The No. 1 risk to retirement – and one way to guard against it

Future retirees often daydream about golden years that never end.

In reality, too many golden years could be a nightmare.

“The No. 1 risk in retirement, hands down, is longevity risk,” said David Blanchett, head of retirement research at PGIM DC Solutions, calling it “a risk that increasingly we all have to face ourselves. Now, if we knew with absolute certainty what the market was going to do and how long retirement was going to last, I could tell you to the penny how much you could spend in retirement.”

While some might label the thought of outliving your money as a good problem to have, it’s a problem that can keep financial advisers and their clients up at night. Blanchett addressed longevity concerns during his AICPA & CIMA ENGAGE 25 session, “Lifetime Income: A License to Spend,” offering advice that can set up clients to rest easy in retirement, no matter how long it lasts.

It’s not as easy as pie, but …

A piece of cake?

Following Blanchett’s session, a fellow Ph.D. and fellow professor at The American College of Financial Services joined him for a fireside chat. Michael Finke shared a tasty tale that encapsulates the bitter impact that longetivy risk can have on retirees.

You’re throwing a birthday bash for your son, and about 20 kids – but an unpredictable range of five to 40 kids – will show up. You have to cut each kid a piece of birthday cake as they walk through the door.

“Do you cut the first kid a one-twentieth slice of that birthday cake? No, because there could be 30 kids, there could be 35 kids, there could be 40 kids. So you cut the kid a smaller slice of cake,” Finke said. “The kid is a little bit disappointed, but at least he gets a slice of cake.The30th kid comes through the door; there are only five slices left. You’re starting to get nervous. You cut smaller and smaller slices.

“This is an anxiety-producing situation.”

But, Finke continued, there’s a bakery that offers cake insurance. In exchange for payment upfront, they’ll bring you a second cake if more than 20 kids show up.

Such an offering would bring peace of mind to your pieces of cake, and it sums up how Social Security works. Once you claim Social Security, you’ll receive the same slice of cake each year for as long as you live.

But while Social Security alone usually isn’t enough to fully protect against outliving your funds, increased guaranteed monthly income in retirement can add up to palatable protection.

That peace of mind also can help give retirees a license to spend, paving the way for a happier retirement.

The value of ‘lifetime income’ … and how to create more of it

Blanchett defines “lifetime income” as income that is “guaranteed or protected for life.” Research conducted by Blanchett and Finke confirms key findings he shared from the University of Michigan Health and Retirement Study (HRS): Namely, retirees are willing to spend nearly all of their lifetime income, but they’re more hesistant to spend from other sources of income (wage, capital) and they’re downright resistant to spending from savings vehicles such as 401(k)s and IRAs.

“With Social Security, it’s like, ‘Man, I’ve been paying into this thing for 30 years. I’m going to spend it,’” Blanchett said. “You get a pension? You’re going to spend it. You get an annuity check? You’re going to spend every penny of that.

“They want to win there, but they’re just scared to spend down their portfolios.”

Finding ways to increase lifetime income can increase spending in retirement in two fundamental ways, Blanchett said. First and most obvious, retirees’ general willingness to spend lifetime income means that the more there is, the more they’ll spend. But also, research reveals that those with more lifetime income are more willing to spend from other buckets; between the ages of 65 and 69, the rate of spending from assets nearly doubled for those with $60,000-plus of annual lifetime income versus those with $30,000-$45,000.

Social Security is the starting point when it comes to lifetime income, and when you start collecting can make a big difference. For those born in 1960 or later, $20,000 each year for life at the full retirement age of 67 becomes $24,800 if you delay until age 70.

Blanchett believes that happiness in retirement often hinges on being able to cover essential expenses with lifetime income. When Social Security and pensions aren’t enough, Blanchett and Finke both believe in what Finke called the “magic” of a lifetime income annuity.

A lifetime income annuity, in the simplest of terms, works like Social Security and works like Finke’s birthday cake: For a payment up front or some type of ongoing fee, a lifetime income annuity will provide guaranteed income for the rest of your life. Whether you live four years or 40 years after buying an annuity, you can enjoy an equally portioned slice of income each year.

Finke offered the real-life example of a woman who began receiving $1,000 a month in Social Security at age 70 but who, by investing 40% of her $1 million of savings in an annuity, immediately began receiving a guaranteed $2,500 more per month.

“The ability to know that no matter what happens, I’m going to be able to spend at least $3,500 per month, that provides people with a level of comfort that they simply don’t get from investments,” Finke said.

“When we’re confronted with uncertainty, it creates fear,” Blanchett said. “People are terrible at decumulating qualified savings, nonqualified savings, wage income, and capital income. The only thing they appear to be good at actually spending or consuming in retirement is lifetime income.

“The more lifetime income you have, the more satisfied you are going to be with retirement.”

Editor’s note: If you didn’t attend ENGAGE, you still can access this session. Those who purchased an all-access pass to ENGAGE can log in and view this and other archived sessions. For information on ENGAGE 26, including an opportunity to save up to $350, click here.

— To comment on this article or to suggest an idea for another article, contact Bryan Strickland at Bryan.Strickland@aicpa-cima.com.