LONGEVITY:  THE GREATEST RISK IN RETIREMENT

If you ask one hundred people what is the greatest risk they will face in retirement, you might hear things like inflation, stock market risk, higher taxes, or the cost of health care.  In reality, the greatest risk in retirement is living longer than you planned, i.e., longevity.  To most people, it is not a well-understood concept. 

The amount of time the average retiree spends in retirement has increased significantly over the past two generations.  Life expectancy in 1900 was 48 years, but by 2000 it was 78 years, and two-thirds of all the people who have ever lived are over age 65 today.[1]  The median age in 1960 was 29.5, but today it is 38.8 and has increased by 3.4 years since 2000.[2]  70% of the United States’ wealth is held by people aged 50 and above.  But money is only a part of a successful and happy retirement.  However, having a purpose is essential as well. As the human lifespan increases due to healthier lifestyles and medical advances, longevity has become a crucial aspect of retirement planning.  All of this has resulted in a shift in retirement patterns.  We will discuss the effects of retirement planning, including economic, financial, social, and personal implications.

Most people underestimate how long they will live.  As people age, their life expectancy does not go down one-to-one as each year passes.  Ironically, the longer you live, the longer you are likely to live.  The number of years left declines, but one’s expected age at death increases.  Today, more people are living to the age of one hundred than ever before. 

For those that are advising seniors, the opportunity is enormous to provide support to those who may live 30-40 years or more in retirement.  In fact, understanding a client’s longevity and informing a client about the good, bad, and ugly of living a long life is one of the most essential pieces of advice one can provide.  Some might say that by not addressing this issue, you are guilty of malpractice. 

But how does one plan since no one knows how long they will live?  You can certainly use various sources to help you, which obviously depends on your general health, health insurance, wealth, gender, genetics, exercise, eating habits, smoking, drug abuse, education, etc.  Here are a few of the better ones that help project potential longevity: Living To 100 Life Expectancy Calculator; True Vitality Test by Blue Zones; and Actuaries Longevity Illustrator – Welcome to the Actuaries Longevity Illustrator.

Living too long is one of the greatest worries for retirees, right behind dying too soon.  It is a delicate balance between spending too much early in retirement versus saving for many tomorrows.  One of the toughest things a financial advisor does is permit people to spend their money, or the flipside is telling one to cut back because they are spending too much. 

Some will spend like crazy in the early years of retirement, knowing they will have to cut back later in life, but “what the heck, I may not be here tomorrow, and I want to enjoy life now.”  Others fear outliving their assets and sacrifice much early as a result.  People rarely run out of money unless they are spending it on themselves or a loved one that needs medical attention.  As investments and savings decline, people cut back on their lifestyles. 

ECONOMIC AND FINANCIAL IMPLICATIONS

Longevity has significant implications on the economic and financial aspects of retirement planning.  With people living longer, the cost of retirement has increased, as retirees require more funds to sustain themselves over a longer period, especially if inflation is running hot.  Further, the traditional retirement age of 65 may not be feasible for many people, as they may need to continue working to support themselves financially.  Congress thinks this will be the case as they first raised the Required Minimum Distribution (RMD) to 72 and, more recently, to age 75.  This also creates an economic burden for individuals, and the government (federal, state, and local) as Social Security and other retirement benefits may need to be extended to accommodate longer lifespans.  Many potential retirees will continue to work well past 65 years because they love what they do and want to continue working.  Others may continue working but in a different profession.

Okay, let us get the money implications out of the way first.  A retiree oftentimes does not need, as opposed to wants, to replace 100% of their pre-retirement income when they retire.  Let’s look at a hypothetical couple who combined are making $100,000 a year, which means they are paying about $7,660 in Social Security and Medicare taxes and are putting $10,000 into their 401k(s).  That means they live on a pretax income of $82,340 or about 82% of pre-retirement income. 

So how do they replace the paycheck they have been getting for the past 40-50 years?  The first step is to know how much each will get from Social Security at various ages.  All they have to do is to go to ssa.gov to register.  Today Full Retirement Age (FRA) is 67.  This age is important for two reasons. However, one can take a Social Security benefit as early as age 62; if one does, the benefit is reduced by 30% (5/9^th of 1% per month). Secondly, if one takes Social Security before FRA, one can only earn up to $21,240 annually in 2023.  For every $2 earned income over this amount, one loses $1 of Social Security.  Once they reach FRA, there is no income limitation.  Should they financially be able to wait until age 70 to begin their benefit rather than at FRA, the benefit will increase by 8% each year.

