Confronting Longevity Risk: How to Afford a Long Life in Retirement
Updated: Sep 12, 2019
As a physician, you focus on helping others to live a long, healthy life and you want the same thing for yourself. But will you be able to afford a long life? You’ve heard the advice over and over: save for retirement, as early as you can, for as long as you can. It’s prudent counsel, and since most physicians have a healthy disposable income (even while repaying student loans), you may be well on your way to accumulating a sizable nest egg through a 401(k) plan, a SEP IRA, Roth IRA, or other tax-advantaged retirement accounts and taxable investments. In other words, you’re doing what you need to do, right?
Yes and no. Putting money aside for retirement is only part of the picture – planning how to spend that money after you’ve retired is also critically important. Think of it as treating a patient with a chronic but manageable condition – making the right diagnosis is crucial, but unless you establish a treatment plan that is monitored and adjusted as needed, the outcome is far from guaranteed.
Since we can’t know how long we will live, we all face a condition known as longevity risk. The risk of outliving our retirement savings is something all but the wealthiest need to take seriously. In this article, we discuss mistakes physicians and other high earners often make with respect to longevity risk. By avoiding these mistakes, you will increase the likelihood that your financial resources will be sufficient for what could be 20 or more years of enjoying life after you stop working.
Conventional Wisdom May Not Apply
Have you heard the rule of thumb that says to put 15% of your pre-tax income into retirement savings? M.D.s may want to modify that rule since they typically don’t start saving for retirement until close to age 30 (after med school, residency and maybe a fellowship). In terms of retirement savings, you are likely far behind your contemporaries who started saving right after college, or shortly thereafter. The math, based on compounding interest, is not in your favor.
Consider two people, Mary and Joe, who save the same amount every year, but Mary started at age 24, while Joe began at age 29. For every $100 Mary saves, Joe has to save about $134 to accumulate what Mary will have when they reach age 65 (assuming a 5% annual return). M.D.s who want their retirement savings to “catch up” should set a goal of saving more than 15% of their income. An extra $200 per month could mean an additional $150K saved by the time you retire.
Another Rule Bites the Dust?
For decades, the standard assumption has been that if we withdraw no more than 4% of our nest egg each year, we won’t outlive our retirement savings. However, this general rule assumes 30 years of spending because life expectancies were much lower decades ago than they are today. In 1935, the year Social Security was created, a white male born in the U.S. was expected to live to age 61, and a white female to age 65. Statistically speaking, the average person was expected to live only a few years in retirement (or die before retirement began). Contrast that with those born in 1990. According to the Social Security Administration’s life expectancy tables, having reached the age of 29, white males in the U.S. can expect to live to age 81.7, and females to age 85.6. If they live to age 67, men are expected to live another 20 years, women another 22 years, and one in five can expect to live past 90. Those with high incomes tend to have more access to quality healthcare, leading to longer lives, so it is prudent to assume you will live longer than what the averages predict. In other words, your retirement is likely to last much longer than in the past, so your savings have to last longer too.
As retirement approaches, many people gradually adjust their asset allocation to hold more bonds. Bond prices are usually far less volatile than stock prices; excluding bonds with very long maturities – 20 years or longer. Shifting into bonds helps retirees avoid selling equities to meet living expenses during a market downturn. And, as we all know, downturns will happen from time to time, without warning. Considering that interest rates have been at persistently low levels, high-quality bonds may not be earning much more than 2.0-2.5% after taxes. Depending upon the size of your nest egg, your risk tolerance, and your goals; A 4% withdrawal rate may be too generous.
Estimate Your Expenses – Realistically
Of course, the amount you will want to withdraw depends upon your retirement lifestyle. People often underestimate how much income they will need to cover their living expenses in retirement. This is especially true for high earners who are accustomed to a lifestyle that includes things like dining out regularly, high-end vacations, a club membership, maybe a second home, and so on. For many physicians, the notion that your expenses will decline significantly when you retire simply doesn’t hold up. In fact, you’ll have more free time to spend more money.
If you have been enjoying the finer things in life during your working years and want to continue to enjoy them after you retire, you’ll probably need to generate very close to 100% of your current income from a combination of social security benefits and retirement savings. Also know that Medicare doesn’t cover all medical expenses (for example, dental and vision care are not covered, along with other things) and doctors are not exempt from the inevitable decline in health that goes along with aging. Longevity risk increases if you spend a big chunk of your savings in the early years of your retirement and have less of a cushion to meet expenses if you live beyond your early 90’s.
Go for a Balance
In a nutshell, retirement could last longer than you expect, so you’ll want additional savings to cover that risk. Since investing in low-yielding bonds could deplete your savings too quickly if you withdraw much more than the bonds earn, you’ll probably want to keep at least some of your portfolio in equities. However, equities can be volatile in the short-term, so you need stable sources of income to avoid selling when the market is down.
A common asset allocation guideline is to invest 100 minus Your Age in equities – so, if you are 65, you would invest 35% in equities. This may be overly conservative, so 110 or even 120 minus your age may be better, especially if you can easily cut back on expenses if needed. Yet, if there is little to no longevity risk based on your accumulated assets and desired spending, then perhaps you could or should be more aggressive with your stock/bond mix. This holds especially true if you have legacy goals, such as leaving an inheritance to your children because the investment horizon would then be much longer than your expected lifespan.
One source of stable lifetime income is Social Security. However, it is quite possible those benefits will be reduced when the current Social Security surplus is depleted (currently projected to occur in 2035). Although it is somewhat unlikely that your benefits will be dramatically reduced, they are still likely to cover only a small portion of retirement expenses for doctors and other high wage earners. If you want more steady income that will last for the rest of your life, you might consider an annuity with a guaranteed lifetime payout. Annuities may involve high fees, so talk with your independent financial advisor, one who receives no compensation for selling annuities, before you sign up. Annuities are rarely the best option from a mathematical standpoint, but the promise of certainty can offer some individuals peace of mind.
Gold Medal Waters financial planners can run simulations to show how much income your retirement savings portfolio is likely to generate under many different scenarios over time. Armed with this information, you can make a realistic plan about what you can comfortably spend while you enjoy retirement. And remember, do whatever you can to say healthy so that longevity is not viewed as something to fear, but as a blessing. Please reach out to us with any questions.