This post focuses primarily on the implications of assuming, or planning, to live longer than one’s life expectancy.
For
the purpose of this post, we are going to assume that when you are
asked how long you plan to live and you reply, “I plan to live to 95 (or
100),” you actually have a financial plan, and it involves assuming
that you will die at age 95 (or 100).
Background
Four of the important assumptions in determining how much you can afford to spend in retirement are:
- Your lifetime planning period (LPP),
- Your spouse’s LPP,
- The household LPP while either spouse is alive, and
- The household LPP while both spouses are alive.
Of course, if you are single, the only assumption you need be concerned with is your own LPP.
Most financial advisors and retirement experts recommend planning to live longer than your life expectancy. In our post of September 5, 2020,
we referred to a Morningstar Research report authored by David
Blanchett that recommended that individuals (or their financial
advisors) develop retirement plans by assuming adding a specific number
of years to life expectancies. In his report, Dr. Blanchett said:
“Through
simulations it is determined that adding five years to the life
expectancy estimate for a single household, and eight years to the
longest life expectancy of either member of a joint household (or to
each member if separate end ages are used for spouses), at the assumed
retirement age, is a reasonable approach to approximating the retirement
period…”
As noted in that September 5 post, the five-year and
eight-year additional years developed by Dr. Blanchett are approximately
the same differences in LPPs between the 50% probabilities (life
expectancy) and the 25% probabilities of survival from the Actuaries Longevity Illustrator (ALI) that we recommend for the default assumptions in our Actuarial Financial Planner (AFP) workbooks.
Implications of assuming (or planning for) longer-than-life-expectancy retirement periods
While
assuming longer-than-life-expectancy periods of retirement will
increase the expected number of years of household expenses (and the
present value of such expected expenses) in retirement, it will also
increase the number of years that household lifetime income streams of
payments like Social Security, pensions and life annuities may be
expected to be paid (and the present values of those streams).
Therefore, this longer-than-life-expectancy planning strategy will
generally favor lifetime income types of assets over non-lifetime income
assets, like bonds, when it comes to building a Floor Portfolio for
retirement. In fact, if a discount rate consistent with non-risky
investments is assumed, the purchase price of a single premium immediate
life annuity will generally be significantly less than the present
value of the expected annuity payments under the contract at time of
purchase.
Similarly, lifetime income products that defer payment
of benefits, like deferring Social Security benefit commencement or
lifetime annuity products with cola increases, will frequently have
higher present values if longer than life expectancy retirement (payout)
periods are assumed. Since we encourage readers to annually compare the
present value of household assets with the present value of household
spending liabilities to determine their annual household Funded Status,
investments or actions that can increase the present value of household
assets relative to household liabilities are always worth exploring.
This is especially true if a household wants to fund their essential
expenses primarily with non-risky investments.
Probabilities of mortality vs. LPPs
There
is a relatively wide range of ages that we can expect to live to
centered around our current age plus our current life expectancy. Some
retirement experts/financial advisors believe that probabilities of
mortality/survival are more sophisticated and should be incorporated
into the process of determining how much households can afford to spend
each year. We disagree. Pieces of us do not die each year. In any future
year, we will either be 100% alive or we will 100% die during that
year. We just don’t know which year “that” year is and therefore, we
must plan conservatively. However, once we plan to live to a specific
age, that specific age should be used in our plan until we obtain
information that is inconsistent with this assumed (or planned) age.
Why four LPPs for married couples?
This
gets a little geeky here, but instead of simply taking the longer LPP,
LPP-Either Alive is technically the lifetime planning period where
either spouse is expected to be alive. In order to determine present
values of expected expenses over the entire joint lifetimes, but with an
assumed percentage decrease in expenses upon the first death within the
couple, it is also necessary to know the LPP when both of the couple
members are expected to be alive.
It should be noted that the LPP
default assumptions, and all default assumptions in the AFP, can be
changed by clicking on the default box, selecting override and inputting
the override assumption in the override box.
Conclusion
Given
the uncertainty of when we will die, most financial advisors/retirement
experts recommend planning to live longer than our life expectancy. If
this is actually your plan (and you are not just talking), you should be
aware that certain decisions, like whether to purchase a life annuity
or when to commence your Social Security benefits, may also be affected
by your LPP assumption(s).
