The slogan “live long and flourish” has remained popular in modern culture since Star Treks Mr. Spock came with the greeting almost 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 can live long, but not necessarily thrive.” High-tech machines and miracle cures can prolong length of our lives, but not necessarily 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 that is a lot to consider. We all want to live a long life, but implicit in this goal is the desire to live it under favorable conditions – to have a plan to deal with longevity.
Not knowing how long you will live in retirement does not mean you can not handle your risk of longevity. A retirement plan can, and should, address ways in which you can manage to live longer than your life expectancy. There are many planning options, but in our current environment, five key strategies deserve special consideration when building your own retirement plan.
1. Social security
Pension benefits from social security enjoy a unique position with pensioners as a guaranteed form of inheritance insurance. Even for the very wealthy, these monthly payments are an important source of livelihood. A wealthy married couple can receive more than $ 1 million in social security payments during their retirement years. Fundamental to this benefit is that it pays off throughout retirement, regardless of whether the participant reaches or exceeds life expectancy. And it is important that the payments are made in real dollars, ie. the benefits are adjusted annually to reflect the consumer price index.
In dealing with the risk of living too long, the key strategy is to postpone the application for social security benefits for as long as possible, ideally up to 70 years. There is no shortage of research on the best application strategy for social security. Economic models have been created for different scenarios—a couple where one spouse has a shortened life expectancy; if social security pays reduced benefits from 2032 due to public underfunding; wealthy retirees who expect to get a high return on their invested assetsand with very few exceptions, financial modeling indicates that delayed application for social security is the preferred strategy to address the risk of longevity in retirement. If you are concerned about the financial risks of living too long, wait to report.
For many, this raises the issue of cash flows early in retirement. The average retirement age is well below 70, so the question is how to increase retirement income until social security benefits begin at age 70. Consider these two approaches. First, begin your retirement by deducting your savings after tax and qualifying assets (IRAs and pension funds) so you can defer your Social Security application until later. In addition to covering your cash flow needs in the early years of retirement, this approach can save you significant taxes. Second, you need to create a social security bridge to fill the income gap between retirement and application. Let’s say, for example, that you plan to retire at age 62 but want to defer your Social Security application until age 70. You can buy a single premium immediately annuity that pays income in these years. Similarly, you can take out a reverse mortgage that utilizes the equity in the home to finance the eight-year interim period. Because these bridge strategies are typically not inflation-adjusted, it is all the better to use them early in retirement, so the real dollar benefits of social security are there in the years to come.
Social Security is the poster child for the use of annuities in retirement. This public benefit is a lifelong annuity that cannot be paid or paid out. By using employment taxes derived from working individuals and further savings on benefit expenses for retirees who die prematurely, this social security pension creates a “mortality premium” for those living earlier than expected. The longer the individual lives, the higher the effective return on the taxes paid by the worker during the work year.
Benefit-based pension schemes work in the same way. They are a form of long-term insurance because if you are lucky enough to be covered by such a plan, it will continue to pay an annuity income even after you have lived longer than 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 are 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, income from this capital is not automatically guaranteed to continue over your lifetime.
You can counter this risk by buying commercial annuities. Recently, there has been an explosion in available product designs – too many to detail here. Suffice it to say that annuity designers can accommodate incipient income right away or defer income into the future. In addition, the benefit can be fixed or flexible.
Through legislation and regulation, the federal government has encouraged Americans to consider supplementing their retirement savings with annuities. In 2014, they blessed the Qualified Annuity Contract (“QLAC”) in tax-deferred pension plans. Subject to certain limits, a retiree may use IRA funds to purchase a lifelong annuity beginning in the future. The tax incentive for QLACs is that the funds used will not be subject to the required minimum distributions (RMDs). In other words, all IRA funds you use to create a future lifetime income will not be forced to be withdrawn by the age of 72 RMD. The second pro-annuity nod from Congress appeared in the 2019 SECURE Act. This two-part law makes it much 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 pension income for life – and that’s what annuities do.
3. Long-term care insurance
The history of long-term care insurance in the United States has been disappointing. However, this is not a reason to avoid using such insurance. The sad situation is that one-half to two-thirds of older Americans will at some point require long-term care. These people can live long but do not necessarily thrive. Long-term care insurance can at least reduce the financial challenge of this condition by absorbing many of the costs associated with long-term care.
The stony history of long-term care insurance can be a case of looking out of the rearview mirror. Insurance companies have become more adept at pricing this product. Popular contracts now reimburse an insured for long-term care expenses when, after a specified period, the insured is unable to perform at least two daily activities (“ADLs”) such as dressing or bathing. With an average stay in a long-term care facility of more than two years, this insurance provides security for those who are worried about living too long – especially when they are dependent on others for their care. Especially because the incidence of long-term care events increases with age, long-term care insurance directly addresses the risk of longevity in retirement planning.
This is another situation where public policy makers have tried to encourage individuals to solve the problem of longevity by buying insurance. In this case, through the tax legislation first enacted in 2006, Congress made long-term care insurance, whether independent or as part of a life insurance or annuity contract, tax-favored. Second, a significant number of states have enacted legislation that allows certain long-term care insurance plans to avoid being considered for Medicaid requirements. In other words, a person can purchase a qualifying long-term care insurance plan that provides a monthly income that will not be used to determine if that person is eligible for Medicaid.
4. Investment Strategies
In the private sector, most current employer-sponsored pension schemes are some form of defined contribution plan, such as a 401 (k) or SIMPLE IRA. This means that a future ex-employee at retirement is sitting on a pot of money that requires yet another decision on retirement: how to deduct this capital as retirement income. They should avoid taking too little or too much while ensuring that they do not run out of money before running out of oxygen. This requires the retiree to structure – and administer – both a retirement and investment strategy. The senior pulls down the retirement savings while striving to increase the remaining balance. It is a lot to demand of someone in their golden years.
In a previous posts I covered three of the most common pull-down strategies retirees can use. All three are designed to balance the need for pension income with the need to maintain sufficient pension capital. Implicit in these strategies is the need for part of your pension savings to be invested in equities – for example, equities, mutual funds or ETFs. A pension portfolio needs an equity element to keep up with inflation, ensure growth and maintain sufficient capital for an indefinite period. Without an equity allocation, you risk living a longer life than expected before your pension funds are depleted before death. Even if you have covered a significant portion of your income needs with lifelong annuities, it is important to have an element of growth in your portfolio. It addresses the inflation risk of living too long and provides an opportunity to leave a legacy to heirs.
Two essential needs of a retiree are housing and medical care. And the cost of these services potentially increases with age due to fragility and long-term care needs. For the financially disadvantaged, Medicaid is a safety net program that can handle these basic cost of living. In terms of health coverage, Medicaid provides coverage to 7.2 million low-income seniors who are also enrolled in Medicare. Additionally, Medicaid programs can pay for housing-related services that promote health and community integration. However, it does not pay for rent or for board and lodging, except in certain medical institutions such as nursing homes.
With the longevity issue facing many seniors, Medicaid can be a legitimate planning option for middle- and low-income individuals. If you or a relative expects to require long-term care and your financial resources are limited, advance planning can make it possible to use Medicaid as a source of funding. There are techniques to legally use 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 will all prosper. The challenge is that we do not know how long we will live and how much it will cost to thrive. Mr. Spock also has a thought about this: “Insufficient facts always invite danger.” Gather your facts and address the opportunities and risks of living a long life.