How A Long and Healthy Life Is A Financial Problem
Longevity is a key concept when planning safe withdrawal rates.
Research shows (based on U.S. historical data—see above caveats) that safe withdrawal rates for 10-year retirements approach 10%. Retirements in the 20–25-year range push 5%, and 30 years or more dip under 4%.
The rule is simple: The longer your money has to last, the lower the percentage you can withdraw. It is inherent in the mathematics of amortizing a fixed pool of capital—your savings.
Now that we know the math, let’s look at the problem: People are living longer.
Remember our 1921 retiree? He had a life expectancy of little more than 65 years. When Social Security was created they set the retirement age at average life expectancy. It was never intended to fund 30+ year retirements.
Since that time, average life expectancy has increased by roughly 1/3 of a year for every year, thus increasing by 30 years in the last 100 years.
Our 1921 retiree didn’t need a lot of savings because he could spend a large chunk of principal every year. Our 2010 retiree doesn’t have that luxury.
Today, a healthy couple retiring at 65 has a good probability of at least one spouse living into their 90s. That means that today’s retirees must budget for 30+ years and be extremely careful about any strategy that amortizes their savings by spending principal.
Additionally, this average life expectancy is a moving target expected to increase by the time your date with destiny arrives. If history provides any guide, it is reasonable to expect the average to rise another 10 years over the next 30 years, moving our 2010 retiree into a 100+ year lifespan. This may sound extreme, but with developments in biotechnology and nanotechnology it may actually prove to be a conservative estimate.
Finally, understand that all this discussion is about averages, but half the population outlives the averages. Already the 95% confidence interval8 life expectancy is over 100 years and rising.
There has never been a higher risk that you could outlive your savings. Extremely long retirements exceeding 30+ years are entirely reasonable to plan for; yet, all safe withdrawal research to date is based on the premise that you spend your assets to zero at 30 years.
This could be very dangerous.
For many people this assumption could cause you to run out of money long before you run out of life.
Lesson Learned:
Both 2nd and 3rd Generation research into safe withdrawal rates has assumed 30-year retirements as the maximum. Trends in human longevity and developments in medicine make that a dubious assumption at best and dangerous at worst. The longer your life expectancy, the lower percentage you can withdraw from savings.
The bottom line is a safe withdrawal rate that spends principal is an oxymoron when longevity expands beyond 30+ years. Any spending of principal is not safe over very long periods. You should adjust your investment strategy and withdrawal rate accordingly.
