managing itPlanning for a Long Retirement
The effect of rising prices combined with increasing lifespans exposes you to the chance of outliving your savings. Here are ways to prepare.
The primary goal of a retirement investment and income strategy is to ensure that your savings last throughout retirement. Achieving that all-important objective includes addressing two critical risks: longevity and inflation. American life expectancy is higher than ever and is likely to continue rising. Living longer not only requires you to continue spending over a greater number of years but also further exposes you to increases in prices for goods and services. For a retirement that may last well into your 90s, inflation may ultimately become more of a concern than market volatility. "Longevity has transformed the model for how people should save and invest for retirement," says Christine Fahlund, CFP®, a senior financial planner with T. Rowe Price. "We now have to prepare for a post-work life that could last three decades or more."
According to the Society of Actuaries, there is a 50% chance that one partner in a couple will live to age 92, and a 20% chance that one will live to age 98.* Those chances are likely to improve if current aging trends hold. "To be prepared," notes Fahlund, "it's important to have a realistic spending plan and consider ways to maximize the withdrawal amounts you receive from your investments, Social Security, and possibly continued employment."
* Society of Actuaries and the National Association of Personal Financial Advisors (NAPFA), 2011
Outliving your savings may pose the greatest threat to your retirement. Consider taking the following steps to protect your income stream throughout your life.
Practice Retirement®: Keep Working But Start Playing Sooner. The traditional view of retirement divides your life into two clearly defined stages: working followed by playing. Retirement, however, has evolved—and along with it the expectation that you must receive your gold watch before you are "allowed" to start playing. Fahlund believes that in your early 60s you can begin enjoying the lifestyle you see for yourself in retirement as long as you remain employed into your late 60s. "If you envision traveling to India when you're retired," she says, "consider the option of going there on vacation when you're age 63 and still employed. Why wait?"
Fahlund points to a number of advantages that come with staying at your job longer. "By carving out time to travel or indulge in a hobby while you are still working," she says, "you will be able to benefit financially from additional years of salary and benefits, and you will be able to capitalize on the opportunities during this vibrant phase of your life."
Spend from your wages, not your savings. You are likely to have more to spend by remaining at your job than you would by retiring and relying on your savings to pay for the activities you want to enjoy. The longer you remain employed, the more time your current investments and savings will have to potentially grow and the fewer years you may need to support yourself from your investments in retirement.
Receive employee benefits longer. Capitalize on the benefits your employer may offer—such as health and life insurance and matching contributions to a retirement plan. Remember that Medicare does not begin until you reach age 65. Retiring earlier may mean you have to pay significant health insurance premiums each year until you reach that age when you will be at least partially covered by Medicare.
Delay taking RMDs. Taking required minimum distributions (RMDs) from the retirement account you have with your current employer can be delayed if you are still employed there at age 70½ (certain restrictions apply). The IRS rule states that you must begin taking RMDs by the later of either April 1 of the year after you reach age 70½ or April 1 of the year after the year you retire from the company. (RMDs from all other prior employer retirement accounts and all IRAs, except Roth IRAs, must begin at age 70½, regardless of your employment status.)
Fahlund adds that you don't necessarily have to work full-time in your 60s to enjoy the benefits of additional income. A part-time paycheck will reduce the amount you need to withdraw from savings, even if it adds up to only a few thousand dollars a year. "The more expenses that can be covered by wages, rather than investments, the better," Fahlund says. "Little steps like this can, over a long retirement, really make a difference in your likelihood of not running out of money."
Delay Social Security benefits. You are eligible to begin receiving Social Security benefits once you turn age 62. However, your starting benefits will increase approximately 7% to 8% every year you delay taking them from age 62 up to age 70, plus adjustments for inflation. By waiting until age 70, your benefit payment would have almost twice the purchasing power of what you would have received if you had started them at age 62. "The majority of retirees," says Fahlund, "will come out ahead by delaying taking their payments for even a year or two."
