Be it medical technologies, better lifestyles, or a myriad other reasons, Americans are living longer. The Society of Actuaries recently updated its mortality tables, indicating that American men are living an average of two years longer and women are living 2.4 years longer. That’s great news because we all want to live long, fruitful lives!
However, it can become worrisome later in life when our earning potential is much lower and we begin to run out of money. That makes the longevity of retirement nest eggs a chief concern for those on fixed incomes like pensioners.
Living longer affects more than just pensioners as plan sponsors must also prepare to pay out over a longer period of time. That puts more pressure on them to evaluate the risk. In what could be considered a preemptive strategy, some plans are offering lump sum payouts to rid themselves of pension liabilities. The plans with ample funds are likely to keep offering payouts.
Assuming the pension is safe – which as we’ve seen is anything but guaranteed – what can pensioners do to keep from outliving their money? With so many dynamics at play, the answer is not easy.
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Take the lump sum payout?
First off, if a pensioner is offered a lump sum, they need to decide if it makes sense to take it, versus keeping the funds with the plan sponsor, which again is no easy answer.
For instance, unmarried retirees may want to consider the lump sum payment, especially if they have children, or other beneficiaries. There’s a good chance that a retiree can use the lump sum to purchase an annuity that would replicate the pension income. Such annuity can be set-up to pay-out any remaining balance to beneficiaries at death, something not available with most pensions.
But things become more complex with a retired married couple. There are more people counting on the pension to live, and there could be beneficiaries in the mix too. Many pensions only pay spouses a portion of the lump sum payout. In situations like this, it’s vital to run the numbers with a financial professional.
One of the biggest questions to ask related to taking a lump sum payout is whether retirees think they can replicate, or even improve, the value of their pension income with annuities, investments, or a mix of both.
Important questions to ask
To be sure, these concerns are not exclusive to pensioners offered lump sum payouts, they apply to anyone who relies on a pension for income in their golden years. To make their money last, retirees should honestly evaluate the following criteria with family, beneficiaries and financial planning professionals.
Standard of living
Age and health status
Rising cost of living over time
Investment risk aversion (especially in the first few years of retirement)
The answers to these questions will be different for everyone.
Obviously, healthier retirees should plan for a longer retirement and understand how cost of living increases will affect their standards of living. This is especially important since medical costs are usually the largest costs of living, and all signs point to them increasing over time.
The fact that we’re living longer means a fixed level of income actually buys less and less over time, often resulting in retirees dipping into savings or other financial sources to survive. Most pensions don’t include cost of living increases. If someone retires at 60 and has a 30-year retirement, a 4 percent historical inflation rate means they might need more than twice the income to maintain their standard of living down the road.
All these factors combine to address an incredibly important piece of the retirement puzzle – the mix of financial instruments (and resulting risk profile) that will fund retirement.