We often joke that our job was created because of increasing life expectancies and pensions seldom being offered. Obviously, finance and investing has become more complicated and there are an ever-increasing number of investment vehicles and planning strategies we help our clients choose between. We also know there is great value placed in our ability to help clients balance current and future wants and needs. Although each of these subjects is vital to include in our discussions we have with clients, we inevitably come back to one major question with all clients: how do I take what I have saved and make it last for my lifetime?
When Social Security was established in 1935, the minimum retirement age to receive full benefits was set at age 65. The average life expectancy in 1935 was 61 years old! When Social Security started paying monthly benefits in 1940, the average life expectancy for those having attained age 65 was 77.3 years for Men and 79.6 years for Women. Although Social Security is in the process of moving full retirement age to 67, life expectancies for people who attain age 65 have risen more than 7 years. We find similar, if not worse, trends when we look at private and government pension systems. Simply put, life expectancies have increased quicker than retirement plans have been able to modernize to these facts. We have all heard the statistics about Social Security and various pension systems being under great stress; we believe this lack of evolution has placed and will continue to place more burden on individual retirees.
With healthcare costs climbing, fewer pensions being offered, and limited inflation on social security, individuals and families are charged with creating their own lifetime income stream from their accumulated assets prior to retirement. Today, we work with multiple people over 100 years old. In most of these cases, they stopped working at least 35 to 40 years ago. Think about the financial lifecycle of such a person. They started working sometime in their early 20’s, worked and saved for 40 years, and now are living off of what they saved for more than 40 years. Interestingly, most of these individuals have some type of a pension, either from their own work or a current or deceased spouse. We are confident this will not be the case for the 100+ year old’s we see over the next 20 years because we know of the evaporation of that offered benefit. Retirees will be required to not only accumulate significant assets but also create a plan that is sustainable over many decades. We believe this challenge creates two critical questions for retirees: 1) how will inflation impact my ability to provide a lifetime income stream and 2) how could retiring early impact this same income stream?
Using our Monte Carlo system, we tested several cases to measure the impact of an extended retirement (i.e. early retirement and/or extended life expectancy) as well as the impact of varied rates of inflation. Although inflation has been subdued for the past two decades, we find it vital to include a higher rate of inflation in our calculations, particularly for those testing lifetime income. In this case study, we have Bob and Mary Saver who are both 50, working, with plans to retire at age 65. They each make $60,000 per year and have already saved a combined $600,000 towards retirement in 401ks. In this case, they show a 92% chance of success with life expectancies extended to age 100. This would be a very strong result. (A 92% chance of success is one we would deem quite good, a conclusion we typically establish at 85%).
But notice the impact if we increase the inflation rate:
3.97% Inflation = 92% Probability of Success (this is our base case)
4.97% Inflation = 84% Probability of Success
5.97% Inflation = 80% Probability of Success
Now notice the impact if we extend the life expectancy ten years to 110 on these same inflation rates:
3.97% Inflation = 91% Probability of Success
4.97% Inflation = 80% Probability of Success
5.97% Inflation = 65% Probability of Success
We recognize that these are extreme conditions to apply. As unlikely as 5.9% average inflation and both members of a married couple reaching age 110 might be, these are the sort of variable we like to include to test the resiliency of a financial plan. In the case of Bill and Mary Saver, the probability of success is barely effected by them living ten years longer. Their plan is impacted severely by higher inflation so this might lead us to adjust their allocation to combat this over time. By testing their situation against marked stresses, we are able to expose possible vulnerabilities in their plan.
With so much innovation in the healthcare space, it is imperative that we all assume we will live much longer. The idea of accumulation of retirement assets and then depletion of said assets in retirement is a now-risky approach. For that reason, we have introduced the idea of an “Endowed Retirement” to many clients. Much like an endowment for a University or College, the goal is to establish a pool of funds substantial enough to perpetually provide an inflation-adjusted income stream. If this is established, the longevity risk discussed above can be virtually eliminated. We recognize it might sound unlikely to live past 100 or 110 but there are countless scientists working on reversing and/or slowing the effects of aging. Considering the progress made over the last century, it is easy to understand why some experts feel we are not even close to the end of innovation that will lead to us living longer lives.
“I think there are those alive today who will live to be 200 years old,” declared Stanford Professor Stuart Kim.
It would be nice to know your retirement funds would last that long.