The catchphrase “live long and prosper” has remained popular in modern culture since Star Trek’s Mr. Spock mouthed the greeting nearly 55 years ago. Lately, however, the phrase has taken on a new, ironic meaning. I recently heard a financial advisor use it, with a roll of his eyes, to indicate “we may live long, but not necessarily prosper.” High tech machines and wonder drugs may extend the length of our lives but not necessarily the quality. With the new concern over “long COVID” people are realizing that living too long in a disabled state is a legitimate risk in retirement planning. Add to this the financial toll involved in living past your life expectancy and it’s a lot to contemplate. We all want to live a long life but implied in this goal is the desire to live it under favorable terms – to have a plan for dealing with longevity.
Not knowing how long you will live in retirement doesn’t mean you cannot deal with your longevity risk. A retirement plan can, and should, address ways to manage living past your life expectancy. There are many planning possibilities, but in our current environment, five key strategies deserve particular consideration as you build your own retirement plan.
1. Social Security
Social Security retirement benefits enjoy a unique position with retirees as a guaranteed form of legacy insurance. Even for the very affluent, these monthly payments are an important source of lifetime income. An affluent married couple can receive more than $1 million in Social Security payments over their retirement years. Fundamental to this benefit is that it pays throughout retirement irrespective of whether the participant reaches or exceeds life expectancy. And importantly, the payments are made in real dollars, i.e., the benefits are annually adjusted to reflect the Consumer Price Index.
In dealing with the risk of living too long, the key strategy is to delay filing for Social Security benefits as long as possible, ideally until age 70. There is no shortage of research concerning the best filing strategy for Social Security. Financial models have been made for various scenarios—a couple, where one spouse has a shortened life expectancy; if Social Security pays reduced benefits starting in 2032 due to government underfunding; affluent retirees expecting to receive high return on their invested assets—and with very few exceptions, financial modeling indicates that delayed filing for Social Security is the preferred strategy for addressing the longevity risk in retirement. If you’re worried about the financial risks of living too long, hold off on filing.
For many, this raises the issue of cash flow early in retirement. Average retirement ages are well below age 70, so the question is how to augment retirement income until Social Security benefits begin at 70. Consider these two approaches. First, begin your retirement by drawing from your after-tax savings and qualified assets (IRA and pension funds) so that you can delay filing for Social Security until later. In addition to covering your cash flow needs in the early years of retirement, this approach can save you significant taxes. Second, create a Social Security bridge to fill in the income gap between retirement and filing. Say, for example, you plan to retire at age 62 but want to delay filing for Social Security until age 70. You can purchase a single premium immediate annuity that pays income during those years. Similarly, you could take out a reverse mortgage that taps home equity to fund the eight-year interim. Because these bridge strategies are typically not inflation-adjusted, it is all the better to use them early in retirement so that the real-dollar benefits of Social Security are there for future years.
Social Security is the poster child for use of annuities in retirement. This government benefit is a lifetime annuity that can’t be cashed out or outlived. By utilizing employment taxes extracted from working individuals, and further saving on benefit expenses for retirees who die prematurely, this Social Security retirement benefit creates a “mortality premium” for those who live past life expectancy. The longer the individual lives, the higher the effective return on the taxes the worker paid in during working years.
Defined benefit pension plans work in a similar manner. They are a form of longevity insurance because, if you’re lucky enough to be covered by such a plan, it continues to pay an annuity income even after you have lived past your life expectancy. However, due to the lack of defined benefit plans and the proliferation of defined contribution plans, Americans often have a deficit in annuity-based retirement income. If you’re like many retirees, you have Social Security as an annuity, and nothing else. While you may have significant sources of retirement capital in your employer-sponsored plans, the income generated from this capital is not automatically guaranteed to continue over your lifetime.
You can address this risk by purchasing commercial annuities. Recently, there has been an explosion in available product designs – too many to detail here. Suffice it to say that the annuity designs can accommodate beginning income immediately or deferring the income into the future. Plus, the benefit can be locked-in or flexible.
