How long do you think> you'll live? Whatever your answer, it's less grim than you think: Two-thirds of Americans underestimate how long they'll live. And with life expectancies at an all-time high, that otherwise-good news is becoming a serious challenge for retirement planning.
According to recent data from the Centers for Disease Control, the average life expectancy is now over 78 years for the first time in American history. For people who are healthy and have good genes, it's even higher. A 65-year-old healthy man has a 50% chance of living to age 85 and a 25% chance of living to 92, according to the Society of Actuaries. For a healthy 65-year-old woman, there's a 50% chance she'll see 88 and a 25% chance to reach 94. If those two people are married, there's a one-in-two chance one of them will celebrate a 92nd birthday.
Longer life spans also mean longer retirements. A couple in its 60s needs its nest egg to stretch 30 years or more but advisers are having trouble convincing clients they'll need at least three decades of savings. In spite of the statistics and actuarial numbers, only about a quarter of retirees and 20% of pre-retirees think they'll live to turn 86. "Life expectancy has increased dramatically, and people have old numbers in their minds," says Kate Warne, investment strategist at Edward Jones.
There's also a strong financial incentive to bury one's head in the sand. Living longer and stretching retirement savings may very well mean spending less. "The most important thing is really to make sure you stick to the spending plan you lay out in the beginning," says Bill Bengen, a financial adviser and author of "Conserving Client Portfolios During Retirement" in Chula Vista, Calif. "The first couple of years of retirement are the most important."
For example, a retiree with a $1 million portfolio and assuming an annual average 7% rate of return and a nominal rate of inflation, could spend $52,000 per year for 20 years, says Bengen. But if that pot needs to last 30 years, on the other hand, the annual budget drops to $45,000.
To emphasize the new retirement reality, many advisers are using 90, 95, even 100 years as the expected life expectancy when designing a client's portfolio. "Initially, there is a blank stare," says Drew Denning, vice president of the retiree services division at Principal Financial Group. "At first clients think 15 years of retirement is reasonable." This also means preparing clients who may have had relatively low out-of-pocket medical costs while employed for significant health care expenses, especially at the end of that long retirement.
And those costs can really kick in as we age, says Anthony Webb, a research economist at the Center for Retirement Research at Boston College. "Bad health catches up with all of us," he says. And despite recent changes in Medicare, retirees especially women have significant out-of-pocket medical costs, according to a December 2010 report by the non-profit Employee Benefit Research Institute. Men retiring at 65 in 2010 will need an estimated $124,000 to $211,000 saved up to cover health insurance premiums and out-of-pocket medical costs and there's still a 10% chance they'll run out of savings, the report said; Women, who typically live longer, need $143,000 to $242,000. And those figures don't include the costs of a nursing home or assisted-living facility. About 70% of those over 65 will end up living in a long-term-care facility, according to the U.S. Department of Health And Human Services. In 2009, the average cost for a room in an assisted living facility was $3,131 a month; a semi-private room in a nursing home was roughly double that rate.
But in spite of these increasing costs and longer retirements, advisers say their strategies haven't changed much. Lisa Kirchenbauer, a financial planner with Omega Wealth management in Arlington, Va., uses 100 as a life expectancy when planning. "Most of my clients won't live to 100, but what if they do? My job is to run the worst case scenario." That might mean cutting expenses, moving to a smaller house or working longer but she won't decrease estimated rates of inflation or life expectancy. Chris McDermott, senior vice president of retirement and financial planning for Fidelity Investments, says it also requires the appropriate "asset allocation to hedge against longevity risk." Maintain enough stock exposure to combat inflation; limit withdrawals to 4% to 5% per year; and delay Social Security payments as long as possible. One strategy that specifically addresses longevity is buying a fixed immediate annuity, which turns a single lump-sum payment into a stream of cash that extends until death like a self-funded pension. Last year, sales of fixed immediate annuities were $8 billion, up 2% over 2009, according to Beacon Research.