When you think about potential risks to a well-funded retirement, what are some of the first things that come to mind?
Maybe it’s that you don’t have room in your budget to save enough. Maybe it’s that the market won’t produce the kinds of returns it used to. Maybe it’s inflation. Maybe it’s a possible future cut in Social Security payments.
We could probably ask you to rattle off 10 or 15 concerns, and you might never get to one of the most serious, but overlooked, risks to a successful retirement plan:
A long life.
The Tea
“Geez, guys, we know Halloween is right around the corner, but isn’t ‘getting really old can hurt your wallet’ a little macabre, even for you?”
It sure is. But it’s also the truth.
What’s funny is, many people—even those who already have a financial plan—already have a similar fear. That is, they worry that what they save will be insufficient, and that their retirement savings will run dry before they die.
WealthUp Tip: One of the biggest factors in making your savings last in retirement is a good withdrawal strategy.
However, that fear is generally rooted in expecting to die at or before a certain age.
Longevity risk is a little different.
Longevity risk is the possibility that you could outlive your savings—because you live longer than expected.
It’s something that many of us don’t even think about, let alone financially plan for. But we should.
“When people are planning for retirement, one of the overlooked risks is the idea of longevity risk—living to an older or very old age and outliving your personal savings,” says R. Dale Hall, FSA, MAAA, CFA, CERA, who is the Managing Director of Research at Society of Actuaries. “If people retire and only plan for a 15- or 20-year retirement but live into their 90s, they can easily outlive their savings or potentially end up with fewer assets to leave their heirs.”
So today, we’re going to spend some time talking about longevity risk, and how it should change the way you think about retirement.
The Take
Because we’re going to talk about life, death, and the money in between, we decided to do it the right way—by talking to an actuary.
Actuaries are the ultimate experts in risk management. They use mathematics, statistics, and financial theories to assess the financial impact of uncertain events to help businesses and other clients account for (and often minimize) risk. They’re critical to a number of industries, most notably (and unsurprisingly) the insurance industry.
WealthUp Tip: A financial advisor can help you understand a variety of retirement risks. The question is: Do you need one?
Actuaries also play a vital role in one of the largest retirement systems of all: Social Security. The Social Security Administration even has an Office of the Chief Actuary, who “The Office of the Chief Actuary plans and directs a program of actuarial estimates and analyses relating to SSA-administered retirement, survivors and disability insurance programs and to proposed changes in those programs.”
TL;DR: They’re the right people for this job.
Earlier this week, we sat down with Hall to get his thoughts on a variety of topics revolving around longevity risk. Read on to see what he has to say about how to account for longevity risk, including how to quantify that risk, why we overlook it, why early retirees really need to be careful, and more.
Why we don’t think about longevity risk
“We think of risk as very big things: ‘What happens if my car is lost in a flood?’ or ‘What if my house is on fire?’ But longevity risk has a different nature.
First and foremost, why wouldn’t I want to live a very long time? I hope I wake up and see the next day! It seems like more of an opportunity than a risk.
But it raises some specific issues: namely, outliving your savings.
It’s also not as dramatic; longevity risk happens slowly. It’s like a house fire that’s only slowly burning within the walls, but it’s building, and suddenly, it becomes very visible—and at that point you can’t react as quickly as you might need to. There’s no putting that fire back in the box.
And that’s what we see happening when people aren’t contending with longevity risk. They wake up one day and realize ‘I don’t have enough savings’ or ‘I need a lifestyle change.’ Or, some event occurs at an older age, like a health event or financial event, and there’s no getting back to where you were in your planning very quickly.
So it’s one of those things that can slowly grow over time, but when it finally becomes realized as a true risk, it can be hard to react quickly to it and solve it.”
A major longevity risk blind spot: Our personal experiences
“A lot of people underestimate what their potential for living to 80, 85, 90, 95 might be. People will take the current approach and say, ‘My parents retired at 65, they unfortunately died when they were 80, so that’s what I should be planning for. That’s normal. That’s my sphere of observation.’
What they don’t recognize at times is two things:
- The distribution of the range of scenarios can be big.
- When their parents live from 65 to 80, these are people that were born typically 30 years earlier.
We’ve grown up with different medical treatments and technology. Cancer rates are wildly different than 30 years ago, people with different chronic conditions—diabetes, or kidney and heart conditions—live a longer, healthier life. It’s radically different.
But people overemphasize what they’ve seen with their own relatives and transport it to ‘this is what’s going to happen in my experience.’ We keep noting the world of medical technology is so much different, and that you have to recognize this exposes you to a lot of longevity risk.”
The risk of longevity risk is rising
“Longevity risk is a problem that’s also happening more, and it has the potential to be more common today than we’ve seen in the past.
In 2024, roughly 100,000 people were expected to reach 100 years of age in the U.S., according to [estimates from the U.S.] Census Bureau. But looking forward, the Census Bureau says that could quadruple to more than 420,000 by 2054.”
For more context: In 1950, the Census Bureau estimated the U.S. had only 2,300 centenarians. By percentages, then, centenarians:
- made up 0.0015% of the population in 1950
- are expected to account for 0.03% in 2024
- are expected to account for 0.11% by 2054
How to account for longevity risk
“You have to start by understanding longevity risk—understand that there’s a range of scenarios that might play out. Identify the major barriers to achieving longevity success.