Through legislation and regulation, the federal government has been encouraging Americans to consider supplementing their retirement savings with annuities. In 2014, they blessed the qualified longevity annuity contract concept (“QLAC”) inside tax-deferred retirement plans. Subject to certain limits, a retiree can use IRA funds to purchase a lifetime annuity that begins in the future. The tax incentive to QLACs is that the funds used will not be subject to required minimum distributions (RMDs). In other words, any IRA funds you use to create a future lifetime income won’t be forced to be withdrawn at the RMD age of 72. The other pro-annuity nod from Congress appeared in the 2019 SECURE Act. This bipartisan law makes it far easier for employers to offer commercial annuities as one of the available investments in defined contribution plans such as 401(k)s and 403(b)s. The point of these government actions is that public policy encourages individuals to lock in retirement income for life – and that’s what annuities do.
3. Long-Term Care Insurance
The history of long-term care insurance in the U.S. has been disappointing. This, however, is not a reason to avoid using such insurance. The sad situation is that half to two-thirds of older Americans will at some point require long-term care. These people may live long, but not necessarily prosper. Long-term care insurance can at least lessen the financial challenge of this condition by absorbing many of the costs associated with long-term care.
The rocky history with long-term care insurance may be a case of looking out the rearview mirror. Insurance companies have become more adept at pricing this product. Popular contracts now reimburse an insured’s long-term care expenses when, after a set period, the insured is unable to perform at least two activities of daily life (“ADLs”) such as dressing or bathing. With an average stay in a long-term care facility exceeding two years, this insurance offers peace of mind for those worried about living too long – especially when they are dependent on others for their care. Particularly because the incidence of long-term care events increases with age, long-term care insurance directly addresses the longevity risk in retirement planning.
This is another situation where public policy makers have tried to encourage individuals to address the longevity issue through purchasing insurance. In this case, through tax legislation first passed in 2006, Congress has made long-term care insurance, whether standalone or as part of a life insurance or annuity contract, tax favored. Second, a significant number of states have passed legislation that allows certain long-term care insurance plans to avoid being counted for Medicaid eligibility requirements. In other words, an individual can purchase a qualifying long-term care insurance plan which provides a monthly income that will not be used for determining whether that individual is eligible for Medicaid.
4. Investment Strategies
In the private sector, most current employer-sponsored retirement plans are some form of defined contribution plan, for example a 401(k) or SIMPLE IRA. This means that at retirement, a soon-to-be ex-employee is sitting on a pot of money that requires yet one more retirement decision: how to drawdown this capital as retirement income. They must avoid taking too little or too much while at the same time assure they will not run out of money before running out of oxygen. This calls for the retiree to structure – and manage – both a withdrawal and investment strategy. The senior will be drawing down retirement savings while striving to grow the remaining balance. That’s a lot to ask of someone in their golden years.
In a previous post I covered three of the most common drawdown strategies retirees can use. All three are designed to balance the need for retirement income with the necessity of preserving sufficient retirement capital. Implicit in these strategies is the need for some portion of your retirement savings to be invested in equities – for example stocks, mutual funds, or ETFs. A retirement portfolio needs an equity element to help stay up with inflation, secure growth, and sustain sufficient capital for an indeterminant period of time. Without an equity allocation, living a longer than anticipated lifetime risks exhaustion of your retirement funds before death. Even if you have covered a significant portion of your income needs with lifetime annuities, it is important to have a growth element in your portfolio. It addresses the inflation risk of living too long and offers the potential for leaving a legacy to heirs.
Two essential needs for a retiree are housing and medical care. And the costs for these services potentially increases with age due to frailty and long-term care needs. For the economically disadvantaged, Medicaid is a safety-net program that can address these fundamental expenses of living. In terms of health coverage, Medicaid provides coverage to 7.2 million low-income seniors who are also enrolled in Medicare. Further, Medicaid programs can pay for housing-related services that promote health and community integration. It does not however pay for rent or for room and board, except in certain medical institutions such as nursing homes.
With the issue of longevity facing many seniors, Medicaid can be a legitimate planning option for middle- and lower-income individuals. If you or a loved one anticipate requiring long-term care, and your financial resources are limited, pre-planning may make it possible to use Medicaid as a funding source. There are techniques for legitimately spending down wealth to qualify for Medicaid, including the use of certain trusts, annuities and long-term care policies. With this safety net program, living too long can at least mean living with dignity.
We all want to live long; and we all want to prosper. The challenge is we don’t know how long we will live, and how much it will cost to prosper. Mr. Spock has a thought on this as well: “insufficient facts always invite danger.” Get your facts together and address the opportunities and risks of living a long life.