At AgeUp, we’re huge fans of not dying. It’s great. So great, in fact, that you might think there’s no downside. Not to be a bunch of Debbie Downers, but if every cloud has a silver lining, then at least some silver linings have clouds. And in this case, the storm cloud hovering over a long, healthy life is the premature death of your retirement savings.
If you’ve ever run out of money before payday, you’ll know it’s a terrible feeling. But imagine running out of money and paydays. That’s called “longevity risk,” and it’s a much bigger problem than most people realize. Let’s say you want to retire at age 65 and plan to make your savings last for 20 years. Life expectancy in the U.S. in 2018 is 79.3 years, so 20 years’ worth of retirement savings should be plenty, right? Not exactly.
Average life expectancy isn’t your life expectancy
The life expectancy of 79.3 years is an average from birth, but some people die young, which lowers the average life expectancy across the board. This might sound obvious, but once you live to a given age, you can’t have died before that age, so the average life expectancy from birth no longer applies to you. If you’ve lived to be age 60, your life expectancy is much longer than 79, and the longer you live, the longer you can expect to live.
For a more accurate picture of how long you should plan for your retirement to last, look at your remaining life expectancy. The Social Security Administration’s life expectancy tables say men born in 2014 can expect to live 76.2 years, and women can expect to live 81 years. But a woman who’s 65 years old in 2014 can expect to live another 20.4 years, which translates to a life expectancy of 85.4. A man who’s 65 has an average remaining life expectancy of 17.8 years, or 82.8. Once you’ve lived to age 80, you can expect to live even longer: 88.2 for men and 89.6 for women.
And these are averages, so about half will live even longer, and some much, much longer. A woman who is 65 today has a 30% chance of living to age 90, and a 20% chance of living to 94 or beyond. The bottom line is that individuals aren’t averages, so you shouldn’t expect to live an average amount of time.
Life expectancy age 60-90
|Age in 2014||Women||Men|
If you were to retire at 65 and live to 95, that’s 30 years of retirement, which is nearly the same length as your career. How much money have you made and spent in your working life? How much will you need to pay for prescriptions? For long term care?
There’s also the potential for world-changing medical and technological breakthroughs that may dramatically extend life expectancy. A cure for common cancers or a leap forward in heart disease research could mean millions more people living to 100 and beyond. Autonomous vehicles promise to all but eliminate car accidents, which is another leading cause of death. That’s all great news of course, but it also brings new problems, like…
How long will your money last?
Back when pensions were the norm, the longevity risk burden fell on the government or company. Now that we’re living in a mostly 401(k) (or nothing at all) world, solving the problem of longevity risk is up to individuals and their families.
One common strategy for sustainably drawing down your retirement savings is known as the 4% rule. In a nutshell, the idea is this: in your first year of retirement, you’d withdraw 4% of your retirement savings to cover your cost of living. Every year after that, you’d withdraw the same amount, plus a slight increase to keep pace with inflation.
Let’s say you retire at age 65 with $500,000 in savings. Following the 4% rule, you’d withdraw $20,000 the first year. The following year, you’d withdraw somewhere around $20,400, which is the original $20,000 plus 2% to keep pace with inflation. The next year you’d take out $20,800, and so on for the rest of your life. How long the money will last at this rate depends on how much you adjust your withdrawals to account for inflation and the yearly investment returns from your retirement savings (the standard mix for the 4% rule is 60% bonds and 40% stocks).
The looming savings crisis
The 4% rule works provided there’s not a major downturn in your investments and you have enough saved to live off a 4% withdrawal…but only if you have enough saved. In a 2018 study by the Insured Retirement Institute, 38% of baby boomers had less than $100,000 saved for retirement, and only 25% were confident their savings will last throughout retirement.
You can plan to be frugal, but life has a habit of getting in the way. The average 65-year-old couple retiring in 2019 can expect to spend $285,000 on out-of-pocket healthcare costs alone. And that figure doesn’t include food, rent, or the hundreds of other expenses you’ll encounter in life.
Once you start dipping into savings beyond 4% and drawing down the principal, the duration of your savings drops dramatically. And again, this all assumes you have enough saved to live off of a 4% withdrawal. If you need more to live on than 4% provides, there’s a great chance your retirement fund will go bust before you do.
A new approach to longevity risk
The numbers are alarming, but that doesn’t mean all is lost. At AgeUp, we’re working on a new way to help your parents address the “problem” of living a long, healthy life.