Will a retiree accurately evaluate his or her risks in retirement? According to a Boston College Center for Retirement Research study,1 many retirees list market volatility as their top perceived retirement risk, followed by medical costs and longevity. This seems to be the result of retirees’ views of their survival probabilities, assessment of the market, and lack of understanding of healthcare costs.
Yet, objectively, longevity and healthcare present greater risks than market volatility.
This means that retirees may underestimate the need to financially prepare to live longer than expected. While longevity often is discussed in terms of living to age 100, the longevity risk is simply that a person will outlive their money. That is, if a person expects to live to age 82 and in fact lives to age 87, longevity risk could be an issue.
As a financial professional, you can help clients better understand the proper order of their objective retirement risks. Here are some questions that may help.
It can be difficult to persuade a retiree to discuss longevity. For many, longevity is difficult to evaluate. They may be reluctant to give much weight to the evaluation and may adopt a “Who knows? But I certainly don’t buy green bananas anymore,” attitude. Asking about relatives can make the conversation easier and still provide some insight on their rough odds. If most of their relatives have passed away in their late 70s, planning for age 100 may be a stretch. A retiree with parents who are active and healthy in their 90s can suggest the need to plan for a longer life.
TIP: Social Security has a basic longevity estimator that can be used as a springboard for the “how long will you live” conversation.
Every retiree has certain expenses that must be covered every month. Typically, these include housing cost, utilities, food, Medicare premiums, and similar items. If these necessary expenses are covered by income that is guaranteed to arrive every month for life, it reduces the risk that the client will fully deplete other resources.
The volatility of the underlying portfolio is a normal risk of investing in the market. Sequence-of-returns risk occurs when a retiree must take a distribution from the portfolio at the same time normal volatility causes the portfolio to drop in value. If the market drops 20%, and the retiree must sell securities to cover his or her expenses, the account suffers a permanent loss. That is, the retiree had to sell more shares to get the same dollar amount. The extra shares that had to be sold are gone forever.
It’s important to note that other than Social Security benefits and pensions, annuities are the only way to help your clients create guaranteed lifetime income. Sources of guaranteed income can significantly reduce longevity risk by limiting the need to use discretionary assets at a point when the market is down.
TIP: Encourage clients to write down their monthly expenses and compare the total to the amount of all the guaranteed income sources they have in place, such as Social Security benefits. If the gap between these numbers is negative, they might consider other sources of guaranteed lifetime income to maintain their lifestyles.
Longevity risk also is affected by inflation. As inflation increases expenses over time, the guaranteed lifetime income amount may not keep up with the retiree’s rising costs. Social Security does provide cost-of-living adjustments (COLAs), but most corporate pensions do not. While some government pensions have COLAs, the calculation used may not provide a sufficient increase to cover expenses.
There are two ways a retiree might consider addressing inflation:
Longevity Month is the perfect time to review your retired clients’ guaranteed lifetime income sources. Take the opportunity to address any income gaps and create a plan for future potential inflation-related expenses. Reach out to clients today!
For more information about retirement-planning, please contact our Retirement Strategies Group at RSG@PacificLife.com or (800) 722-2333, ext. 3939. PacificLife.com
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Pacific Life refers to Pacific Life Insurance Company and its affiliates, including Pacific Life & Annuity Company. Insurance products are issued by Pacific Life Insurance Company in all states except New York and in New York by Pacific Life & Annuity Company. Product availability and features may vary by state. Each insurance company is solely responsible for the financial obligations accruing under the products it issues.
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