100 years and counting: The financial reality of extended longevity
People’s chances of running out of assets and savings during retirement increases greatly if they live longer. Financial advisors have a critical role to play in helping clients mitigate this risk.
Many people struggle to accept the fact that there is now a good chance that they will live into their 90s and even beyond 100. This has implications for their financial situation, as they may not have provided adequately for their old age.
Tom Lenkiewicz, Head of Retirement and Asset Location at J.P. Morgan Private Bank, pointed out that based on the US Social Security Administration’s Actuarial Life Table, “there’s already a 19% chance that one member of a married couple of healthy non-smokers will make it to age 100.” He added that “when you layer in advances in healthcare and pharmaceuticals, and just the overall improved scientific understanding of the process of aging, 100 may become the norm and not the exception.”
As Lenkiewicz laid out in an article discussing financial planning for a longer life, a 65-year-old retired couple with a target annual spending of USD750,000 would need an additional USD4.7 million in assets from their current portfolio to cover an extra ten years of life (see Figure 1).
The problem is exacerbated by a lack of awareness about the likely trajectory of retirement spending, which often follows a “horseshoe” curve, said Poppy Fox, an Investment Director at discretionary investment management firm Quilter Cheviot.
“At the beginning of retirement, people tend to spend quite a lot of money because they’re generally in good health and have got lots of energy. They want to travel and do all the things they wanted to do after leaving their jobs,” she explained.
“However, once they’ve finished travelling, they’re often quite happy metaphorically pottering around their garden in their slippers. Then, as their health declines at the later end of retirement, they spend more on healthcare or a care home. So it's high spending, lower spending, then higher spending again,” she said.
Healthcare costs magnify the risk of failure
Given the steep rate of medical inflation and the widening gap between the number of years people live (their lifespan) and the number of years they are healthy (their healthspan) many people may also not be prepared for their later-life healthcare spending.
That’s why it’s crucial that financial advisors inform clients of the risk of running out of money during retirement, said Fahad Hassan, Chief Investment Officer at Albemarle Street Partners, a boutique investment consultancy and discretionary fund manager serving advisors.
“That risk of failure depends on not just the overall amount of money in the retirement pot, but also on how much you’re taking out,” he said. “That is heavily influenced by the returns in the initial years, which have a disproportionate impact on the sequence of returns.”
For instance, “if you went into retirement and all of a sudden there's a big market decline, your pot shrinks before the market goes up again. If you're withdrawing money during those earlier years, you've crystallized losses as you're removing that money,” said Hassan.
In that scenario, people may be better off temporarily reducing their spending. “Withdrawals don't have to be front-end loaded," he said. "Let's say you're planning to buy a motor home and travel the world — you could decide to do it three or five years from now rather than immediately. Or you could adjust your withdrawal rate to, say, 90% of what you were originally thinking.”
“You’d want to do be making those adjustments early in a well-thought-through manner by sitting down with an advisor and using a cash-flow modeler,” said Hassan.
Meanwhile, because many financial planning tools work on the assumption that retirement spending is relatively predictable, they need to better incorporate this concept of spending flexibility, given that retirees typically have some ability to adjust their spending and portfolio withdrawals in response to changing circumstances. Integrating dynamic rules into retirement income plans could make it easier for clients to make optimal spending decisions.
Derisking too soon
Another trap people can fall into, according to Fox, is adopting an overly cautious approach to their pension portfolios, with insufficient allocation to risk assets such as equities.
Many pension plans automatically derisk portfolios in the run-up to retirement by switching out of equities into bonds — known as lifestyling. “Taking a little bit of risk off the table is not necessarily a bad thing if your portfolio has been very high-risk, but I certainly don't think you want to go to 100% fixed income if you're potentially going to live to 90 or 100,” Fox said.
Andrew Oxlade, a Member of the Board of Trustees of the UK’s International Longevity Centre, highlighted a recent analysis by Fidelity which looked at what would happen to a retirement portfolio invested 100% in global equities over the past decade.
“If you had GBP100,000 in 2015 and invested it in a global stock market fund, and took out 4% a year, rising with inflation, after ten years you’ve effectively taken out more than GBP40,000, but you’d be left with nearly GBP189,000,” said Oxlade — with the caveat that this performance might not be repeated (see Figure 2).
Lenkiewicz stressed the need for portfolio growth because “some people may under-appreciate the impact of not just additional years of life, but also additional years of inflation eroding their purchasing power.” He cautioned, however, that “it has to be balanced with risk tolerance and risk capacity.”
Giving while living
In addition to ensuring their retirement pots can see them through their golden years, many people also hope to leave something behind for their loved ones. Given high rates of inheritance tax in many developed nations, “there’s a very big incentive to make money last exactly,” said Oxlade.
This has given rise to a growing trend of “giving while living” as part of estate planning.
“We’re seeing a lot of our clients realizing that they’ve probably got more than enough for themselves, and they’d rather help the next generation whilst they’re still alive, and then they can also see the benefit of it,” said Fox.
But careful cash flow planning is vital to doing that, Fox added. “It’s a very tricky balance of having to put your own life jacket on first and make sure you look after yourself before you start helping others.”
Putting off retirement
People’s chances of outliving their retirement pots also fall markedly if they continue working, even on a part-time basis, said Oxlade. “I have two colleagues in their 60s who say ‘the closer you get to retirement, the less appealing it becomes.’ Of course, not everyone is in a rewarding job that they enjoy, but it could increase your chances of a healthy life by keeping you engaged. It allows you to maintain your social connections and have a sense of purpose.”
Hassan echoed that view, suggesting that these are topics advisors should discuss with clients. “Maybe they’d rather work three days a week, not five days. Maybe they should consider changing industry. These things around flexibility of what work means in those later years is, I think, something that advisors can really help with — or they should help with.
Meanwhile, Lenkiewicz sees scope for advisors to have even broader discussions with clients about living better as they live longer. “Not just focusing on the economics, but also paying close attention to matching up their healthspan with their lifespan to avoid spending those additional years in long-term care facilities or hospitals.”
Lenkiewicz also emphasized the need for people to invest in relationships with friends, family and their communities to make their final years more meaningful. “We have to look at it more holistically,” he said.
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