Longevity-Proof Your Future
If only living into one’s tenth decade -- an increasing probability -- felt like a five-star proposition. In a recent BlackRock survey, more than half of investors reported that they're worried about outliving their assets.
It's hard to imagine that many of us will fare as well as those who had the dumb luck to retire in 1980, just before an epic bull run in stocks and bonds. Someone who retired then with $350,000 invested in a 60/40 split between stocks and bonds would have accumulated $1.3 million 30 years later, assuming a 4 percent annual withdrawal rate from savings, Bankrate recently pointed out. But whether we're decades from retirement or staring it in the face, we can make important tweaks to our finances now to increase the odds of long-lived financial success.
We've all read about the importance of having the right mix of assets -- the balance between growth and income, domestic and international, and so on. Before even thinking about that, consider this: How much you manage to save for retirement is five times as important, in ensuring that your money lasts, as asset allocation decisions, according to a study reported in the American Society of Pension Professionals and Actuaries Journal.
- Special Report: The Future of Retirement
While not easy, increasing savings is a simpler prospect than settling on an asset mix. Yet according to Vanguard’s annual report on the savings habits of the 3 million employees in the 401(k) plans it administers, the median annual savings rate of 6 percent hasn't changed since 2008. Even if you add a typical 3 percent employer match, the 9 percent savings rate still falls short of the 12 percent to 15 percent savings goal that Vanguard and others recommend as ideal.
For those who can afford to squirrel away more, small adjustments can have a big impact over time. A 40-year-old earning $100,000 who boosts his 401(k) contribution from 6 percent to 7 percent could increase his 401(k) balance by $100,000 at retirement. (This assumes that an employer provides a 3 percent match and that the portfolio has an annualized average return of 6 percent.) Move the savings needle up to 10 percent, assuming that match, and the additional savings approach $400,000 over 30 years.
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Saving more today for a distant goal can be a hard sell. So here's a little psychological trick to keep you motivated: Research has shown that envisioning a later-life you can be an effective kick in the pants to save more. The Face Retirement tool at Merrill Edge produces age-adjusted photos of your future self.
An academic study of more than 2,300 individuals points to a further subtle behavioral nudge that can influence your planning: Framing your future in terms of how long you will live, rather than when you might die, increased individuals’ estimates of their longevity by seven to nine years.
A popular retirement-planning nugget says the younger you are, the more you should invest in stocks, given the decades you have to ride out the intermittent swoons. Steve Utkus, principal at the Vanguard Center for Retirement Research, suggests focusing on a more nuanced reason to do this: Your investments should complement your human capital.
When you're young, the vast majority of your financial "assets" are in the form of your future earnings over a long career. So “the value of your earnings power looks a lot like a fixed-income investment, in terms of a consistent income stream,” says Utkus. That means that to balance that out, you want to emphasize equities when you are young and your human capital is at its peak.
Vanguard’s target-date retirement funds for people in their twenties through forties keeps 90 percent invested in stocks. At the 50-year mark, the stock portion begins to ratchet down, reflecting the reduced role of human capital (your earnings power may peak around 50) and the likelihood that your investment portfolio is now a bigger piece of the asset pie.
That said, the prospect of increased longevity makes it imperative to have exposure to growth-oriented investments such as stocks into retirement. That's partly due to the effect of decades of inflation. “People understand what inflation is, but they don’t understand the impact of inflation,” says Bill Benjamin, chief executive officer of US Bancorp investments.
It is, in a word, big. Over a 30-year retirement, inflation will cut the purchasing power of every dollar in your 401(k) down to nearly 40 cents, assuming a fairly benign 3 percent inflation rate.
William Bernstein, principal at Efficient Frontier Advisors, is a longtime student of inflation and other investment risks. He distinguishes between the types of risks investors need to guard against in his new e-book, "Deep Risk: How History Informs Portfolio Design." In looking at what he terms shallow risks (losing money from intermittent market volatility) and deep risks (permanent loss of capital), inflation emerged as the deep risk with the highest probability of affecting one's life.
The best overall defense against deep risks, he says, is a globally diversified stock portfolio with a value tilt and a small allocation to inflation hedges, including Treasury Inflation Protected Securities (TIPs) and natural resource producers.
Bernstein advises increasing TIPs exposure inside tax-deferred accounts to a "healthy dollop" as you head into retirement. Given the poor yields on TIPs now, he suggests using today's rising stock market to slowly take some profits and hang out in cash until TIPs yields become more appealing.
Delaying when you begin to draw Social Security benefits is another good hedge against inflation. For every year from your full retirement age (between 66 and 67, depending on the year you were born) to age 70, your benefit increases by an inflation-adjusted 8 percent. “It’s not that you have to work 15 more years,” says Vanguard’s Utkus. “You want to think about working a few more years as a hedge against your longevity.”
The risk of long-term-care costs obliterating savings is another threat to assets later in life. Frank Jaffe, a certified planner at Access Wealth Planning in Roseland, New Jersey, believes so strongly in long-term-care insurance that he requires clients to sign a document if they opt not to buy it.
It's costly -- though not compared to the cost of having to self-insure 100 percent of care, should you need it down the road. Many insurance companies have quit the business, which was becoming unprofitable, in part because people were living longer. Companies that still offer the coverage include John Hancock Financial Services, a unit of Manulife Financial Corp., Mutual of Omaha, MedAmerica and Massachusetts Mutual Life Insurance Co.
The premiums on the policies get more expensive the longer you wait to buy. Married couples can get a discount of as much as 30 percent if they buy a policy together, says Babs Hart, a long-term-care specialist at Hart Insurance Group in Birmingham, Alabama. A typical policy for a couple of 60-year-olds might run $3,500 a year, instead of $2,500 per person separately, she says. For a 50-year-old couple, the premium might be $2,000.
A relatively new area of insurance tied to the prospect of longer lives is longevity annuities. A policy is purchased at age 65 but typically begins paying out only at age 85. Access Wealth Planning's Jaffe sees it as a potentially important tool. A 65-year-old investing $50,000 in a longevity annuity today could collect $22,000 a year beginning at 85. "That's a relatively small sum to effectively create a late-life pension," says Jaffe.
Still, as with long-term-care insurance, it remains a hard sell to clients who are leery of forking over money for a product they may never need. Jaffe has a different perspective. "As their adviser, I'm not worried about them dying," he says. "My concern is how long they may live."
(Carla Fried is a freelance writer based in California.)