Longevity Risk in Retirement and How to Plan for It

By Chris Duderstadt

August 7, 2023

Longevity Risk in Retirement and How to Plan for It

Key Points – Longevity Risk in Retirement and How to Plan for It

  • Defining Longevity Risk
  • Why It’s Important to Have a Budget, Even in Retirement
  • Understanding Your Income Sources
  • Why We Take Planning for Longevity Risk So Seriously at Modern Wealth
  • 8 Minutes to Read | 23 Minutes to Watch

Is Longevity Risk a Legitimate Risk in Retirement?

One of the top concerns that our advisors hear from clients and prospective clients is running out of money in retirement. We all want to live long, healthy lives, but just how big of a concern should longevity risk be with retirement planning? Well, the best way to mitigate longevity risk in retirement is to plan for it. We’re going to explain how to go about doing that to help you have more confidence, freedom, and time in retirement.

We’re Passionate About Planning for Longevity Risk at Modern Wealth

Before we discuss how to plan for longevity risk in retirement, we need to define longevity risk and explain why we understand the importance of planning for it. According to Investopedia, longevity risk is the chance that life expectancies and actual survival rates exceed expectations or pricing assumptions, resulting in greater-than-anticipated cash flow needs.

Planning for longevity risk is truly at the heart of why Modern Wealth Management exists. Dean Barber started his own business because he didn’t want to see people run out of money in retirement. Longevity risk really hit home for Dean when he was growing up after he witnessed his grandfather needing to move in with his parents. Dean helped people plan for longevity risk for 26½ years as the CEO and founder of Barber Financial Group. He’s now proud to be doing it on more of a national scale as a managing director at Modern Wealth.

“Longevity risk is really the risk of having too much life at the end of your money. Nobody wants that.” – Dean Barber

Our advisors will be quick to tell you that some of the specifics for planning for longevity risk will depend on your unique situation. Oftentimes, the hardest part of planning for longevity risk in retirement can be where to start. So, we’ve made a list for you of seven ways to plan for longevity risk.

7 Ways to Plan for Longevity Risk

1. Assessing You’re Assets

This is a simple yet critical first step to planning for longevity risk. How much have you saved for retirement? What are your income sources and what would your retirement cash flow look like if you retired today? How much is in your 401(k)? Do you understand how your 401(k) is being taxed? If you have a traditional 401(k), your distributions will be taxed when you take them out. But if you have a Roth 401(k), you’ll pay the tax beforehand and then get tax-free growth on the distributions. It’s important to understand that it isn’t about what goes in, but what comes out.

Do you have any IRAs? If so, you need to understand the rules for taking money out of those IRAs. Those have changed drastically because of the SECURE Act and continue to change with SECURE 2.0 and the revisions that have been made since it became law on January 1, 2023.

Maybe you have a pension? While pensions aren’t quite as common as they used to be, we still receive a lot of questions about them, as they can still be a key source of income in retirement.

And, of course, you have your investments. Many people think that they have a financial plan when they really just have an investment portfolio. Understanding sequence of returns risk is an important component to planning for longevity risk in retirement. It can be easy to give in to fear and greed when investing. That’s why we strongly suggest that you have a diversified investment portfolio. If you had your ideal asset allocation at the beginning of the year, think about the returns you’ve had since then. That asset allocation probably isn’t exactly how you want it anymore, so it might be time to rebalance.

2. Setting Up a Spending Plan

This is a nicer way of saying a budget, which can make some people cringe, but this is critical part of planning for longevity risk. We encourage you to set up a spending plan for retirement that considers expenses such as health care, housing, groceries, travel, and other major expenses in retirement.

Also, think about how those expenses are different from each other. Obviously, the costs are different, but they also inflate at different rates. Your mortgage won’t inflate at all, while health care and college tuition for kids/grandkids will inflate even higher than good and other services. That’s why we apply a higher inflation factor to health care when building a financial plan.

Speaking of health care, there are a lot of unforeseen expenses that can derail your retirement if you don’t plan for them. Your situation can quickly change if you and/or your spouse requires a long-term care stay or extensive medical care. It’s important to not only make sure that the spouse requiring medical attention is in good hands, but the healthy spouse who will be paying for the unexpected expenses.

Health-related incidents are just one example of unexpected expenses and planning for longevity risks. It’s critical that your health insurance and other insurance coverages—property and casualty, auto, house, life, etc.—are up to date.

3. Properly Claiming Social Security

There was one retirement income source that we left out of the first point, and we did that intentionally. That’s Social Security. It doesn’t tend to play well with other sources of income because Social Security is taxed differently than any other income source. So, we thought that it deserves its own point on this list of how to plan for longevity risk.

There’s an unfortunate misnomer that the date you can start claiming Social Security (when you turn 62) is synonymous with the date you retire. In many circumstances, delaying when you begin claiming your benefits, you can get much larger monthly payments that can enhance your income stream later on in retirement in a big way. And remember that your decision of when to claim Social Security isn’t just about you. It’s about your spouse as well. There are more than 600 iterations of how you and your spouse can claim Social Security. The difference between the best and worst iteration can be a significant amount of retirement income.

