Morningstar's director of personal finance, Christine Benz, chatted with David Blanchett, head of retirement research for Morningstar Investment Management. Below are excerpts of Blanchett's views.
Longevity risk: Extending life expectancies means that people are living longer in retirement, which, in turn, creates financial challenges.
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.
Life expectancy is the average number of years remaining for someone of a particular age. For 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: How long do I forecast my retirement to last? And, 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+ years into retirement.
The link between affluence and life expectancy.
It’s a very tragic think to think about planning for your own demise. But, how long are you going to live? Well, there are important drivers of mortality rates, and one thing we've seen is that on an average people are living longer and longer and longer and that's called improvement. However, these improvements in mortality are being realized mostly by wealthier individuals. So, someone, for example, who is in the top income decile or percentile could easily live four or five years longer than the average.
So, when thinking about how long you're going to live, think about what makes you unique. If you are a wealthy, active, healthy, nonsmoker, you could easily live eight years longer than the average. Again, that has really profound impacts about how long you plan your retirement to last.
The trade-offs associated with embedding a long life expectancy. What people should be prepared to do to adjust their plans to accommodate a really long life span.
One doesn't want to go broke at age 95. Everyone wants 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.
Immediate annuities are those where you give the company money and they pay you today. A problem with immediate annuities is that people don't always need a guarantee right now. If I retire at 65 years, 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.
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.
A stock-heavy portfolio if you want to embed a long runway for retirement.
The longer time frame you have to invest, the 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.
