The road to retirement is never smooth, especially when it comes to developing a sustainable retirement income plan. Four challenging impediments to a successful retirement include longevity risk, long-term care risk, “sequence of returns” risk, and public policy risk. Understanding these risks and industry-best practice solutions will pay big dividends in the creation of a more secure retirement income plan.
Longevity risk is complicated, because it involves securing income for an unpredictable length of time. While the average life expectancy of a male at age 65 is 84 and of a female is 86, averages fail to tell the whole story. If you plan for a client to live to the average life expectancy you will be wrong half of the time, not an acceptable failure rate when it comes to retirement planning. Roughly 25 percent of people alive at age 65 will live to age 90 and over 10 percent will live to age 95. Factor this in for a couple and there is greater than 50 percent chance one of them will be alive at age 90. If this comes as a surprise, know that most people underestimate their own life expectancies.
Exceeding one’s life expectancy puts significant strain on their ability to meet their income needs throughout retirement. Many solutions are available to help mitigate the risk of outliving the retirement income portfolio.
First, consider deferring Social Security benefits to increase benefits. Each year benefits are deferred beyond full retirement age, the benefits will increase by 8 percent each year up until age 70. Additionally, these larger benefits will continue for life, so the longer the person lives, the better it is to defer. Of course, in order to get more money with this strategy the person needs to live past a break-even point, where it would have been beneficial to claim early. However, deferring Social Security can be an effective strategy for anyone who expects to live well into his 80s or 90s as they will receive more money and will be better protected against inflation and longevity risk.
A second solution to offset longevity risk is the purchase of an annuity. Some annuities, known as immediate annuities, will provide income starting today. Others, known as deferred income annuities are built specifically to address longevity concerns. A special type of deferred income annuity can now be purchased inside of an IRA, known as a qualified longevity annuity contract (QLAC), which can prevent someone from running out of money if they exceed their life expectancy.
Longevity risk often goes hand-in-hand with another major risk, long-term care risk. Long-term care is a topic that most people find unpleasant to discuss. Declining health and mental capacity is an inevitable fact of life for most people. Nearly 70 percent of those who live to 65 will eventually require some sort of long-term care. However, most of that care will not be in an institutional setting but is provided by unpaid family members in an informal setting. When a nursing home or assisted living facility becomes a necessity, it can be devastating financially as annual costs often exceed $100,000.