Are there good reasons to take the benefit early despite these limitations? The answer is “yes, but”. Here are three reasons.  If one must retire before FRA and absolutely needs the money to live on, then there is no choice.  If one is in ill health with a shortened life expectancy, it makes sense to do so.  Thirdly, if one spouse has a bigger income and, therefore a significantly bigger Social Security benefit, the spouse with the lower benefit might find it more beneficial to start early.  Should the spouse with the bigger benefit die first, the surviving spouse loses their benefit but continues to get the deceased spouse’s benefit.  Calculating different scenarios about the “best” alternative is complicated and it is strongly recommended to use software to assist in making a recommendation.  Here are two to consider: SSAnalyzer and Maxmize My Social Security.  These are tools to help, but they are not definitive.

Returning to our couple, let us assume they retire at age 67 (Full Retirement Age) and have a combined Social Security benefit of $42,000.  This benefit will be further reduced by about $4,800 to cover the expense of traditional Medicare Part B and D, which of course, is a part of their budget.  Thus, they need to replace $40,340 from savings and investments.  Many financial planners suggest that one can draw down 4% of the investment nest egg, which means at a minimum, our couple needs just over $1 million in savings. 

What does it take to get $1 million?  Less than you think but more than many are capable of achieving.  In fact, only about 10% of those retiring today have accumulated that much money.[3]  Worse still, the average retirement savings for those age 60-64 was only $208,000 and the median for 65+ was $164,000 in 2022.[4]  According to the Survey of Consumer Finances by the Federal Reserve, the average retirement savings for all families was $255,130 and the median was $65,000 in 2019.[5]  The median retirement savings for people aged 55-64 was $120,000.[6]  The average retirement savings for Americans approaching retirement (ages 55-59) was $223,493.56 and for ages 60-64 was $221,451.67.[7]  The numbers have not changed much through the pandemic. 

But back to saving $1 million.  Investing $5,000 annually over a 43-year career and earning a hypothetical return of 6% will get you there.  But then there is that annoying thing called inflation.  Assuming a 2.5% rate of inflation, a college student starting today will need to accumulate $3.6 million to have the equivalent purchasing power at retirement and would need to put away $18,000 yearly.  Even with a six-figure starting salary, that is no easy task. 

But inflation will also affect our retired couple over the next 30-40 years.  The good news is that Social Security is adjusted for inflation every year. However, many argue it does not keep up with the Consumer Price Index (CPI) as Social Security is adjusted by using the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W), which clearly is not the same inflation that affects retirees.  Assuming the same 2.5% for inflation, however, to keep up with inflation, our couple needs to draw down $53,000 in 10 years, $68,000 in 20 years, and $87,000 in 30 years.

How does an advisor help?  It is impossible to cover all of the important financial aspects and all of the many permutations, but we will cover many.  Where does one start?  The first step is developing a net worth statement for the client.  What are the assets, and how are they invested?  What debt do they still have?  Then you need to develop a budget for them to discover the various potential sources of income balanced against their expenses. Hopefully, there is more income than expenses, but in many cases, it will be the reverse.  Before dealing with income sources, let us look at the expense side.

Divide the budget into two parts: those expenses that are “must haves” (mandatory/fixed) and those that are “like to have” (discretionary/variable).  Ideally, the client will cover the mandatory expenses with predictable sources of income (Social Security, pension, bonds, CDs, annuities, etc.) while covering the discretionary expenses with variable sources of income (investments). 

But what expenses might be reduced or eliminated, and at what cost/trade-off?  Here are a few examples to consider.  One of the biggest expenses is health insurance.  If they use traditional Medicare, Part A (hospital) is free, but Part B (doctors, diagnostics, etc.) has a minimum cost in 2023 of about $165 per month, and Part D (drugs) minimum monthly premium is about $32.  Since Medicare does not pay for everything, many will buy a Medicare Supplement policy which might cost another $150 per month and is recommended if they can afford it.  That is a total annual cost of about $4,200 per year for each person for Medicare Part A and D.  That amounts to about 10% of our couple’s total income.  For those couples that have income greater than $194,000, they will pay even higher premiums. This first threshold for an individual is $97,000. 

Wow!  Is there a way to reduce or eliminate this cost?  The simple answer is once again “yes, but.”  The retired couple may want to consider using a Medicare Advantage Plan instead of traditional Medicare.  A Medicare Advantage Plan requires that the insured still pay a premium in the same way they would for traditional Medicare, but there is no need for a supplemental plan because Medicare pays the plan a fee to cover all of the cost of care through what is known as “managed care”.  Some Medicare Advantage Plans will actually provide additional income to the retiree and will cover things that Medicare does not cover, like dental and eye care.  In 2022, about 48% of those eligible for Medicare used a Medicare Advantage Plan.[8]  Why wouldn’t everyone want this over traditional Medicare?  The tradeoff is that many tests, surgeries, etc., must be preapproved, and the doctors one sees will be limited to those approved by the plan.  Nonetheless, it is an option to consider, especially if the retiree is in good health.  Each year, the retiree can make a change from one plan to another should they wish. 

