Four Top Risks Multiplied by Longevity
About 20 years ago, I decided it was time for a different vehicle. I went down to one of the local dealerships that one of my friends was managing at the time to see if he had anything that would fit what I was looking for. After looking at a number of options, I finally settled on a truck that had about 34,000 miles on it, which in this situation meant it was still under the manufacturer’s 36,000 mile warranty. I paid for the truck and then drove it home, so I could use it to get back and forth from work every day.
For the first month, everything seemed to be running just fine. Then one day without warning, the transmission stopped working. Upon realizing I had a transmission problem, I called my friend who had sold me the truck and explained the situation. I did ask him what he could do to help me out. His first question was about how many miles were on the truck And I quickly looked at the odometer and told him it was right around 36,200 miles, to which he replied that there was nothing he could do. They were no longer responsible for the truck because it no longer qualified for the manufacturer’s warranty.
I couldn’t believe it! Was 200 miles really going to be the difference between me having to pay thousands of dollars to get the truck fixed, and the manufacturer being responsible for it? As it turned out, yes, 200 miles did make all the difference in the world because the cost of the transmission repair came right out of my pocket.
I tell you this story because retirement is a lot like a manufacturer’s warranty. In the early years of your retirement, you can avoid many of the problems that can arise. But the longer your retirement lasts, the more risk your retirement will face. We call this situation longevity risk.
Longevity risk is any potential risks attached to the increased life expectancy of an individual.
Life is full of fears. However, there’s one fear is outpacing any other when it comes to retirees. That is the fear they’re going to live too long.
It was only a couple of years ago that their three greatest fears were death, taxes, and public speaking. So why did things change? The reason is because of longevity. Retirees are realizing retirement’s going to be much longer than what they had originally prepared for. It’s not uncommon for retirement to now last up to 35 or 40 years.
As a result, 68% of retirees are afraid they’re going to run out of money before they run out of retirement. When a retiree runs out of money, it creates major issues. The biggest issue is retirement is going to look a whole lot different going forward than it has in the past. A retiree has to now figure out what they are going to do to help them cover the financial gap. Is their family that can step in that they can rely on? Can they turn to their church or some other public organization, or is the government their only option? As you can tell, none of these are great options, especially when you’re a retiree who is wanting to be independent.
I’ll be covering the four top risks that are multiplied by the longevity, and then I’ll conclude by giving you a couple of tools you can use to help you eliminate the risk longevity creates.
The top four risks that are multiplied by longevity are sequence of return risk, withdrawal rate risk, long term care risk and inflation risk. A sequence of return risk is the risk that the stock market’s going to be down when it comes time to take money out of your retirement assets, and you will lose all future benefits of the money you have to withdraw from the account.
When I was a child, our family raised most of our food. One of the foods we always raised was potatoes. If you’ve ever grew potatoes, you may agree with me that you’ll never find a better potato than one that has been freshly dug from your own garden. As a result, I always want to eat every potato that we raised. But luckily, my mom was smarter than me and taught me a very important lesson. I could have eaten every potato, but we would have lost our next year’s crop.
Why, you ask? Because you can grow new potato plants from an existing potato. Therefore, she would always have set aside about 10% of our potatoes to be used as seed for the next year. This way we could continue to benefit from the potatoes we already had without having to go out and buy new ones.
If the stock market has dips during your first five or ten years of retirement, when you’re first starting to draw down your assets, you’re going to run out of retirement assets much faster than you expected. It’s going to be a little bit like these potatoes in that if you end up having this issue, you’re going to run out before you get through retirement.
The second issue is withdrawal rate risk. This risk means you’re going to take money out of your retirement faster than it can be replaced by investment returns, and this will cause you to run out of money before you run out of retirement. Have you ever gone to a movie and bought a bucket of popcorn and some snacks, all the while thinking to yourself, I can’t wait to enjoy these during the movie, only to go into the movie theater and eat everything you bought before you even got through the initial commercials.
With withdrawal rate risk, the same process is basically happening, but the consequences are far more severe. We’re not talking about just not having snacks to come for you during the scary or emotional parts of the movie. We’re talking about retirement that’s going to consist of macaroni and cheese or pork and beans.