“You need to claim Social Security with the thought in mind that you and/or your spouse are going to live a long time. When you maximize Social Security and are thinking about a longer life expectancy, that will typically involve the higher income earner delay claiming Social Security all the way to age 70.” – Dean Barber

Social Security claiming strategy for you and your spouse is one of the many things that’s highlighted in our Retirement Plan Checklist. This checklist includes 30 yes-or-no questions and an age-based timeline of things to consider leading up to and during retirement so you can gauge your ability to retire successfully. Download your copy below.

Longevity Risk

Retirement Plan Checklist

4. Considering How Long Your Family Members Have Lived

This is actually more of a two-part point. Yes, considering your family’s history of longevity is an obvious point with planning for longevity risk. Still, there’s a chance that you could be an outlier and live longer than your relatives. The risk of running out of money in retirement is very real, so going on the conservative end of guessing your life expectancy is the way to go.

“Average life expectancy is built into most financial planning tools. However, we believe that it’s essential to go past that average life expectancy. Most of the people that have done a very good job of preparing for retirement are taking care of themselves and are in better health. They’re going to live longer in many cases.” – Dean Barber

Oftentimes, we’ll put someone’s life expectancy age in the mid 90s or even up to 100. That isn’t what the average life expectancy is, but if we stress test the plan for living longer, it usually works. And we know it will certainly work if you don’t live that long.

5. Your Health Is Your Wealth

We can’t have a list of how to plan for longevity risk in retirement without mentioning the importance of staying healthy. Your wealth isn’t just about how much money you have. Think about how to define true wealth. You do have your financial wealth, but time, socialization, and health are also different types of wealth. Those different types of wealth are intertwined in many ways too.

“One aspect of longevity risk is living past your capabilities of being able to enjoy your life. Taking care of your health is critical so you can enjoy your longer life.” – Dean Barber

Staying healthy can increase your longevity, which makes the other items we’re listing for how to plan for longevity risk that much more important. The longer you stay healthy, the better the odds are of you working longer (if you wish) or finding other ways to generate income in retirement.

If you don’t stay healthy, you’re subjecting yourself to significant medical expenses and obviously a lower quality of life. And as we mentioned earlier, that doesn’t just impact you. It can negatively impact your spouse and other family members, so staying healthy plays a big role in planning for longevity risk.

Life Insurance in Retirement

A lot of people also don’t think about life insurance in retirement. Dean thinks of life insurance in retirement as something that we need to stress test. What happens if one spouse passes early? How will that impact the surviving spouse? They’re going to be in a higher tax bracket and lose the lowest of the couple’s Social Security benefits. Maybe there is a pension involved. What are the expenses going to look like for the surviving spouse?

“If those expenses put a strain on the surviving spouse, what would $100,000, $200,000, $300,000, or even $500,000 in life insurance do? What if that came into play in the event of a premature death? In that case, you need to include that additional premium in your spending plan. Which one ends up being better?” – Dean Barber

6. Having a Fluid Financial Plan

Were there a few things earlier that you thought about when we discussed unexpected expenses that you need to make sure to plan for in retirement? That illustrates why everyone needs to have a fluid financial plan.

As you approach and go through retirement, various things in your life are going to change. As those things change, you need to update your plan accordingly. We recommend reviewing your plan at least twice a year with your CFP® Professional so you can assess your financial situation and plan for longevity risk.

“For example, think about a car replacement. You’re going to have less car replacements the older you get because you’re going to be less mobile. If you were thinking about having a car replacement at 80, maybe that isn’t necessary anymore?” – Bud Kasper

7. Working with a Team of Professionals

Working with a CFP® Professional is critical. There’s a big difference with working with a financial salesperson who will just sell you investments compared to a CFP® Professional who will try to figure out what’s important to you and create a goals-based plan that helps you fulfill your needs, wants, and wishes.

But working with a CFP® Professional is just the start of who you need to be working with in the retirement planning process. That CFP® Professional should be working with a CPA that review your plan from a tax perspective. What tax planning opportunities might be available to you? At Modern Wealth, we have CPAs in house as well as estate planning, insurance, and investment specialists. We take a team approach to plan for longevity risk to help give you more confidence, freedom, and time in retirement.

So, do you have any questions about longevity risk? We’re ready to talk to you about how to plan for longevity risk in your retirement. You can schedule a 20-minute “ask anything” session or complimentary consultation with one of our CFP® Professionals by clicking here. We can meet with you in person, by phone, or virtually depending on what works best for you. Let’s create a plan for you that allows you to live a long, happy life without the worry of longevity risk.

Longevity Risk in Retirement and How to Plan for It | Watch Guide

00:00 – Introduction
02:20 – Thank You to a Long-Time Fan
04:28 – What Is Longevity Risk and Why Plan for It?
06:23 – Social Security Is Involved?
08:11 – Inflation, Taxes, Health Care, and Longevity Risk
08:32– TRIVIA
09:11 – Back to Inflation, Taxes, Health Care, and Longevity Risk
12:13 – Your Health is Your Wealth
16:39 – Life Insurance in Retirement
18:49 – Question 13 in the Retirement Plan Checklist
19:52 – A Simple Example with Cars
21:45 – What Did We Learn Today?

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Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management, LLC, an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management, LLC does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.