People are living longer, and that presents unique challenges
Life expectancy has risen over the last half-century,1 and while this is great news, it does complicate retirement planning. Longevity risk — the possibility of outliving one’s retirement savings — has risen in profile as the population lives longer. Though it’s a new challenge, it presents an opportunity for financial professionals to talk to their clients about retirement income allocation.
Gone are the days when financial professionals could focus solely on helping their clients build their savings. While still a critical component of the relationship, you now need to help them navigate the retirement income landscape. In fact, clients move 90% of the retirement assets they’ve held in other retirement accounts to the financial professionals that help them create retirement income plans.
It is mutually beneficial to be familiar with longevity risk and to help your clients plan accordingly. Let’s take a closer look at exactly how a new focus, and a new thinking, on retirement income can help both you and your clients succeed.
Understanding longevity risk
Longevity risk puts one of retirees’ greatest concerns in the spotlight. According to a 2021 Transamerica survey of U.S. workers, outliving their savings and investments was cited by 42% of respondents as their greatest retirement fear — the highest of any response — even greater than declining health (39%) and long-term care costs (34%).2
"Living longer, and not planning for it, can throw a wrench in some of even the best laid plans."
However, one of the biggest disconnects exists when it comes to how long older adults can expect to live. Financial professional Jeremy Keil says that this largely comes to a lack of understanding of life expectancy.
“Most people underestimate their longevity because they base their expectations on what happened with their parents and grandparents,” he says. “They have 20-to-50 years of medical advances over their grandparents. They also read about 'average life expectancy' in the newspaper, which is based on newborns, not 60-year olds.”
Living longer, and not planning for it, can throw a wrench in some of even the best laid plans . Marguerita “Rita” M. Cheng, the CEO of Blue Ocean Global Wealth, agrees with Keil.
“Longevity risk Is something that we need to be addressing, because it’s not unusual for people to spend 40 years in retirement – that’s not that farfetched,” she says.
The 4% rule was the conventional wisdom for retirement income planning. Basically, it instructed your clients to withdraw 4% of their initial portfolio account balance for their first year of retirement and then adjust that amount each subsequent year for inflation. If they do this, their savings should last for the rest of their life.
The 4% rule may no longer be the sure thing it once was. Whether due to inflation, rising life expectancy, or changing expectations for retirement lifestyle, you may need to help your clients devise a new asset allocation strategy or portfolio construction to help them create a lifetime income stream.
“If you’re taking out higher withdrawal rates early on in the portfolio in a down market, the client is taking on longevity risk because there’s a chance they’ve depleted the portfolio where it can’t grow – this is why it’s important to have cash reserves,” Cheng says. “This is why it’s important to have different buckets of money.”
"...but most people will focus on the so-called ‘four Ls’: Longevity, lifestyle, liquidity, and legacy."
The timetable for retirement has changed. Not that long ago, a 65-year-old couple could reasonably assume they both might die by the time they reached 95. Now? There’s a 25% percent chance at least one of them will reach 98, and a 10% chance they could reach 102.3 This highlights the crucial role that retirement income can play in your clients’ financial planning — how can they wisely spend their accumulated assets over their remaining years?
Find a W in the ‘four Ls’
Of course, retirement income planning is different for everyone depending on what their priorities are, but most people will focus on the so-called ‘four Ls’: Longevity, lifestyle, liquidity, and legacy . According to economist Dr. Wade Pfau, it’s crucial to take these four pillars into consideration when strategizing with your clients because you have to determine how to balance and optimize these four areas based on their priorities. Cheng addresses the four L’s early on in client relationships.
“You need to know your assets, your liabilities, your income, your expenses — all the quantitative stuff, that way we can talk about the qualitative stuff,” she says. “My job is not to micromanage you, it’s to know what’s important to you today, so that I can make sure you can do that in the future.”
The four Ls are not without their own hurdles. Pfau identifies issues such as inflation risk, market risk, interest rate risk, and longevity risk as some of the biggest obstacles in building the four pillars of retirement income planning.
What are you thinking?
When it comes to retirement spending there are two basic schools of thought. Probability-first adherents tend to believe the stock market will be enough to help them reach their retirement goals. On the flip side, those who advocate the safety-first approach find nearly any risk unacceptable and are more likely to incorporate a product like an annuity into their portfolios.
“It’s true, if it’s a largely equity portfolio, it’s more growth oriented, and over the long term you may outperform but there’s a chance you need money sooner as opposed to later,” says Cheng.
Naturally, not everyone innately knows whether they fall into one camp or the other, and some people may be a little bit of a both. Luckily, there’s a retirement income style quiz that can provide some insight and clarity into your clients’ retirement income styles.
The annuity solution
If your clients are concerned about longevity risk, they have several options available to them. They can take proactive steps such as deferring more money into their 401(k) plans, or they could add funds to a more traditional IRA. They can also consider an annuity, which might add a more reliable source of income once they retire. When combined with Social Security, annuities can provide a steady stream of funds to help your clients feel confident they won’t outlive their savings.
“As financial professionals, we have a lot of strategies in our toolbox, including systematic withdrawal from a portfolio, but that’s not always a guarantee,” Cheng says. “And that’s when an annuity may make sense because it does provide sustainable, predictable, lifetime income.”