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How to Plan for Your Retirement Time Horizon

Christine Benz

Christine Benz: Hi, I am Christine Benz for Morningstar. How do you decide on a time horizon for retirement planning? Joining me to discuss that topic is financial-planning expert, Michael Kitces.

Michael, thank you so much for being here.

Michael Kitces: Thanks, Christine. Great to be here.

Benz: Michael, you had a really provocative Q&A on a couple of months ago where you looked at longevity assumptions that underpin a lot of people's retirement plans. A lot of planners do say to plan for age 95, and I'd like your take on the pros and cons of planning for such a long lifespan.

Kitces: I think the pros and cons get pretty straightforward. As we stretch out this time horizon that we're sort of protecting against or worried we're going to live through, we have to keep ratcheting our spending lower and lower in order to protect against the risk that we're going to live this long. Or we have to look at annuitizing our money and getting a lifetime stream of income that will let us go that long.

And as we really elongate that time horizon, we really do get to some pretty profound trade-offs in spending. We use sort of the safe withdrawal-rate research. The safe withdrawal rate when you're going out 30-plus years is much, much lower than what you get when you're only going to plan for 15 or 20 years, and suddenly you have to cut your spending by a quarter or a third or more because you might sort of maybe live out to 95. And certainly, no one wants to outlive their money.

But not a lot of people want to die with a huge pile of money left over because they were hedging a long life that never occurred. And I think that's just a really fundamental challenge and trade-off that we have to face. But I think sometimes we don't spend enough time really looking at what those numbers and facts look like and what those trade-offs really entail.

Benz: So, how should people approach that question? As you said, most people would say, "My ultimate goal is to not run out of money." So, if that's a goal, how should you plan for your own time horizon?

Kitces: Well, ultimately we get two ways that we can classically do it. Number one, we simply go buy a lifetime annuity and take the question off the table. So the fundamental trade-off we get by annuitizing money is the company will pay us payments as long as we're alive, and that's the deal. So, if I don't live very long, I have a shorter life expectancy, I'll get the payments as long as I live. If I turn out to live an unexpectedly long time, I'll get payments as long as I live, and that's how the annuity companies function. And it's pretty easy for them to do the math with large numbers to figure out how to make it work even though it's difficult for us to do it with sort of our sample size of one of me.

The alternative method that's out there is we simply pick a conservatively long lifetime, life expectancy. We determine some safe withdrawal rate that's feasible for that time horizon. And we go down that road just acknowledging, all right, the good news is I didn't sacrifice some of the liquidity, the constraints of annuitization. The bad news is: A, I'm going to dial my spending down in case I live a long time, though we see those numbers are often not far off from the annuity numbers; and B, we still entertain some arguably remote risk, but some risk that I'll live past my time horizon particularly if I didn't pick a really long one.

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Benz: You've run some numbers on the likelihood that people will live to 95. That's the time horizon that a lot of planners use. What are the odds that someone will actually make it until that day?

Kitces: That's part of the surprise we see. They're not as high as we sometimes realize. So, the odds for a married couple that's 65 years old, that both of them actually make it for 30 more years until age 95 is only about 6%. The odds that one of them makes it is about 16% or 17%. That's just Social Security Administration's life-expectancy tables.

Now, we can add a little bit of padding or maybe life expectancies are elongating a little bit for that. But I think sometimes we forget, we see all these numbers like the number of people who are living to age 100 is expected to quadruple in the next couple of decades. That's because it's going from almost no one to a larger number that's still almost no one. We're still talking about like going from 0.2% of people to 0.8% of people. Yes, that's a quadrupling. No, that doesn't mean it's going to be an average or anything close to an average.

And so, when we just start looking at those numbers and say, well, there's only even about a one in six chance that one person from a couple is alive in 30 years, never mind both of them, does it really make sense as a baseline to assume that you have a 30-year time horizon for which they have to maintain their exact same spending for all 30 years and therefore ratchet the spending as low as we tend to in order to hedge against that risk?

That's a very expensive trade-off, and in the real world I'm not quite convinced that we always weigh the trade-offs that way. We do look at, "All right, well, maybe one of us will be alive but not both, that's probably going to change our lifestyle a bit." If our lifestyle is a little bit different, [we adjust our assumptions] probably a bit lower; maybe we can spend a little bit more now because we're just not going to be living much later. We see some research coming forth that says, people in their 80s and 90s, they just don't spend as much as folks in their 60s, particularly the more affluent individuals who have more discretionary spending in the early years. That really tends to tail off in the later years.

