Dallas Salisbury spends the better part of his time at work researching the probabilities of retirement success for American workers. So when Salisbury, the chief executive of the Washington, D.C.-based Employee Benefit Research Institute, is calculating his own retirement plan, he uses figures he calls “very conservative.”
But to most planners, Salisbury’s figures may sound alarming — or just plain crazy. His plan must get him to age 108, he says. He sets projected rates of return at 1% over inflation and, when analyzing annuity products, he sets inflation at 8% compounded annually.
“I don’t want to have any chance of outliving my money,” he says.
At 65, Salisbury plans to continue working for some time. That’s also part of his retirement plan. “Most financial planners would look at our situation and they’d say we’ve saved too much,” he says. “My wife says we haven’t saved enough.”
WHAT IS ENOUGH?
The question of how much money is enough leads to another question, which is perhaps the most difficult and most central issue advisors face when helping clients plan for retirement: How long should you expect clients to live?
Getting this variable exactly right is virtually impossible. Getting it wrong can have a profound impact on a client’s quality of life, lifestyle and legacy.
Will your clients live to 85? 95? 105? Underestimating life span can leave clients vulnerable to outliving their assets — and forced to live on Social Security benefits alone. (For those worried about the stability of the Social Security system, this is an even scarier thought.)
Yet being overly conservative with your longevity assumptions could mean clients enjoy their money (and their lives) far less than they could have — both before and during retirement.
“There’s a fundamental tension,” says industry researcher, blogger and Financial Planning columnist Michael Kitces of Pinnacle Advisory Group in Columbia, Md., who has questioned whether advisors may be too conservative in their assumptions. “Choosing an arbitrarily long time horizon ensures that clients don’t overspend, but they die with money left over.”
Some planners also argue that longevity fears are overblown, because minor adjustments to life expectancy wind up having relatively minimal impact on a spending or investing plan. “Once you are planning beyond 30 years, you don’t gain that much by shortening” the time horizon, says David Yeske, managing director of Yeske Buie, with offices in San Francisco and Vienna, Va.
Similarly, he adds, a fairly conservative estimate means that clients will still be safe with even longer life spans: “Once you plan for your money to last for 30 years, it’s likely going to last a lot longer.”
Advisors may start their planning by looking at life tables, but for most clients, average life expectancy is of limited help. After all, if the average life expectancy of a 65-year-old female is about 85, there is a 50% chance that she will live past that age — an unacceptable basis for planning, advisors say.
Besides, it’s clear that clients are above average when it comes to longevity. The healthier, wealthier and more educated people are — which is to say, the more likely they are to be a planning client — the longer they are likely to live. And the older they are, the longer they can expect to live. The life expectancy of a newborn is 76 years for a male, according to the 2010 Social Security period life table. A 65-year-old male, however, has already beaten infant mortality and other early-onset ailments; as a result, he is expected to live to 82.5.
Marriage also adds another dimension — because in any couple, there’s a greater chance that at least one member will live longer than either is expected to live individually — a factor Kitces says many advisors fail to recognize. The joint life expectancy for a 65-year-old couple is 27.1 years, based on the 2000 annuity mortality table. And, of course, the expenses for the surviving spouse aren’t simply half of what they might be for a couple — an important planning consideration.
Yet planning for both members of a 65-year-old couple to reach a certain age — say, 95 — may make plans more conservative than advisors realize, Kitces argues. Let’s say those clients have an 18% chance of at least one spouse living to 95 — and their portfolio plan has a 90% success rate in Monte Carlo tests. That means the 10% chance of running out of money will only be relevant for the 18% of scenarios in which at least one has lived to 95. “The true joint probability of failure is only 1.8%,” Kitces explains. “Their plan is actually 98.2% successful now, not ‘just’ 90% from the Monte Carlo software.”