It's vital to consider the impact of inflation on your income. Over the long term, inflation can dampen the real—or inflation-adjusted—returns on your investments. U.S. consumers have experienced average annualized price increases of 3% since 1926. Using that number as a guide, you can anticipate that your purchasing power will erode by close to half in the next 20 years. "If you need $100 to buy an item when you are age 65, you probably will need nearly $200 to buy that same item when you are 85," says Fahlund.
Practice Retirement®: Balancing Work and Play in Your 60s
A gradual transition away from your career will help you test the retirement lifestyle you see for yourself, while continuing to earn a salary and benefits.
working, spending, and saving
working & spending
A good rule of thumb for a 30-year retirement is to withdraw no more than 4% of your retirement assets in the first year that you stop working—then increase your withdrawal amount every subsequent year by approximately 3% to keep pace with inflation.
Four common-sense strategies can protect your purchasing power through retirement.
Continue to invest in equities. Be sure to continue to invest a significant portion (60% to 40%) of your portfolio in equities for your retirement—especially in the years between ages 55 and 75. Over the long term, equities have been shown to provide more growth potential than either fixed income investments or cash. Because you may need to support yourself with withdrawals from your nest egg for more than 30 years, it is important that you understand that you will need to dip into principal as you age. Income from dividends and interest only will not be able to sustain the needs of most retirees for that many years. Therefore, by continuing to rely on the growth potential of your portfolio, the amounts you can afford to withdraw are more likely to increase sufficiently to keep up with inflation. In other words, we are living in a different world than that of our parents and grandparents. No longer can we plan to spend the income and never invade the principal; instead, we must take measured withdrawal amounts from the portfolio each year, regardless of whether they are principal or income.
Develop an inflation-adjusted withdrawal strategy. Your aim should be to live and spend comfortably while giving your savings a high probability of lasting up to 30 years or more, depending on your retirement age. A good rule of thumb for a 30-year retirement is to withdraw no more than 4% of your retirement assets in the first year that you stop working—then increase your withdrawal amount every subsequent year by approximately 3% to keep pace with inflation. "In our studies, we found that if markets decline temporarily during your retirement, you can stop those increases for a few years to provide a little cushion," Fahlund says. "Then resume the increases later when markets have rebounded. This can greatly increase your odds of a successful retirement.
"Remember that your lifestyle and spending can determine how inflation affects your retirement. The larger your withdrawal amounts each year, the more rapidly inflation will erode the remaining balance of your portfolio.
Consider supplemental health insurance. Inflation in health care has far outpaced the overall annual inflation rate. This trend makes it difficult to predict medical or long-term care costs 30 years from now and makes it important to consider medigap insurance options to supplement Medicare—and to consider the costs of future premiums, deductibles, and potential copays. Most people should also look into purchasing long-term care insurance, says Fahlund, since the cost of nursing home or other long-term care generally is not covered by Medicare. Unfortunately, these policies are becoming increasingly difficult to find. More insurance companies are leaving the marketplace because they do not want to be exposed to significant financial risks they could face as retirees live longer, due in part to rapid advances in medicine. Consider that today women live an average of 4.9 years longer than men, according to the Centers for Disease Control and Prevention. A longer lifespan means women are likely to have greater medical expenses than men.
Use Social Security as a backstop. Your Social Security benefits are increased each year for inflation, as measured by the consumer price index. In January 2012, for example, 55 million Social Security beneficiaries received a 3.6% bump in their monthly benefits. These inflation adjustments strengthen the case for delaying benefits as long as possible: The higher your initial benefit, the larger the dollar value will be of any cost-of-living adjustments. And if your portfolio were to be completely depleted, you would still have a predictable, steady stream of inflation-adjusted income for the rest of your life—and for the life of your surviving spouse as well.
LOOK AHEAD TOGETHER
Be sure to talk with your family about your plan for a long retirement. By letting members of younger generations know of your intentions, and what you do and don't expect from them, you can help them make their own financial plans. Those conversations, combined with sound risk-reduction strategies, will give you and your loved ones confidence that you have the financial security and flexibility to address your evolving needs throughout a long and fulfilling new chapter in your life.