You’ll want to consider a range of scenarios where you might live longer than you expect. We see too many times that people focus their retirement planning around life expectancy. That’s natural, but by its own nature, that’s like planning to be right only 50% of the time. It’s an average.
WealthUp Tip: Understanding all your potential health care costs in your later years is an essential part of retirement planning.
The analogy I would use is: If we had to catch a flight at an airport, I don’t think any of us would leave at a time that only gave us a 50% chance of being on time. You have this great vacation planned, but you only have a 50/50 chance of getting there? You’d want to plan for a 95% chance of making the plane. You’re shooting to avoid all major risks by leaving at a time that gives you a 95% chance of being successful.
Retirement planning should be viewed in the same way.
You can use the Actuaries Longevity Illustrator, sponsored by the Society of Actuaries and the American Academy of Actuaries, to see what the range of potential outcomes might be.
Instead of focusing on strategies where you’ll only be successful 50% of the time, you can use this tool to focus on financial strategies for retirement where you’ll be successful 90% or 95% of the time. Instead of life expectancy age, you want to focus on life preprancy age.
It’s not ‘How long do I expect to live?’ It’s ‘How long should I prepare to live?’
The Illustrator helps put things into easy visuals so you can see the distribution of various outcomes and put together some solid probabilities. The probability of you making it to age 85 is X%, and age 90 is Y%, and age 95 is Z%. It makes the possibilities very tangible.
Source: Longevityillustrator.org.
Editor’s note: This image is just part of a much longer readout from the tool.
The retirement tool’s experience differs by age. The possible range narrows as you get older. But there’s also “longevity credit” the longer you live. Because once you actually get to age 65, you’ve taken out a lot of the risks of unfortunate premature death. But the tool is most valuable for people 45 and up who are thinking about getting to a retirement age (or are nearing a retirement age) and want to start doing some forward planning.
Also note that the Illustrator will ask questions along the lines of your healthiness level and your health habits. And you can run the tool multiple times: What if I call myself extremely healthy? What if I call myself moderately healthy? And in the back of this calculator, there is actuarial stuff going on to see how these factors impact mortality.”
Longevity risk and early retirement
“Longevity risk is even more important with early retirees.
If you’re going to retire early, you’ve just expanded the horizon—the chances of being exposed to different retirement risks, by five or 10 or 15 more years.
If you retire at 50, what comes along with stopping retirement there? For one, how do you have healthcare covered from 50 until 65, when Medicare starts to kick in? If you’re going to self-insure and not be in an employer program, are you exposing yourself to the financial risk of an extreme health condition that would be more easily covered in an employer-sponsored insurance program?
Anecdotally, people who are retiring early are paying attention to current numbers to validate current retirement rather than ensuring longevity risk is being covered. So it’s more important for people who are retiring early and need to cover 40 to 50 years, than 20 to 30 years if you retire at 65.”
Investing and longevity risk
“We talk about constructing portfolios for retirement. That’s important to do. It makes sure your investments are correctly aligned with your goals.
But people think of retirement as finishing the race—that you can relax and stop paying attention. However, reaching retirement age is just the first stage of a longer retirement process. Retirement planning is just as important in your retirement years as it is building up to them.
Retirement can last 30 or more years, so we should be cognizant of whether we need to make radical changes that don’t necessarily account for longevity risk.
Don’t get me wrong: Retirement is a great thing to celebrate. But it’s a celebratory milestone in a much bigger race of enjoying a happy and healthy retirement.”
The thing we emphasize the most is there are a number of solutions out there to mitigate longevity risk, and that number is growing.
It’s beyond having Social Security as a base level of income. Sometimes that’s just a small percentage of a high-net-worth (HNW) person’s retirement.
The concept of lifetime payouts match extremely well with longevity risk. Many in our profession work in pension plans, life insurance, annuity plans, and those are part of a broad set of financial tools that builds a strong foundation to fight longevity risk. But I don’t think anyone advocates that you take all your assets and stick it into something that will spit out a monthly payment for life. There’s certainly value in keeping a portion of assets that grow with inflation to cover those kinds of risks.”
Adapting your plan for longevity risk
“A long life is something that people obviously consider positive, but it requires planning for a much longer retirement than in the past.
There can be a variety of solutions: working longer, deferring Social Security to increase the benefit you eventually get. It could be a lifestyle change: where you shop, how you budget, what you might do to save more money for the future.
The plan just needs to be routinely re-evaluated. Every great coach has a game plan, but then they make minor adjustments as the game goes along. That’s the right mentality to have.”
—
In case it wasn’t obvious by now, we like to be a little cheeky with our weekend missive. But to be clear: Our jokes about life being a risk to your wallet are just that—jokes. We should all want to live a long, happy life. And we should all try to be financially prepared for that.
Riley & Kyle
Like what you’re reading but not yet a subscriber? Get our weekly financial insights and updates delivered to your inbox every Saturday morning by signing up for The Weekend Tea today! You can also follow WealthUp on Flipboard for more great advice and insights.
On the date of publication, Kyle Woodley did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.