BY WEALTH ADVISER
Introduction: The changing landscape of retirement and longevity
As medical advancements and improved living conditions continue to extend human lifespans, the traditional concept of retirement is undergoing a significant transformation. Today’s retirees are facing a new reality: the very real possibility of living well into their 90s or even past 100. This shift in longevity is reshaping how we need to approach retirement planning and financial management.
The Australian Bureau of Statistics (ABS) regularly publishes life expectancy data that illustrates this trend. For instance, a 60-year-old today has a median life expectancy of 85 for males and 87 for females. However, these figures only tell part of the story. As we’ll explore, planning for the median can leave many retirees financially vulnerable in their later years.
This article delves into the concept of planning for a potential 100-year lifespan, examining the implications of increased longevity on retirement finances and offering strategies to ensure financial security throughout an extended retirement period.
Understanding life expectancy: Beyond the median
When planning for retirement, many individuals and financial advisors rely on median life expectancy tables. However, this approach has significant limitations that can lead to inadequate preparation for a long retirement.
Median life expectancy represents the age at which half of a given population is expected to have died, and half is expected to still be alive. For example, if the median life expectancy for 60-year-old females is 87, it means that half of today’s 60-year-old women are expected to live beyond 87. This immediately highlights a problem: planning based on the median leaves a 50% chance of outliving one’s financial preparations.
Moreover, life expectancy is not static. As Ashley Owen points out in his analysis, “The longer you live, the longer you are likely to live.” For instance, while a 60-year-old female today has a median life expectancy of 87, if she reaches 80, her median life expectancy extends to 91. This dynamic nature of life expectancy is often overlooked in traditional planning models.
To better understand the range of possible outcomes, it’s helpful to look at survival probability curves. These curves show the likelihood of survival to various ages for different age cohorts. For example, Owen’s analysis reveals that for current 60-year-olds:
Approximately 84% are likely to live to age 70
64% are likely to live to age 80
40% are likely to live to age 90
Around 14% are likely to live to age 100 These figures underscore the importance of planning for the possibility of a very long retirement, potentially lasting 40 years or more.
The financial implications of increased longevity
The prospect of a retirement lasting several decades presents significant financial challenges. Traditional retirement planning models, which often assume a retirement period of 20-30 years, may fall short in the face of increased longevity.
One of the primary risks associated with increased longevity is the possibility of outliving one’s savings. This fear, often referred to as FORO (Fear of Running Out), is a growing concern among retirees. As Aidan Geysen from Vanguard Australia notes, “FORO, also known as longevity risk, is a growing problem. The most common symptom is loss aversion -- a heightened sensitivity to investment risk due to concerns over potential future losses.”
This fear can lead to overly conservative investment strategies and underspending in retirement. Paradoxically, while these behaviors stem from a desire for financial security, they can result in a lower quality of life during retirement years and potentially leave significant unspent assets at death.
The Intergenerational Report 2023 highlighted this issue, noting that “outliving one’s savings is a key concern for retirees in deciding how to draw down their superannuation, and consequently most retirees draw down at the legislated minimum drawdown rates.” This cautious approach often results in retirees leaving a significant proportion of their balance unspent, with projections suggesting that outstanding superannuation death benefits could increase from around $17 billion in 2019 to just under $130 billion in 2059.
Strategies for a 100-year financial plan
Given the potential for extended lifespans, it’s crucial to adopt strategies that can sustain financial well-being over many decades. Here are some key approaches to consider:
Total return investment approach: Rather than focusing solely on income generation, a total return strategy takes into account both capital growth and income. As Geysen explains, “A total return strategy therefore involves using both capital and income returns from investments to fund everyday living expenses on a sustainable basis.” This approach provides more flexibility and potentially higher returns over the long term.
Sustainable withdrawal rates: Determining a sustainable rate at which to draw down retirement savings is crucial. This rate should balance current spending needs with the need to preserve capital for future years. While specific rates will depend on individual circumstances, many financial experts suggest starting with a withdrawal rate of 3-4% of the portfolio value, adjusted annually for inflation.
Diversification and asset allocation: A well-diversified portfolio spread across different asset classes can help manage risk while providing opportunities for growth. As Owen notes, “Having a diversified portfolio will offset the risks of being too exposed to one asset class.” The specific allocation will depend on individual risk tolerance and goals, but maintaining some exposure to growth assets like stocks can be important for long-term inflation protection.
Consideration of guaranteed income sources: Products that provide guaranteed income, such as annuities or the Age Pension, can play a valuable role in a retirement plan. Research suggests that retirees with guaranteed income sources tend to be more willing to spend their savings, potentially leading to a more enjoyable retirement.
Regular review and adjustment: Given the uncertainties involved in long-term planning, it’s important to regularly review and adjust your financial strategy. This might involve reassessing spending levels, rebalancing investments, or adapting to changing health or lifestyle needs
Psychological aspects of long-term retirement planning
Planning for a potentially very long retirement isn’t just a financial challenge – it’s also a psychological one. Many retirees struggle with the shift from accumulating savings to spending them down.
As Samantha Lamas from Morningstar points out, “Although most retirees’ stories aren’t as dramatic as Scrooge’s, it’s not uncommon for retirees to have more than enough to live comfortably for the rest of their lives but still think a vacation is out of the question.”
This reluctance to spend often stems from deep-seated fears about running out of money. However, excessive frugality can lead to missed opportunities for enjoyment and fulfillment in retirement years.
To address these psychological barriers, Lamas suggests several strategies:
Refer back to your financial goals and life values regularly. Ask yourself if your current spending aligns with these goals and values.
Track your spending and take note of any significant changes. Consider whether these changes truly align with your desired lifestyle.
Be mindful of your emotions when spending retirement income. If you find yourself constantly pinching pennies despite having adequate resources, it may be time to reassess your approach.
Consider reframing your retirement savings as a paycheck. This mental shift can make it easier to spend the money you’ve saved.
Keep reminders of your goals and values visible. Whether it’s a Post-it note on your fridge or a note in your wallet, these reminders can help you focus on using your money to create the retirement lifestyle you desire.
Conclusion
Planning for a potential 100-year lifespan requires a shift in how we think about and manage retirement finances. By understanding the limitations of median life expectancy figures, adopting flexible and sustainable financial strategies, and addressing the psychological aspects of long-term planning, retirees can better prepare for a potentially very long and fulfilling retirement.
The goal isn’t just to ensure you don’t run out of money – it’s to strike a balance that allows you to enjoy your retirement years while maintaining financial security. As Owen aptly puts it, “Be prepared for the real possibility of living a lot longer than you might have thought!”
By embracing a ‘100-year plan’, today’s retirees can approach their golden years with greater confidence, freedom, and financial security, ready to make the most of however many years lie ahead.
References:
The psychological shift from saving to spending in retirement (firstlinks.com.au)
Overcoming the fear of running out of money in retirement (firstlinks. com.au)
How not to run out of money in retirement (firstlinks.com.au)
Comments