The most common concern among American retirees by far is running out of money. A 2024 study by Allianz found that 63% of Americans fear running out of money more than they fear dying.
The concern is understandable; having worked your entire career so you can live the life you imagine, few enjoy the prospect of having to make reductions to their lifestyle due to a funding shortage. These concerns can feel even more pressing in an inflationary environment that also includes rising medical costs. In this month’s blog post, I want to take some time to discuss some of the key strategies we use at Opus 111 Group to manage Longevity Risk (the risk of outliving your assets).
Understanding Your Retirement Needs
The first step in making sure you don’t outlive your assets is knowing how much you intend to spend.
We work with our clients to help understand their needs and wishes for retirement spending—how to cover essentials like food, housing, and healthcare, while still budgeting for the things you have been looking forward to—trips, new and old hobbies, and philanthropic giving. Armed with this knowledge, we can begin to craft a customized plan to help them manage their spending prudently as they enjoy a work-optional lifestyle.
One must also assess how well a financial plan holds up in periods of elevated inflation. Thanks to aggressive rate cuts in the wake of The Great Recession, many were lulled into a false sense of security that inflation would not trouble their portfolios or their retirement spending needs. Sadly, COVID-19 and the massive increase in money supply in its wake roused the sleeping inflationary dragon. At Opus, we stress test our plans against both historical inflation rates, as well as rates one and two standard deviations above the average. This lets us have a degree of confidence that a plan has a chance at succeeding even in high-inflation environments.
The Withdrawal Rate Landscape
For many years, the financial industry was dominated by William P. Bengen’s “4% Rule.” In a 1994 article in the Journal of Financial Planning, he proposed that a withdrawal rate of 4% of a portfolio’s total value should be sufficient to sustain a portfolio over a retirement period of 30 years. Bengen’s “rule” was simple, easy, and reassuring. Unfortunately, the 4% rule was also based off a 50/50 split between stocks and bonds within a portfolio. The interest rate environment over the past 15 years have severely eroded the feasibility of maintaining such a high percentage of assets in bonds, especially during a long stretch where real returns (the income paid by the bond adjusted for inflation) were flat or negative.
In 2020, economist Wade Pfau—a well-known figure in the financial advisory world—claimed that “there is something like a 65% to 70% chance that the 4% rule works for today’s retirees rather than being a near certainty.” For his part, Pfau estimates that a 3% withdrawal rate is a safer place to start. Morningstar largely agreed, pegging the rate for “safe” withdrawals at 3.3%, assuming a 30-year retirement starting in 2021.
Making matters worse – the concept of 30 years of retirement spending may also prove to be an underestimation. While the U.S. average life expectancy is currently 79.4, the population of centenarians (those aged 100 or older) is expected to quadruple over the next 30 years. Personal family history is ultimately a more accurate predictor of individual life expectancy, but the demographic data is clear: Americans must be prepared to save more, work longer, or both as they prepare for retirement.
So how does Opus approach planning for retirement spending? Our team begins with what we call a Sustainable Income Ratio (SIR), which represents the percentage of your desired retirement income that comes from income sources you cannot outlive. Using the SIR as a baseline, we can then develop a withdrawal rate from the remainder of the portfolio that we feel is likely to withstand both longevity and inflation risk, while still allowing a client to meet their needs in the short and long term.
Methods for Extending Portfolio Longevity
The primary method for extending portfolio longevity is keeping a larger percentage of your money in growth-oriented assets like equities. While this also introduces more volatility and greater potential downside risk to your portfolio, the growth potential can help your money stretch for longer into your retirement. Of course, with a well-developed Sustainable Income Ratio, maintaining a greater equity allotment is a less stressful experience.
For those who want more guardrails on their growth assets in retirement, the world of structured products developed tremendously in the past decade. These products are complex and use derivatives (options trading with calls and puts) to help build in levels of protection against downward performance. In exchange, there is a cap on the maximum possible appreciation for such holdings. For those with precise knowledge of how much further growth their portfolio needs to sustain them in retirement, structured products can be a crucial way to build in more downside protection in an uncertain market. One should carefully work with a financial advisor to determine whether structured products fit their goals and needs as they continue to plan for portfolio longevity.
The biggest risk to retirees’ portfolios is the rising cost of medical care. Adjusted for inflation, total national health expenditures were 10 times greater in 2023 than they were in 1970. The cost of skilled nursing care has also risen tremendously. In the zip code of our Seattle office, CareScout estimates that an assisted living community costs approximately $7,100 per month, or $85,200 per year.
As a result, retirees often see a sudden—and drastic—spike in their healthcare spending in their final years of life. This spike often greatly reduces their portfolio, reducing what they have available to pass on to their heirs. We work diligently with our clients to help them obtain the right level of Long-Term Care Insurance—coverage that pays out when a policyholder has difficulty with several activities of daily living like getting dressed or bathing. LTC Insurance, as it is called, plays a pivotal role in preserving a portfolio’s longevity for your heirs. Even for those who don’t plan to leave a legacy, the funding provided by LTC insurance can help ensure that a retiree is able to choose the community that is the best fit for their lifestyle, rather than cost being the primary focus.
Conclusion
There is no single measure that will ensure that you don’t outlive your assets. Gone are the days of the 1960s, when 41% of all private-sector workers were covered by a pension plan. Still, the right combination of methods can go a long way toward mitigating both inflation and longevity risk with a retiree’s accrued life savings.
We believe that a retiree should focus on enjoying the life they have imagined, secure in the plan they have created with their advisor and knowing that their advisor is doing their best work to manage their portfolio to meet their long-term goals. If you’d like to learn more about our process-The Praxis Formula or how we construct and manage portfolios, please reach out to our team.
Andrew Harvey AIF®, CPFA™ is the Chief Operating Officer and a Financial Advisor in Opus 111 Group’s Seattle office. He created Opus’ SYFI (Secure Your Financial Independence) Program for young professionals in 2022 and works in Opus’ Retirement Plan Consulting division. In his spare time, he plays the Irish sports of Hurling and Gaelic Football for USGAA side Tacoma Rangers. Andrew lives in Kent, Washington with his wife Lauren and their two cats, Bella and Leeloo.
The information in this article is for educational purposes only and should not be regarded as specific legal, financial, or tax advice.