How to Fund a Long Retirement

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. What sort of life expectancy should you forecast and how should you factor that into your retirement plan? Joining me to discuss that topic is David Blanchett. He is head of retirement research for Morningstar Investment Management.

David, thank you so much for being here.

David Blanchett: Thanks for having me.

Benz: David, you've done a lot of great research on many different topics over the years. Today I want to talk specifically about longevity. Sometimes people in your field call it longevity risk. But from a lot of standpoints, from a lifestyle standpoint, it's a good thing that people are living longer in retirement. We've seen extending life expectancies. But it does create financial challenges, right?

Blanchett: Right. So, the biggest unknown when you retire is how long you're going to live. Obviously, the stock market is a big question, bond rates, etc. But if retirement lasts one year or 40 years, that has huge implications on how much you have to save and how you fund your retirement.

Benz: OK. So, I guess, I'm hoping you can give some concrete tips about how people can forecast their own life expectancies. They might start by looking at the tables that you can find here and there, maybe showing that the typical 65-year-old can expect, what another 22, 25 years in retirement. But that's just a starting point, right? You wouldn't want to just take that and run with it?

Blanchett: Right. So, you used the word life expectancy. Life expectancy is kind of the average number of years remaining for someone who is that age. And so, someone who is zero, who just was born, the life expectancy could be age 75. Well, if you survive to age 65, it's closer to 22 to 25 years, so the average 65-year-old, let's just say lives to age 90. The question then becomes, well, how long do I forecast out retirement to last? And an important thing to be aware of is, well, if I use life expectancy, there's a 50-50 chance I could live longer than that forecast period. Things get a lot more complex if you throw in a couple. So, if there's two people that you're planning for, well, either could survive easily 30-plus years into retirement.

Benz: And your level of wealth is also a factor here that there's a chance that you've had better healthcare during your lifetime and better access to healthcare. So, how does a person's relative affluence affect their life expectancy?

Blanchett: It's actually quite significant. When you think about kind of planning for your own demise, it's a very tragic thing to think about, but how long are you going to live? Well, there are important drivers of mortality rates, and one thing we've seen is that people are living longer and longer and longer and that's called improvement. So, on average, people are living longer but here is the thing though: These improvements in mortality are being realized mostly by wealthier Americans. So, someone, for example, who is in the top income decile or percentile could easily live four or five years longer than the average American. So, when thinking about how long you're going to live, think about what makes you unique. If you are an active, healthy, nonsmoker, wealthy American, you could easily live eight years longer than the average American does, and that has really profound impacts about again how long you plan retirement to last.

Benz: So, assuming someone wants to be really conservative and say, OK, we're going to plan to live to age 95; we'll plan for that 30-year retirement. There are trade-offs associated with embedding such a long life expectancy into your plan. What are those, and what should people be prepared to do to adjust their plans to accommodate a really long life span?

Blanchett: So, we don't want to go broke at age 95. We want safety and certainty. But if you're someone that says, well, I'm going to plan to live 40 years in retirement, it is incredibly expensive to fund retirement for 40 years. So, if you want that level of certainty, I think the important place to look is possibly buying some kind of an annuity, because annuities do guarantee income for life. Now, annuities are not like wealth-maximizing vehicles. You shouldn't--it's a form of insurance. You don't buy the insurance hoping to make money. You buy it to hedge that risk where if you happen to outlive your savings, you have still this guaranteed income for life.

Benz: And the purest form of that type of annuity is the deferred income annuity?

Blanchett: Right. So, going back over 1,000 years we've had immediate annuities where you give the company money and they pay you today. Well, a problem with immediate annuities is that people don't always need a guarantee right now, right? If I retire, I'm 65 years old, a question is not so much how will I create money tomorrow. It's how will I create money if I'm alive 25 years from now? So, while immediate annuities are one way to create income for life, a more natural kind of hedge against the risk is what's called a deferred income annuity or longevity insurance, also called qualified longevity annuity contracts or QLACs which are providing you an income stream if you live to a certain age. So, I could buy it, for example, today at age 55 and then if I'm alive at age 85, it starts paying me income for life.

Benz: How about Social Security? Does delaying Social Security makes sense if you're concerned or you're planning for a really long period in retirement?

Blanchett: Definitely. So, Social Security retirement benefits are the best annuity around. If you want more guaranteed income, I think definitely delaying Social Security. And another issue there too is, if someone were to pass away in a joint couple, the spouse receives the higher benefit of the two. So, today given the fact that the average male could predecease a female partner by five years on average, having that higher benefit could be material for that spouse when or if he passes away.

Benz: So, the name of the game is the higher-earning spouse should really take a step back and think about delaying because that will provide a benefit for the whole couple?

Blanchett: Definitely.

Benz: How about the portfolio? If you're thinking about your portfolio and thinking, well, I want to embed a long runway for retirement, does that mean I should own more stocks because I need that higher return potential for my portfolio?

Blanchett: So, potentially. I think there are kind of common rules where the longer time frame you have to invest, more aggressive you can be. But an important question there for retirees is, will you be able to sleep at night? I think that once you stop working, a lot of individuals don't like that risk in their portfolio. Can you withstand a drop of 20% and still be OK? So, I would say, take the risk up till you're able, but don't be aggressive just because you've got to fund retirement for 30 or 40 years.

Benz: David, important topic, longevity. Thank you so much for being here to share your thoughts.

Blanchett: Thanks for having me.

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