If you ask pre-retirees and retirees to name the most serious financial risk they face, they often cite investment risk. That’s not surprising, given that this risk received a lot of attention in 2022 due to the volatility in the stock market and the sharp increase in interest rates. But while investment risk is certainly a significant risk, it isn’t the most serious financial risk facing retirees, especially in the long term.
That designation belongs to longevity risk. In fact, a recent brief from the Boston College Center for Retirement Research demonstrates that for most retirees, longevity risk is more likely to play havoc with your finances over the long run than market risk despite the reverse belief by pre-retirees and retirees.
For those of you in this cohort, there are both narrow and broad views of longevity risk that deserve your attention. Let’s take a look.
Longevity risk – the narrow view
Longevity risk is commonly defined as “outliving your money,” and protecting against this risk is certainly an important retirement planning task.
The best strategy to protect against this definition of longevity risk is to maximize your Social Security benefits, which are designed to last for the rest of your life no matter how long you live, are increased for inflation, and don’t drop if the stock market crashes.
Other possible strategies to make sure that your money lasts for the rest of your life include buying a low-cost, lifetime income annuity and selecting a careful strategy to invest and draw down your invested assets.
With this latter solution, one such strategy supported by my research is to use the IRS required minimum distribution to determine the amount to withdraw from savings each year. This is combined with investing in common low-cost target date, balanced, or stock index funds. This strategy can easily be implemented in most IRAs and 401(k) plans.
However, there are additional, more wide-ranging aspects of longevity risk that deserve your attention.
Longevity risk – the broad view
A more robust definition of longevity risk is “everything that can go wrong during a long retirement.” Nowadays, many retirees are living into their 90s and beyond. For retirees in their early to mid 60s, that could mean living another 25 to 30 years. And a lot can go wrong during such a long period of time.
In addition to the narrow definition of longevity risk, a broad view would include the following risks:
- Inflation risk: This is the risk that the purchasing power of your regular income will diminish significantly over time. Again, the events of 2022 have focused much attention on the risk of inflation.
- Healthcare risk: For most retirees, it’s inevitable that at some point, you’ll incur significant expenses due to your health conditions. Strategies to protect against this risk include making careful choices when it comes to Medicare, selecting the appropriate insurance to supplement Medicare, and doing all you can to take care of your health. Don’t forget addressing possible dental, vision, and hearing aid expenses, which aren’t covered by Medicare.
- Long-term care risk: This is the risk that at an advanced age, you or your spouse will become frail and need help with the activities of daily living. You’ll want to develop strategies for paying for and managing this care if you need it.
- The risk of diminished capacity for making financial decisions: As you age, you might not pay as close attention to your finances as you should and will be more vulnerable to financial losses due to making mistakes or being a victim of fraud or exploitation.
- The risk of expensive house repairs: Over a long period of time, you’ll most likely need to replace your home’s roof, heating and cooling systems, hot water heater, and other pricey systems. You’ll want to consider when you might need these repairs and hold some money in reserve for that possibility.
- The risk that you’ll need to move: As you age, you may not be able to live in your current home due to frailty, or you may no longer be able to afford your house. It’s better to address this potential risk sooner rather than later; if you wait too long, you may be too frail to manage a move on your own and might need to rely on family and friends.
- Isolation risk: In addition to being a detriment to your enjoyment of life, being isolated from family and friends is a serious health risk. One way to address this risk is to carefully consider the home and community that best suits your life in retirement.
- Family disruptions: At some point in the future,you may be asked to support family members who need financial help. While this can be a compelling situation, you’ll want to make sure you don’t jeopardize your own financial security by providing the financial resources they need.
- Climate risk: Your home and general geographic area may incur more risks due to drought, fires, rising temperatures, and severe weather events. This is more reason to carefully consider the best place to live in retirement.
Whew! This list might seem very intimidating. However, you don’t need to address these risks all at once—you have time to explore your options and consider the solutions that work best for you. If you haven’t yet retired, you’ll want to start your planning well before your actual retirement date.
Nobody promised that living a long time would be easy. However, if you take the necessary steps to improve the odds that you’ll live long and prosper, your future self will thank you.