Friday, July 12, 2013

Plan on Living to 95

In my previous post, I referred once again to withdrawal strategy risk--the risk of either withdrawing too much or too little each year.  If we only knew when we were going to die, planning would be so much easier.  Some retirees believe that it is sufficient and appropriate to base withdrawals on their current life expectancy.  As we will see in this post, the very significant downside of this strategy is that withdrawals may not keep pace with inflation (or may even decrease in dollar amount) if you have the good fortune of outliving the life expectancy you used for planning purposes when you first retired.  Based on the Society of Actuary mortality tables, it is much more prudent to assume that you will live to your mid-90s (unless you have already reached your 90s) rather than use published life expectancies when developing your spending budget.

The exhibits below are based on Society of Actuaries Annuity-2000 male mortality tables with mortality projection.  These tables are available in this website at this link.  In both exhibits, the hypothetical retiree is assumed to have $500,000 at retirement at age 65 and desires to have constant real dollar withdrawals throughout retirement.  In the first exhibit, the individual retiring at age 65 assumes he will live exactly the number of years equal to his life expectancy (in this case 21.9 years).  Every fifth year thereafter he adjusts his spending plan based on his revised life expectancy.  His assets are assumed to grow at 5% per year and inflation is assumed to be 3% per year.  He is assumed to use the methodology outlined in this website for his withdrawal strategy with no other annuity income and no amounts left to heirs at death.

The first exhibit shows that if he lives to age 80, his annual withdrawal will only be 75% of his initial withdrawal in real dollar terms and if he lives to age 85, his annual withdrawal will only be about 54% of his initial withdrawal in real dollar terms.

By contrast, if his withdrawal strategy is such that he can live with a 30% chance of outliving his savings (by assuming that he will die at age 93 for the first 15 years, 94 if he makes it to 80 and 95 if he makes it to 85), he will be able to keep his spending constant in real dollar terms for 15 years.  Even if he takes this more conservative approach, however, he is still at risk of lower real dollar withdrawals after age 80.  But arguably he may be in a better position at his advanced ages to live with decreased real dollar retirement income.

According to the Society of Actuaries tables, Females generally have a 30% chance of living to approximately 95 until they reach age 80, at which time their expected age at death increases past age 95 in much the same way as anticipated for males.