How long do you think you will live? This is the greatest area of uncertainty when creating a financial plan. We know that people are living longer, but we don’t know how much longer that will be in 30 to 40 years. Former President George HW Bush was 94 when he died last week. The last three Presidents who died lived in to their 90s (Reagan, Ford, and Bush). Jimmy Carter is 94 years old. These are people born in the 1920’s or earlier. How long should clients born in the 1950’s expect to live?
For a married couple, there is a 72% chance that one of them will live to age 85. There’s also an 18% chance that one of them will live to age 95. Remember, life expectancy means that half of people will live longer than the average. Financial planning clients are healthier than average, work in jobs that tend to put less stress on the body, can afford decent healthcare and have the time and resources to stay physically active.
The typical financial planning client who worked and saved for 35 years to accumulate $1-3 million is not equipped to sustain their standard of living to age 100. Most financial plans that use realistic assumptions for inflation and investment returns are projected to run out of money when the client reaches the early to mid 90s.
One potential solution for solidifying these financial plans is the use of deferred immediate annuities, also known as longevity annuities. These are future income streams that begin payment for several years, typically at age 85. When purchased 20 or 30 years in advance, this future income stream is cheap compared to current annuity rates. The client pays a lump sum to the insurance company, and payments do not begin for several years. If the client dies before annuity payments begin, the premiums are forfeited. Most contracts do not include a death benefit, and the addition of a death benefit increases the cost.
This is where clients and planners have a hang up. They worry about paying for something they might never use. But that is the wrong way to think about insurance. If your house did not burn down last year, do you consider your homeowner’s insurance premium a loss? Do you not hope to outlive your term life insurance policy? Will you be mad if you never need long-term care? Insurance is a transfer of risk, and the price of purchase is the premium. We transfer risk to avoid probable, large losses. Outliving one’s financial assets is something to consider insuring.
Still many retirees fear paying a premium that equates to 10-20% of their nest egg. Longevity annuities are cheaper the earlier they are purchased. Perhaps planning should start earlier, when workers in prime earning years can use bonuses to purchase small slugs of future income streams. Instead of waiting to fork over a large premium, pay more psychologically manageable amounts over a period of years. This strategy makes the purchase of longevity insurance feel similar to life insurance and long-term care.
Don’t let reports of declining life expectancy distract you from thinking about longevity risk. The longer you live, the longer your current life expectancy. Recent declines in U.S. life expectancy are attributable to complications from obesity, such as diabetes, and sadly, the opioid crisis. If you are approaching retirement age, you are most likely past these risks.
If you want a more detailed calculation of your life expectancy, here is a nifty little online calculator.