Good News - Bad News
The older one gets the longer one is likely to live. Life expectancy is defined by Oxford dictionary as “the average period that a person may expect to live.” Life expectancy for a person born in the United States has expanded to 79 years for those born in 2021 from 68 years for those born in 1950, according to Macrotrends. This is an average: there are those who live longer than the average as evidenced by Hester Ford, the oldest living American as 115 years young born in 1905 and those who live shorter. If “average” equates with “mean”, a statistical term splitting the group into halves – half living longer than the “average life expectancy” and half living less – then some of those who reach that number of years will live longer, even much longer, such as Hester Ford who has outlived by nearly 70 years the average life expectancy of about 47 years for a U.S. male in 1905 like him. Dr. David Sinclar, co-founder of the Paul F. Glenn Center for the Biology of Aging at Harvard Medical School, writes in his recent book Lifespan that the human body, well attended and maintained, is capable of reaching 120 and even 150. And he acknowledges the same statistical conclusion mentioned above: those who live longer will live even longer, in a virtuous cycle of health begetting longevity.
AARP, the Association for the Advancement of Retired People, reports that:
1 in 7 seniors lives in poverty and,
retired people spend about 80% of what they spent while they were earning a living.
Longer lives, high cost of living, senior poverty – how do people address this mix?
Social security pays monthly an average of just over $1,500 and $3,100, average and maximum respectively which represents only about 50% of what the AARP says people actually spend in retirement. The higher the wages earned in a career the lower the percentage of retirement income is covered by social security due to savings. But, higher earnings also presumably lead to a higher cost of living. Regardless of the actual numbers, it is nearly crystal clear that to maintain a preferred lifestyle after leaving the workforce with good health more retirement income than simply social security is needed. And, with ever expanding life expectancy, especially for those who outlive the starting average in their age group, that income must cover more, perhaps many more, years.
Social security was established in 1935 when average male life expectancy was about 60 years. With only half living longer than average and the oldest of Americans reached their 80s, the program was designed to pay for few retirees for few years. Today 10,000 Americans turn 65 EACH DAY, and they mostly represent the half who exceed the life expectancy of their birth year of around 66 years for men and 73 years for women. Social security can only provide some of the necessary solution.
Alternatives to Pay for a Longer, Active Retirement
Those working toward and expecting a long and healthy retirement from traditional work wishing to maintain their accustomed lifestyle financial reality require intentional planning and execution. It takes financial resources to pay for a long, healthy, enjoyable retirement after ceasing to earn to pay for that lifestyle. Those resources accumulate and grow over many years, certainly not easily or instantly.
Chipmunks famously work during productive times storing nuts to carry them through times when they can't get nuts. Building wealth is the human equivalent. Earn, save, invest - store up money in savings and investment accounts, real estate, stock portfolios, etc. When the career ends and paychecks stop the switch is flipped from accumulating to consuming those “nuts” stored over the years to “consuming” them. One rule of thumb to calculate how many “nuts” to store is the classic 4% rule. According to some consumption of savings and investments of 4% or less should last for retirement. Of course there are factors that would adjust this, including longevity. Wade Pfau, noted and quoted retirement income academic, promotes a 3% withdraw rate, for example. Assuming a $5,000 monthly spending target for retirement, meaning $60,000 annually (forget inflation for the moment), 4% and 3% withdraw rates would require accumulating $1.5MM or $2MM, respectively. However a group called United Income reports that 1 in 6 retirees is a millionaire meaning 5 in 6 are not. Certainly earned social security and other lifetime guaranteed benefits such as pensions reduce these required amounts though they seem out of reach for many working Americans.
And, the expected rising cost of living over time - inflation - to pay for milk, insurance, taxes, doctor visits, travel, etc. requires investment both before and after retirement. Storage under a mattress, in a savings account or in a safe deposit box only guarantees protecting the “nuts” but not that they grow in numbers as needed to meet retirement spending. Investment in real estate, gold, stocks, bonds, and other items are made with the expectation that the whatever is selected will increase in value though comes with the risk that values could fall, such as was seen in 2008.
Betting Against The House
The “house” - life insurance companies offer an alternative solution: private pensions that pay out for as long a one lives, just like social security. Even if the account balance for a given client goes below zero.
How can the life insurance company make payments after the account balance goes to zero or less and stay in business? Two factors contribute to this capability: law of large numbers and hedging their bets.
Law of Large Numbers
Insurance companies know very well how many people will die each year... they just don’t know which people. So, if they have lots of clients they don’t need to know which will live longer or die sooner than expected because it will “all work out in the wash”. With only a few clients, the outcome of each impacts the financial results greatly, and could produce an unfavorable unprofitable collective outcome. Yet, if there are a very large number of clients the impact of the outcome of each client is very tiny overall. Some call this risk diversification. It is the profession of actuaries. Enough technical stuff.
Hedging Their Bets
Life insurance companies sell, well, life insurance. This is a simple bet: the client bets by paying premium to the life insurance company that they will die within the timeframe of a life insurance policy. For example with simple numbers for illustration only, a 40 year old husband and father buys for $1000 annual premium a life insurance policy that would pay his wife $1,000,000 if he were to die within the 20 years until he is 60. He is essentially betting that for $1000 per year his wife will get $1MM if he can’t work to provide that. Financially his wife wins the bet if he dies within 20 years - she gets $1MM – after paying no more than $20,000. [Note: of course she loses a husband, so this is only counting the money not wishing that outcome for anyone.] Term life insurance pays out less than 2% of the time so the total premiums paid plus investment returns on those dollars make up for the few claims paid.
Personal pension products are called annuities. You bet the life insurance company that you will live longer than they think and give it your money in a single or multiple premium payments. When the agreed time arrives the insurance company begins paying you for the rest of your life (or an agreed amount of time, but here we focus on lifetime income). If cumulative payments exceed the amount initially paid and the account balance falls below zero, payments continue for life. And, if the client dies before the cumulative payments exceed the amount initially paid such that there is money still in the account when payments stop, which does happen, the life insurance company pays that back to client beneficiaries, if that was arranged. Win win!
Think about this: life insurance companies could “bet” the same client both ways – live shorter or longer than average. And if they do this with large numbers of people it really doesn’t matter which of those people have longer or shorter life outcomes; correctly managed math assures that all clients or beneficiaries get paid either death benefits in the case of earlier-than-estimated death, lifetime payments in case of longer-than-estimated life and the company stays in business. Win Win Win!
Retirement Income Solutions
Retirees who wish accept the personal risk that their portfolios, assets, investments, etc. in total are enough to cover their inflation adjusted living expenses for the entirety of their unknown lifespans might tend to select the Chipmunk Method of retirement income planning. Retirees who feel uncomfortable with the real possibility that their total assets might not provide them with lifetime income if they happen to live longer-than-expected lives might like to Bet Against the House by investigating and considering the construction of a personal pension in the form of one or more guaranteed lifetime income contracts from a reputable life insurance company. For those who are unsure which way to go one solutions might be to do as do the life insurance companies: hedge your bets by doing some of each.