Another major expense to consider eliminating is a mortgage payment if our couple still has one.  What needs to be considered?  What is the payment?  How much longer do they have to pay?  What is the balance remaining?  Is the interest rate they pay lower/higher than what they might earn from investments?  Are they using a standard deduction or itemizing for income taxes?  If they are itemizing, then the interest can be deducted for income tax purposes which lowers the effective interest rate.  In this instance, it is usually mathematically better for the retiree to keep paying the mortgage and leave the money that would be used to pay off the mortgage invested because it might earn more over time than the interest being paid.  Conversely, if the interest rate is high, the balance low, and/or they are using a standard deduction, the tradeoff may be small.

But often, the correct financial conclusion may not win the day because the retiree does not want to make any more mortgage payments.  They want to get rid of it, regardless of the financial consequences, because they will “feel” better.  These feelings are strong and should not be dismissed by the advisor as wrong.  Feelings are personal and need to be respected. 

Another expense to address is taxes.  How do you keep them as low as possible?  The client needs well-tax-diversified sources of income with taxable, tax-deferred and tax-free sources.  There are many thresholds to avoid.   As an example, Social Security is not taxed until an individual has $25,000 or a married couple has $32,000 of income.  At that point, up to 50% may be taxed.  When individuals reach $34,000 or a couple reaches $44,000 then up to 85% of Social Security will be taxed.  Try to keep the client in as low a bracket as possible by drawing on a combination of sources.  Using an annuity for cash flow may also help to reduce the tax burden each year.  Those with investments, they may want to do tax harvesting by selling investments with a loss that they no longer want to own to help offset other investments with a gain.

On a year-to-year basis, the client can control those variable expenses by taking no or a less costly vacation, eating out less, making smaller charitable gifts, giving less help to children/grandchildren, using coupons, etc.  But can they do something with fixed expenses?  Work with them to cut the cable, find a less expensive cellphone plan, manage the electric usage, keep fuel costs down, eliminate unnecessary insurance, delay buying that new car another year or two, etc.

For long-range income planning, consider this option.  Our couple has a taxable income of about $55,000 which puts them in the 12% tax bracket.  That bracket does not go higher until taxable income exceeds $89,450.  They could consider taking money out of their IRA that they do not need currently and pay the taxes today in the 12% bracket and put the money into a Roth IRA, which will grow tax-free into the future.  When they pay the taxes, that money should come from other taxable investments so that 100% of what is withdrawn from the IRA is deposited into the Roth IRA. It should be noted that a Roth conversion can create tax implications depending on a personal situation. They should consult with a qualified tax advisor before making any decisions regarding their IRA. 

Now let us turn to the income side.  If one needs more income to cover the fixed expenses, buying a fixed-income annuity may make sense.  The client could purchase one for a fixed or lifetime period, single or joint life, fixed or variable rate, and/or with or without a refund.  There are a multitude of ways to put this annuity income into place.  If you are not licensed to provide this product, find a trusted advisor to help.  Do not use an annuity with a large and/or long surrender charge of more than five years.  Things tend to change during retirement, and what looked good five years ago may not look so good today.  Generally, the longer the surrender charge, the higher the commission paid to an agent.  Have the insurance agent state in a letter to the client the surrender charges year by year in both percentage and actual dollar values.  The letter should also disclose the commission received in percentage and dollar terms.  Any insurance agent that is proud of his/her value proposition should not have an objection to this.  If they do have an objection, they might say, “It is no one’s business,” but you see, it is the client’s business if a better product is available at a lower cost structure.

Although not generally used in the early retirement years, another way to produce predictable income is using a reverse mortgage.*  Again, work with a professional in this area, as just as with any mortgage, there are various fees, products, etc.  Be sure to get a comparison to share with the client.  Again, all charges, including compensation, should be provided in writing to the client.  Various risks are associated with reverse mortgages, including debt, decreasing equity, tax ramifications, and other expenses.  Please review all documents closely.                        

The rest of a client’s investments should be placed into a well-diversified portfolio based on the risk tolerance that a client has demonstrated.  Much like Goldilocks, it can’t be too hot (high risk) or too cold (not enough risk to keep up with inflation).  It has to be just right and tailored to the individual client.  Today, most financial advisors charge a fee rather than a commission, which should not exceed 1.25%.  The fee should decline the more money that is invested.  For our retired couple with $1 million, the fee should be around 1%.  Any retirement investment intends to provide for cash flow and then for growth above the cash flow over time to provide for an inflation hedge into the future. 

