Editor's Note: This story originally appeared on Boldin.
Believe me, you are not alone if you have nervously asked yourself, your spouse or even a financial advisor: “Will my retirement savings last as long as I do?”
Concerns about running out of money in retirement are almost universal — no matter how much money you have. After all, there are many unknowable variables that can impact your retirement security — not least of which is not knowing how long you are going to live.
You might have enough to live comfortably or even luxuriously until age 85, but what happens if you luckily live to be 100?
The good news: There are numerous strategies you can use to significantly reduce your risk of running out of money in old age.
What Does Running Out of Money Really Mean?
Running out of money in retirement does not mean that you are completely penniless. It really is more a question of “will my savings last?”
Running out means you have used up all of your retirement savings and home equity and are left with whatever guaranteed income streams you might have (Social Security, an annuity or a pension if you are lucky).
Most people who run out of money in retirement continue to scrimp by — living on Social Security income — and they have probably opted into Medicaid instead of Medicare.
What Are the Chances of Actually Running Out of Money in Retirement?
According to recent research from Morningstar, approximately 45% of Americans are projected to run out of money in retirement.
And, you are not necessarily safe if you are a high earner. According to a detailed report by the Employee Benefit Research Institute (EBRI), households with low income face a huge risk, but many wealthier households are also likely to run out of money.
- 83% of baby boomers in the lowest income quartile will run out of money in retirement
- 47% of boomers in the second lowest quartile will run out
- 28% of boomers in the second highest quartile will run out
- 13% of boomers in the highest income quartile will run out
Yikes! The above data refers to people who will be retired for 35 years.
However, the information is only slightly better if you are living in retirement for 20 years — even then a full 81% of the lowest income quartile and 8% in the highest income quartile will run out of money.
Use a Phased Approach to Make Retirement Savings Last
There are multiple ways to make sure your retirement savings last as long as you do. One way is to use a phased approach to utilizing your savings.
Peter Tsui is the director of global research and design for S&P Dow Jones Indices. He suggests a method for handling longevity risk — you divide retirement into two phases and fund each phase separately:
Phase 1: The first phase lasts roughly from retirement age until age 85, which according to the Society of Actuaries, is close to the average life expectancy for someone who turns 65 years old. The actual average life expectancy is 87. This means that you have at least a 50% chance of living longer than 87 (perhaps MUCH longer) and a 50% chance of living not as long.
Phase 2: The second phase is from age 85 through the rest of your life — however long that might be.
Funding the Second Phase of Retirement
To fund the second phase of retirement, Tsui recommends that at retirement you purchase a deferred lifetime annuity with income that will begin at age 85 and last until your death.
- A deferred lifetime annuity is simply an annuity that you buy now for income that will start at a predetermined future date. Lifetime annuities pay income for your lifetime, no matter how long that will be.
- The amount of income you will want to purchase will depend on the difference between any other guaranteed lifetime income sources like Social Security and the cost of your desired lifestyle at that time. However, be sure to also factor in healthcare costs, which tend to increase as you get older.
Your remaining savings can be used for the first phase of retirement. Since the time period for using these assets is known, it is much easier to determine how much you can withdraw each year.
Other Ways of Making Sure Your Retirement Savings Will Last
There are numerous other ways to mitigate the risks of running out of money in retirement.
Big savings: If you have a lot of money, you can often live off the dividends and interest earned on those assets, but you need to make sure that you have the right allocations so that your money will both grow and be usable by you in the near term. It is absolutely possible to have more savings at the end of your retirement than when you started.
Bucket approach: Tsui’s two-phase approach is essentially a bucket strategy — allocating different buckets of money in different investments or for different purposes. There are many other ways of bucketing your money for retirement.
Using home equity as a fallback: Some homeowners plan to make their retirement savings last as long as possible and then downsize or get a reverse mortgage to make ends meet thereafter. This can be a viable approach, but you may want to explore cashing in on the home in advance of when you actually need it.
Try to pinpoint your longevity: Some people try to get a particularly good estimate of their longevity and plan their retirement finances around that particular number. There are quite a few life expectancy quizzes that can help you, but they have not yet been proven to be scientifically accurate.
Try any of these scenarios in the Retirement planner and see what gives you peace of mind.
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