43% of people believe the correct withdrawal rate is 10%. However, when the retirement bucket is only getting filled with average rates of return—somewhere around six or 7%—sooner or later, you’re going to run out of money. With current longevity, it’s estimated that the correct withdrawal rate is between two and a half and 3%. This means if you’re wanting your money to last you throughout your retirement, you’re going to need 33 to 40 times the annual withdrawal rate you’re needing to take out each year.
The third risk is long term care risk, and it’s another risk multiplied by longevity. You can look at it like you would an appliance in your home. The longer you have it, the higher probability you have of the appliance wearing out. Long term care risk triples once you get beyond average life expectancy, which is around 85 or 86 years old if you live past the age of 65.
Once you get to this point, you have over a 70% chance of having some type of long term care event. The biggest problem is the government isn’t stepping in to help you out until you spend down your assets. Medicare will only cover 20 days in a long term care facility. That’s only if you’ve been admitted to the hospital for at least three days prior to getting transferred to the long term care facility. After that, it’s up to you to cover the costs until you spend down most of your assets. Then Medicaid will finally step in and help a long term care event can be a major problem for the surviving spouse because the average long term care stay is between two and three years and can cost hundreds of thousands of dollars.
The last risk I want to talk about today is inflation risk, which is becoming even a bigger problem because of how low interest rates currently are. When I was a kid, my parents always gave me and my siblings an Easter basket full of candy and toys. Usually, there was more candy than we could eat in a day. We would leave our baskets out and slowly eat the remaining candy throughout the upcoming week.
One particular year, I’d left my candy out on the cupboard, and I guess my dad got hungry while he was staying up late watching television. I’m sure it just started out with one piece, and then two a few minutes later, then three, and so forth, until he ended up eating everything in my Easter basket. The next morning, my mom was livid, and she let him have it on my behalf. She chewed him out for eating all my candy.
Inflation works very much the same way with your retirement. Because it’s happening so slowly, we don’t usually realize it’s a problem until it’s too late. And a 3% inflation rate can cut your buying power in half within 24 years, which is less time than many people will have during their retirement. This means that if you retire with $50,000 worth of income, by the time you hit that 24th year, you will only have $25,000 worth of buying power.
Longevity risk can cause all kinds of problems with your retirement. But there’s no need to despair because there is hope. You are going to need to start looking at your retirement differently than you have in the past. First off, you’re going to need to get over your dislike for insurance companies. I know for you, insurance companies are the last group of people you want poking around in your retirement. What I found out doing this for years is that they’re extremely good at helping retirees eliminate the risks that are multiplied by longevity risk.
They can do this by using two different products. The first product is a fixed indexed annuity. Fixed indexed annuities are great because they can provide you a guaranteed stream of inflation adjusted lifetime income. The only product on the market that even compares is your Social Security check. Last I checked, I didn’t hear a bunch of people complaining that the money from the Social Security Administration was showing up in their account each month. Because of the way the annuity works, you no longer have to worry about inflation risk, sequence of return risk,or withdrawal rate risk. By using the annuity, you’ll have your monthly inflation adjusted lifetime income there no matter what happens in the market. Even if you live five years or fifty years, that monthly income is going to be there.
The other nice thing is if for some reason you die early, this type of annuity will allow a payment to your beneficiaries of the unused cash balance. What about that long term care risk? Unfortunately, an annuity is not going to be able to cover this risk, but this risk can also be solved through a life insurance company.
They sell a product I call the life insurance retirement plan. It’s a permanent insurance policy that offers a free long term care rider. This rider allows you to use the death benefit of the policy prior to death if you end up having a long term care event. You can learn more about the life insurance retirement plan by attending my webinar HERE called Look Before You LIRP.
Hopefully by now, you can see that if your retirement is structured correctly, longevity risk doesn’t have to be something you’re worried about. You can spend your time enjoying your retirement rather than counting your pennies and wondering how long they’re going to last you as you go through this longest self-imposed period of unemployment many of you are going to have in your lifetime.