SOCIAL AND PERSONAL IMPLICATIONS

Most people want to live a long and prosperous life.  The allure of living longer brings many benefits, such as pursuing new interests, enjoying time with family and friends, traveling more, finding new ways to be engaged and productive, and perhaps working longer, which can increase financial security and help with mental acuity.  It also has negative implications, including stress on the retirement plans like pensions and Social Security, age bias, health plans, long-term care insurance, annuities, life insurance, isolation, chronic and new diseases, and disability, to name a few. 

POSITIVES & NEGATIVES OF LIVING LONGER

While living longer is not really a new phenomenon, it is getting more attention as more people are actually doing it.  Most everyone knows someone who has lived to age 100 and beyond.  Throughout the 20th century, life expectancy increased by 20 years for men and 23 years for women.[9]  With new advances in medicine life expectancy will increase by 4.4 years by 2040.[10]  There are five identified “Blue Zones” where residents seem to live longer and healthier lives:  Ikaria, Greece; Okinawa, Japan; Ogliastra Region, Sardinia; Loma Linda, CA; and Nicoya Peninsula, Costa Rico.  In these regions, primarily due to a healthy diet and lifestyle, living to older age is a natural phenomenon. 

Overpopulation can become an issue if people come to live significantly longer than a “normal” life expectancy.  The elderly cohort will require more and different resources.  Food sources will be stretched.  More waste is created. Greater stress on global warming issues will be generated as pollution increases.  As society ages, the ratio of young to old decreases perhaps to a point where birth rates fall below deaths.  Developed countries might deteriorate because of low birth rates, while third world countries fill the void. 

With people living longer, the percentage of older folks increases which has a negative impact on the overall economy.  There is a smaller labor pool which will make it harder for employers to find qualified workers, leading to higher wages which could set up round after round of inflation.  Productivity will slow and business growth may stagnant leading to more and deeper bear markets for stocks.  Many countries will turn to more liberal immigration policies in order to keep things in balance.  Of course, one country’s gain is another’s loss.  The economic goods and services provided for an aging population are much different than those that are needed in younger population.  Businesses may find it hard to adapt, but those that do will be stronger as a result.  The amount of savings per capita will decrease which will put pressure on banks and other financial institutions. 

Older adults in good health see themselves as younger than their parents at the same age and this mental as well as physical aspect gives them more freedom.  Most importantly, freedom to spend more time with family.  Seeing families with five generations alive has been very rare but will become much ore frequent as time goes by.   Think of the knowledge and experiences which can be shared across multiple generations. 

But on the flip side there are negatives.  As older family members age, they may require personal help from other family members as caretakers and that could cross over several generations, not just the oldest.  Additionally, these older generations could place financial burdens on the younger generations that were not anticipated, harming the younger generations own retirement dreams.  Some younger family members may not be willing to help aging parents/grandparents which will place a burden on society to care for the aged. 

Given greater healthcare, breakthroughs in medicine and better lifestyles, retirees will have greater independence which will allow them to pursue new interests, travel longer, work longer, and be less of a burden on others for a longer period.  Conversely, many will develop chronic diseases as they age and perhaps new diseases will manifest themselves over time.  As a result, the cost of care will become higher.  The cost of health care for those over 65 already represents 40-50% of all healthcare costs and the per capita cost is four to five times greater than the younger cohort.[11]

As longevity increases for many, it will not increase for everyone.  Good genes, higher education, more income, being married or in a committed relationship as opposed to being single, being female, having many friendships, etc. all play a positive role when it comes to longevity.  Some friends will die because they were on the wrong side of these and other factors.  But new personal relationships will develop later in life which will cut down on the adverse effects of loneliness and isolation. 

The financial side of society implications are numerous.  Pension plans, Social Security, annuities, life insurance and long-term care insurance are all based on actuarial assumptions.  What if they are up ended with life expectancy increasing dramatically above current beliefs?  The transfer of wealth from one generation to another will slow and the amount that is passed along may be much smaller. 

Pension plans will run out of money without a significant increase in contributions.  State spending to support retirees could approach $1.3 trillion.[12]  Further, state governments are projected to spend $1.3 trillion to support retirees between now and 2040.[13]  Many will go bankrupt putting pressure on the Pension Benefit Guaranty Corporation (PBGC) which in turn could mean increasing pension insurance costs and/or more government funding needed.  Annuities which often pay for the lifetime of the annuitant will make payments longer putting pressure on the reserves of life insurance companies which in turn will reduce profits and correspondingly stock price.  Some may even go bankrupt. 

