your health, family history, and lifestyle when making this estimate. It’s essential to be realistic and slightly conservative in your estimate to prevent underestimating your possible lifespan.

Next, assess your retirement income sources and expenses to determine if you have sufficient savings to last a long retirement. This process involves:

  1. Calculating your expected monthly expenses in retirement
  2. Estimating your monthly income from sources like Social Security, pensions, and retirement accounts
  3. Determining if there’s a gap between your expenses and income

If you come across a gap, there’s no need to worry. You have options to bridge the difference:

  • Opting for delayed Social Security benefits: Delaying claiming Social Security until you reach 70 can significantly boost your monthly benefit.
  • Downsizing your home: Moving to a more affordable home can reduce your monthly expenses and create extra funds for retirement.
  • Investing in an annuity: Annuities offer an income stream that can help lessen the risk of outliving your savings.
  • Working part-time in retirement: A little part-time work can help stretch your retirement savings further.

By trying these strategies, you’ll be confident in your ability to maintain a comfortable lifestyle after retirement.

What Are Some Other Strategies to Mitigate Longevity Risk?

Apart from annuities, mortgages, or longevity swaps, there exist plenty of other strategies to mitigate the financial risks associated with living long into retirement:

  1. Consider Postponing Retirement: If you derive joy from working and find fulfillment in your career, continuing to work can help you bolster your savings and lessen the duration you need to depend on your retirement funds.
  2. Phased Retirement: If you’re not ready to retire fully, consider gradually transitioning into retirement by reducing your work hours or shifting to a part-time role. This way, you maintain some income but still have more time to pursue new interests like a retiree would.
  3. Create a Charitable Remainder Trust (CRT): A CRT is a financial tool that can provide you with extra income in your retirement years while also allowing you to contribute to causes you care about. By transferring assets to a CRT, you can benefit from a tax deduction and even receive income from the trust’s investments. Upon your passing, the remaining assets in the trust will be allocated to the chosen recipients.
  4. Keeping a Healthy Lifestyle: While it might not be a financial tactic, it’s hard to argue against the fact that looking after your body and embracing a healthy lifestyle can significantly reduce your medical expenses. Who wouldn’t want that as you grow older?

How Can You Ensure Your Retirement Savings Last a Lifetime?

To ensure your retirement savings last a lifetime, create a comprehensive retirement income plan that accounts for longevity risk. This plan should include:

  1. A mix of guaranteed income sources, such as Social Security and annuities
  2. A diversified investment portfolio to generate long-term growth
  3. A realistic budget that accounts for inflation and unexpected costs

Begin by ensuring that your reliable sources of income are enough to cover all your expenses, which forms a base for your retirement income plan. Next, invest some of your savings in a portfolio to help safeguard against inflation and preserve the value of your money.

Review and update your retirement plan regularly to keep up with changing circumstances. Having a plan in place can give you peace of mind and assurance that your retirement will be comfortable and financially stable regardless of how many years you end up living.

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We uphold a strict editorial policy that focuses on factual accuracy, relevance, and impartiality. Our content, created by leading finance and industry experts, is reviewed by a team of seasoned editors to ensure compliance with the highest standards in reporting and publishing.

Senior Writer at Due
John Boitnott graduated from UC Santa Barbara with a Masters Degree in Education. He worked for 14 years as a broadcast news writer for ABC, NBC, and CBS News where he covered finance, business and real estate. He covered financial news for SAP for four years. Boitnott is now working as a columnist for The Motley Fool where he covers personal financial and investing strategies.

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