Here's something that I've always understood, but never seen an article on before -- the fact that we all face extra risks in retirement. This piece from Yahoo details the two added risks of retirement -- longevity risk and spending risk. Let's start with longevity risk:
One of the common concerns I hear from people approaching or in retirement is the fear of running out of money too soon. It's tough (okay, impossible) to know just how long a life expectancy you should plan for. When I run retirement projections for people, I'm now using age 97 as the default life expectancy. If I know that long lives run in a client's family, I may shift this even further out.
When you're planning for your retirement years, you'll want to err on the conservative side of life expectancy, meaning that you should plan as though you're going to live to a ripe old age. When you look at tables showing average life expectancies based on your current age, remember they are just averages.
Yep. I'd be really, really, really conservative on this one. It would be very bad to run out of money before you run out of life. In a bit, I'll detail how I'm handling this risk as well as the other one. My solution for each one goes hand-in-hand with the other.
As far as how to deal with longevity risk, the piece gives a suggestion:
There are protections you can put in place to guard against longevity risk. One is purchasing or electing an immediate annuity.
They then detail what sort of annuity, special circumstance you need to consider, what provisions you'll want as part of the annuity you buy, and so on.
The article then switches to spending risk:
People are living longer in general and spending more money in retirement than previous generations. In particular, people are spending more on gasoline, entertainment, travel, and health care. Most of my clients expect to spend about the same, or perhaps even more, in retirement than they do now. That's because they want to travel, play more golf, or spend more time on hobbies.
In particular, here's a big cost to watch out for:
No discussion of the spending risks in retirement would be complete without touching on the cost of long-term care. According to the MetLife 2006 Survey of Nursing Home and Home Health-Care Costs, the average rate for a private room in a nursing home is about $200 a day or about $75,000 a year.
So, how do we deal with these two risks? Here's what the article suggests:
- Run your retirement projections out to a reasonable life expectancy. Plan for a longer-than-average life.
- Add up what you're spending now if you are about to retire or if you are in retirement. Remember to include less frequent expenses like travel, cars, and real estate taxes. Plug those expense numbers into your retirement projection to see how long your assets last.
- Try to generate enough income from fixed sources (like TIPS or an immediate annuity) to cover fixed costs.
- Make sure your retirement budget has adequately prepared for health-care costs in retirement, which may include long-term care.
This is basically what I'm doing. I'm estimating that I'll live a long life and that my living costs will be higher than I expect. If I then save according to these goals, I should be fine. But, boy, that sure makes for a very big retirement number! Yikes!
Most people should have a fairly good estimate of their life expectancy by middle age and should use somewhat longer than that for planning, not averages.
People are probably spending more in retirement these days because they have it and they are living longer. Wealth can compound quite rapidly when it becomes large enough.
Long term care is really for your spouse or dependents. There isn't much need for it otherwise.
Posted by: Lord | October 24, 2007 at 12:28 PM
It makes a lot of sense to think long. After all, if you die younger then you can leave the money to family or causes. And if not then you know it's ok that you're living to be 95.
Posted by: Mrs. Micah | October 24, 2007 at 12:34 PM
By planning on living long, it will hopefully protect you in the future.
Posted by: Laura | October 24, 2007 at 03:00 PM
In some respects, this article sounds like a promotion for annuity-insurance:
"Try to generate enough income from fixed sources (like TIPS or an immediate annuity) to cover fixed costs."
Fixed costs? It is dead wrong to offer retirement projections based on assumptions that the cost of anything will remain fixed thru the lifetime of the retiree.
The only exceptions would be for fixed-rate liabilities, e.g., mortgages, car loans, etc. But in most cases, people tend not to take retirement until the house and the car are already nearly fully-paid, thus eliminating whatever few "fixed costs" they may have had.
Posted by: F. Morana | October 24, 2007 at 08:26 PM
Planning is always a good thing. Savings is a necessary part of that plan. Attempting to guess how long you will live is a fun little parlor game. But few of us focus on the one preventable and highly controllable aspect of that plan: our current health.
We may shun conservative investing in favor of growing our money faster but few of us can argue that maintaining a conservative approach to health will pay off in the future - big time.
The high cost of health care, and we all know that it is one of the hardest factors to tally can be made much easier if we enter those golden years fit and healthy.
Posted by: Paul Petillo | October 25, 2007 at 11:56 AM