Retirement Risk Series – Longevity Risk
Longevity risk is the risk that you will outlive your retirement savings. It is an important consideration for retirees because people are living longer than ever before, and retirement can last 20, 30, or even 40 years! Let's discuss what longevity risk is, how it can impact your retirement, and some strategies you can use to mitigate this risk.
What is Longevity Risk?
Longevity risk is the risk that you will outlive your retirement savings. Certain events may cause your retirement assets to deplete faster than planned, compounding longevity risk. This can happen if you live longer than expected, if you experience unexpected health issues that require significant medical expenses, or if you experience a downturn in the economy that impacts the value of your retirement savings (especially early in retirement).
How Does Longevity Impact Retirement?
It sounds like a nice problem to have, but longevity can have a significant negative impact on retirement savings. If you outlive your retirement savings, you may be forced to rely on Social Security or other sources of income that may not be sufficient to maintain your standard of living. Additionally, unexpected health issues can lead to significant medical expenses that can deplete retirement savings.
Mitigate Longevity Risk in Retirement
One strategy to mitigate longevity risk is to work longer and delay retirement. Working longer can help retirees accumulate more savings and delay the need to withdraw from retirement accounts. Additionally, delaying retirement can increase Social Security benefits, which can provide a reliable source of income in retirement.
Another strategy is to consider purchasing an annuity. An annuity is an insurance product that provides a guaranteed stream of income for a set period or for the rest of your life. An annuity can provide retirees with a reliable source of income and protect against the risk of outliving their savings. An annuity sets a floor - that is, minimum guaranteed income - that can help ensure a secure retirement.
Retirees can also consider using a fixed withdrawal rate as a guideline. A well-known withdrawal rule is the 4% withdrawal rule. This rule suggests that retirees can withdraw 4% of their retirement savings each year and adjust for inflation. This can help retirees balance their income needs with the risk of depleting their savings too quickly.
A dynamic withdrawal rate is another strategy. A dynamic withdrawal rate, like a “guardrails” strategy, allows for a fixed withdrawal amount that is adjusted annually in relation to changes in the value of retirement assets. So long as the value of retirement assets stays within a certain range (the guardrails) no adjustments are made. However, if the value of retirement assets moves outside the guardrails, either up or down, a corresponding change is made to the amount withdrawn.
Finally, retirees may want to consider working with a financial advisor to develop a retirement plan that takes longevity risk into account. A financial advisor can help retirees understand the risks they face and develop a plan that balances their income needs with their risk tolerance.
Longevity risk is an important consideration for retirees. By understanding this risk and implementing strategies to mitigate it, retirees can help ensure that their retirement savings last as long as they need them to and maintain their standard of living in retirement.
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