How long will you live? How long does your money need to last?
Unfortunately, it’s impossible to answer those questions. “We don’t know how long (our) money needs to last because we don’t know how long we’ll live,” says Michael Finke, a professor of wealth management at The American College of Financial Services.
And not surprisingly the fear of running out of money is one of older American’s greatest concerns, according to a 2019 Aegon Center for Longevity study.
To be fair, we do have a sense of how long people live on average. For instance, in 2018, life expectancy for males at age 65 was 18.1 years and for females at age 65 it was 20.7. But those numbers are of little help when it comes to the number that matters most – how long you will live.
So, what then are the best ways to manage what experts refer to as longevity risk, the risk of outliving your money?
1. Work longer
The longer you work, the more you can save toward retirement and the shorter the period of retirement you have to fund, says Sita Slavov, a professor at George Mason University’s Schar School of Policy and Government.
And that can go a long way toward managing and mitigating the risk of running out of money.
It’s especially helpful, Slavov says, if someone can use the income from working to pay for living expenses while they delay claiming Social Security.
2. Social Security
Social Security, which promises to pay nearly most Americans a specified amount of income for life, “could be considered the best longevity insurance money can buy,” says Joe Elsasser, president of Covisum.
Three reasons why:
► It’s tax privileged. Under current tax law, at least 15% of each payment comes through tax free, says Elsasser. “Compare that to a nonqualified single premium immediate annuity where 100% of payments after basis has been returned become taxable as ordinary income,” says Elsasser.
► It’s inflation adjusted. Currently Social Security cost-of-living adjustments (COLAs) are tied to the Consumer Price Index for Urban Wage Earners and Clerical Workers or CPI-W, which has averaged 1.7% per year over the past decade.
► It’s cheaper than other forms of longevity insurance.
To be sure, Social Security is meant to replace only a portion of your pre-retirement income. On average, Social Security will replace about 40% of your pre-retirement income. But there is at least one thing you can do to increase your Social Security benefit and possibly that of your surviving spouse: Wait to claim until; age 70 if possible or, if not 70, for as long as possible.
Doing so will provide you with the highest possible benefit based on your earnings history and one that will provide the highest benefit possible after COLAs are made each year.
3. Annuities
Annuities, of which there are many different types, also promise to pay an individual a specified amount of income for life. Immediate payout annuities, for instance, “can be useful for retirees because they maximize the amount of guaranteed lifetime income available from a sum of money,” according to the Society of Actuaries.
Whether an annuity is right for you depends on your personal facts and circumstances.
But one thing annuities offer that most other investments and products don’t is something called mortality credits.
Mortality credits, according to AnnuityFYI, are created when people die sooner than expected and don’t receive as many income payments as they would have if they had lived their full life expectancy. That money goes into a pool that will then pay lifetime income to those people who live longer than their life expectancy.
“Annuitization allows us to build an income to about the average age of longevity,” says Finke. “This allows us to live better each year without the risk of running out.”
For his part, purchasing what are called deferred income annuities and qualifying longevity annuity contracts or QLAC is “easy way to cut off the risk of running out of money,” says Finke. “Buying a lifetime income through a deferred annuity that starts at age 80 or 85 can make retirement income planning much easier because you always know that you’ll have a base income that won’t run out in old age,” he says. “Most of us economists are big fans of the tax-advantaged QLACs because they give you a tax break from avoiding required minimum distributions and annuitization when it is most valuable.”
4. Reverse mortgage
A reverse mortgage is a loan that enables homeowners that are generally 62 years of age or older to use part of their homes’ equity to obtain cash proceeds that can be used in many ways, according to the National Reverse Mortgage Lenders Association.
Among other things, a reverse mortgage grows in credit capacity as the homeowner ages, says Shelley Giordano, the founder of the Academy for Home Equity in Financial Planning at the University of Illinois at Urbana-Champaign. “So, in a sense, a reverse mortgage is an ideal vehicle to address longevity challenges.”
Whether the reverse mortgage is configured as debt in the form of draws, or an unused line of credit, or more typically, a combination of the two, Giordano says “a reverse mortgage can help smooth out turbulence in a long retirement.”