And frankly, for a lot of families, though I don't think they necessarily want to count on it, there is family, there are other alternatives. I'm not sure they really vocalize it this way, but we've seen clients where I think the decision basically came down to, "I can spend very little now and have the risk of dying with a whole lot later, or I can enjoy my lifestyle now and have the risk that I might have to rely on my kids a little bit more later." And neither of those is a terribly appealing trade-off, but I think as advisors, we tend to frame everybody in the first bucket because certainly no advisor ever wants to see a client run out of money on their watch.

Sometimes clients aren't necessarily really, I think, keen on that. Some people ultimately look at this and say, "You know what, maybe I'd like to enjoy the money that I've got and look at some other alternatives like relying on family a little bit more as my disaster plan of last resorts." Not ideal, but we're dealing with huge amounts of uncertainty. I mean that's part of the trade-offs that I think we have to acknowledge, and for some families that really is one of the options on the table.

Benz: Have you looked at how level of wealth fits into all of this because when you look at the data, I think you do see that more affluent people do tend to live longer than people with smaller pools of money.

Kitces: We see lots of shifts that people will make on that end. More affluence does add a couple of years of to life expectancy, though frankly it's only a couple of years.

Benz: It's not 10.

Kitces: Yeah, it's not 10, 15. It's a few. And I don't think most people's retirement plans in the real world really change all that much because they say, "Oh, you know I'm really affluent and healthy. I guess technically I should use a life expectancy of 97, not 95." I mean the last two years of a 32-year time horizon usually is not a material change to their planning projections upfront. It's more like when "Do we want to plan for 80s or 90s or 100s, or a decade at a time?" starts to make really material shifts. We do see some websites out there like where you can actually enter in a lot of your personal risk factors and get a little bit more of a customized estimate of what your longevity is going to look like. It's still certainly an average where samples sizes of one will vary from the average, but we can start to weigh in, "I have got these lifestyle factors, I have got this family history and genetic factors, and I've got these ongoing current health issues." And we can start to mix all of that in to get a handle on what life expectancy really is likely to look like for someone and start to make adjustments from there as necessary. So, frankly we see some people where they are not just that healthy. I mean we've had clients come in and say there is no way I'm planning to 95, I'm 68 years old. I'm the oldest male ever in my family to make it to 68 because everyone else in my family dies of heart attacks in their 50s. And they've no interest in planning to age 95.

That's just not how they view their life expectancy and lifestyle. So, I think we can acknowledge a little bit more that it's OK to be a little bit flexible with these numbers. Understand the ramifications. I mean we are talking about the risk of outliving money, and that is scary stuff. But for a lot of people, I think it's OK to acknowledge, "There is also a risk that I don't enjoy the money that I accumulated and die leaving a giant pile of it left over." And as the saying goes, you can't take it with you, and I think a lot of us feel that fear, as well, a need to recognize that there are some trade-offs.

Benz: You mentioned the notion of trying to be as realistic as possible when I'm estimating your own life expectancy as well as that of your spouse. Let's talk about other questions one should ask when trying to assess these trade-offs and trying to make a correct decision about time horizon.

Kitces: There are few things. One, get a good handle on what your life expectancy really looks like, at least the starting number. Use some of the tools that are out there to kind of adapt it to your lifestyle, your heath, your family, and genetic factors.

Benz: And then revisit that, right? As you go along?

Kitces: And then you can certainly revisit it as life and health changes.

The second, I think married couples also have to dig a little bit deeper to look at that. There are two people, there are two lives, and there are two lifestyles often. And so we'll see scenarios that really come down to, "All right here is the lifestyle that we expect to live as long as both of us are alive, but we're just clearly not going to do that when someone passes away."

Benz: The travel may step down, or whatever it might be.

Kitces: Yes. That's heavy morbid stuff and tough things for couples to talk about sometimes. But again, that kind of has real-world spending implications. Things look very different if we're simply going to say, "You know what, the odds are that only one of us is going to be around by our late 80s and beyond, so maybe we're going to plan that at least one of us makes it well into our 90s. But you know spending is going to drop by at least 20% something by then. We're not going to need two cars. We're not going to be going out. We're not going to be traveling as much." There is just lot of stuff that's going to change with health declines if not at least the death of one spouse.

And maybe we're just going to build our plan to say, "We're assuming spending is going to drop by 10% in our mid-80s as we get a little bit unhealthier and less active, and then it's going to drop by another 10% or 20% in our early 90s because if we're even still alive then it may only be one of us or not both of us. And we're probably going to be winding down our lifestyle further by then." And we can build that into our spending plans a little bit more. And no great surprise, you're expecting to spend a little bit later, let's just spend a little bit more early on. And I think that aligns where a lot of people are sort of mentally when thinking about their retirement.

Benz: Michael, thank you so much for being here to talk about this really important question.

Kitces: My pleasure, absolutely.

Benz: Thanks for watching. I'm Christine Benz for