Life insurance premiums will go down because people are living longer.  However, many life insurance policies (cash value, universal and variable) are sold as a “tax free” way to create cash flow through a series of withdrawals and loans during retirement.  This concept must be carefully monitored because the policy cannot lapse prior to death because if it does all of those payments above the amount of net premiums paid will become taxable.  This can happen as a result of the insured living too long.  Although people will be able to stay in their home for a longer period of time, they are more likely to need in-home help.  Eventually, they may need to move to an assisted living facility.  Thus, both the home care and assisted living businesses are set for growth.  Longevity will increase the likeliness that people will need long term care, but it will be delayed because of better health and medicine.  As the age of the insured goes up and inflation drives the cost of care upward, so will the premium for long term care insurance.  Will the insured be able to keep the policy for an extended period with ever increasing premiums?  If not, then the cost must come from investments which will reduce the size of the estate and if the estate is exhausted then it will increase society’s cost through Medicaid and other social services.   

Age discrimination may get worse, especially in the workplace.  Two out of three workers between the ages of 45 and 74 say they have experienced age discrimination.[14]  One need look no further than the current discussion about whether President Biden is too old to be president for another four years to see age discrimination/bias in action.  Forcing retirement (airline pilots, board members, judges, etc.) at certain ages is a subtle form of ageism.  Why don’t those old fogies retire so a younger person can be promoted?  People who want to go back to work both because they want or have to are told they are “too experienced” for the job. The working cohort may have to pay more in taxes to support the non-working older folks and resent that they have less money of their own as a result.  All those old people on the road who drive so slowly should not be on the road.  Obtaining credit is harder for an older person.  A doctor might refuse to provide a referral because the person is too old to have a procedure/test.  The elderly are already being defrauded through phone calls, emails and texts because of their supposed infirmity.  These are just a few examples of age discrimination and bias. 

Because family members may not live nearby, an aging population may find life disrupted by having to move late in life.  This takes them away from support systems, friends, organizations, etc. and they are forced to make/find new ones.  Not easy at that point in life which can lead to depression and anxiety affecting one’s mental health.  Suicides may increase.

CONCLUSION

The effects of longevity are far-reaching and complex.  Economic, social, and personal implications all play a role in shaping life patterns for individuals and society as a whole.  As people continue to live longer and healthier lives, it is essential to consider the challenges and opportunities that come with extended lifespans and plan accordingly.  By doing so, we ensure that individuals can enjoy those extra years while also addressing the economic and social challenges of an aging population.

Copyright©2023

Sources:

[1] The Four Pillars of the New Retirement: What a Difference a Year Makes; AgeWave.com

[2] Census Bureau

[3] https://smartasset.com/retirement/what-percentage-of-retirees-have-a-million-dollars

[4] What’s the Average Retirement Savings By Age? – Synchrony Bank – Synchrony Bank

[5] What Is the Average Retirement Savings by Age? – NerdWallet

[6] 22 Retirement Savings Statistics: How Do You Compare to the Average? (spendmenot.com)

[7] How much does the average American have in 401k? (financeband.com)

[8] Medicare Advantage in 2022: Enrollment Update and Key Trends | KFF

[9] https://www.hamiltonproject.org/assets/files/changing_landscape_american_life_expectancy.pdf

[10] https://www.hamiltonproject.org/assets/files/changing_landscape_american_life_expectancy.pdf

[11] https://www.ilo.org/global/publications/world-of-work-magazine/articles/WCM_041965/lang–en/index.htm

[12] Lower Standard of Living in Retirement Looms for Many Americans: Pew | ThinkAdvisor

[13] State Automated Retirement Programs Would Reduce Taxpayer Burden From Insufficient Savings | The Pew Charitable Trusts (pewtrusts.org)

[14] 10 Facts About Age Discrimination in the Workplace (aarp.org)

 

*Reverse Mortgage loans are based on several factors, including age of the borrower, which is a minimum of 62 years old, interest rates, and the home’s value. Eligibility consists of ownership of the home, residency of the home, the home’s type, and the age of the residence. There may be fees and charges that are applicable, including loan fees and yearly contract charges. Several conditions for loan repayment may begin upon the borrower’s death, selling of the residence, or if the borrower leaves the residence. Interest on the loan payouts may be partially taxable. Kestra Investment Services, LLC and ProVise Management Group, LLC do not provide legal or tax advice. Any decisions on whether to implement these ideas should be made by the client in consultation with professional financial, tax, and legal counsel.