The modern concept of an actuarially planned and funded government pension for all working citizens began in Prussia by Otto von Bismarck in 1889. At the time, the average adult lifespan was age 70 – and retirement payments did not begin until, you guessed it, age 70. Therefore, most people did not expect to live long enough to actually receive any retirement payments. By the 1960’s, the average American expectation was that you would retire at age 65, and then hopefully live another 5-10 years. These 5-10 years of non-working are labeled your “Golden Years.” Today, financial planners are prepping their clients to plan on funding a retirement that may last 40 years beyond age 65. Financial planners call surviving beyond age 80 as “longevity risk,” where you may run out of money when you are least capable to do anything about it. (Today, there are 92,000 Americans older than age 100). Longevity Risk is based upon the life expectancy of reaching a particular age; note that half of Americans will outlive the statistical average lifespan, around mid 70s. For example, if you have reached age 55 today then you should expect to live until your mid 80s. The longer you live, the higher your personal expected life-span increases. There are people reading this who may live to age 105 and beyond. Needless to say, withdrawing money from retirement accounts for 30-40 years requires enormous amounts of assets to draw upon. Plus, old-age frequently correlates with increasing medical bills, procedures, and ongoing prescriptions.
The traditional approaches to reduce financial longevity risk include:
- Working past age 65 to reduce the number of retirement years to fund.
- Buying annuities to receive a monthly payment to offset stock market fluctuations.
- Invest in “Retirement Target Date” mutual funds to outsource changing your portfolio.
- Buy long-term care insurance to reduce the risk of the high-cost nursing care.
- Reduce your investment account withdrawal rate from 4% to 3%, stretching your accounts to last longer.
Those may be helpful, but to me inflation risk is the critical (but invisible) problem to address. Rent, food, and healthcare increase in price over time. Even at a small 3% annual inflation rate, prices double in 24 years. So your fixed annuity or social security retirement, which may have been plenty of money when you first retired, will become increasingly paltry and possibly unable to support you in 20 years. Plus, you have another 20 years to fund with consumer prices doubling yet again. (Yes, there is a small cost-of-living increase to Social Security Retirement payments, but it is never as high as the real inflation rate).
Some of the ways to reduce inflation price increases are:
- Purchase stocks that routinely increase their dividends each year.
- Own investments that can increase their prices with inflation – such as rental real estate.
- Purchase “inflation protected” securities – usually bonds, treasuries, and ETFs.
- Turn on the “reinvestment” option on some of your interest/dividend paying securities during retirement to continually ratchet up their rate of earnings.
Building up the financial assets to retire can be difficult and the potential longevity risk adds another layer of challenge to manage. But these issues must be addressed and planned in order to experience a comfortable retirement without running out of money beyond age 80.