Retirement. When we think about retirement, many of us dream of traveling the world, pursuing our hobbies, volunteering in our community, or getting to spend more time with our families. But, of course, the challenge many of us will face as we retire is how do we make sure our money lasts as long as we do and avoid the risk of running out of money?
After all, the goal of retirement is to spend it how we want.
To do that, we have to answer one obvious question, just how long do we have to stretch our money for?
Back in the 1950s, the average length of retirement for 65-year-old men was eight years. That’s it.
Today, retirement looks very different. One of the biggest changes is that we have a higher life expectancy, and living longer means a longer retirement.
Life Expectancy and Longevity Risk
When it comes to retirement income planning, longevity is often referred to as a risk multiplier.
Living longer than expected can magnify the impact of inflation, market volatility, and long-term care needs.
Yet, longevity is one of the most misunderstood risks as it pertains to retirement income planning.
Part of this misunderstanding stems from the confusion created by the phrase “life expectancy.”
Bill and Jill
Life expectancy is defined as the average number of years of life remaining for a group of people at any given age. To understand just how this impacts our retirement, consider siblings Bill and Jill.
At 65, Bill’s life expectancy is 89. Meaning that he needs to figure out how to make his money last 24 more years if he retires today.
Jill’s life expectancy is 90. That’s 25 years of retirement, but that’s only living to the average life expectancy.
Think of it this way.
You have 100 men in a room and 100 women in another. Half will live beyond life expectancy, and half will live less.
Furthermore, 25 out of 100 men can expect to live to age 94; 5 out of 100 could live to 100.
25 out of 100 women can expect to live to age 96, 5 out of 100 could live to 102. As odd as it may sound, living longer than you planned is an actual risk in retirement.
We call it longevity risk, and longevity risk makes all of retirement’s other risks greater. So it’s a risk multiplier.
Take inflation. Let’s say inflation is a constant 3% during your retirement.
Today, Bill spends $100 on his groceries, but when he reaches life expectancy, his grocery cost will have more than doubled to $222.13. By age 94, his grocery bill would now be $257.51. That’s two and a half times what it was when he retired.
If Bill’s income didn’t increase in retirement, he would quickly find himself looking for ways to cut his grocery spending.
Longevity risk multiplies inflation risk, making Bill’s retirement much more challenging.
How To Avoid The Risk of Running Out of Money
Fixed index annuities (FIAs) may be one potential solution to address the risk of running out of money due to living longer than anticipated. FIAs are designed to be long-term vehicles that offer a myriad of design options.
FIAs are subject to surrender charge schedules but do provide a wide variety of durations. In addition, the availability of income benefit riders, which may be offered either built-in or for an additional cost, can offer retirees the ability to receive lifetime income.
Such lifetime income options can complement a retiree’s other retirement assets to build a comprehensive retirement income plan.