Life expectancy is an important factor in the financial planning process, especially determining how much money to invest for retirement and how much to withdraw when you actually retire. Life expectancy can be defined as the remaining number of years that an individual is expected to live based on actuarial tables used by life insurance companies and the IRS. The longer people live, the higher their projected life expectancy.
The life expectancy of Americans has increased remarkably during the last century, extending our ability to be productive and enjoy life. Average life expectancy for a baby born in the U.S. in 2004 was 77.8 years. In 1900, average life expectancy at birth was 47.3. At age 65, average life expectancy is 18.7 years and many people will live a lot longer. With increased longevity come the twin financial challenges of saving adequately for retirement and carefully planning withdrawals from savings so as not to outlive your assets.
Life expectancy depends upon a number of factors including personal and family health history, occupational health risks, health behaviors (e.g., diet, exercise, and smoking), safety practices (e.g., wearing seat belts), and more. Hundreds of online life expectancy calculators incorporate these factors and can provide an estimated life expectancy. Simply type the words “life expectancy calculator” into an Internet search engine, such as Google, and compare the results of at least three different calculators. Be sure to take note of the assumptions that are used for each calculator. Results will vary according to the assumptions that are used.
Below are three key financial planning decisions where life expectancy estimates are important:
How Much to Save For Retirement- Whether calculations are done online or with a “paper and pencil” worksheet, life expectancy is a key variable. A higher assumed life expectancy increases the savings requirement. The number of Americans age 85 and above is expected to more than triple between 2000 and 2040. Studies indicate, however, that many people underestimate average life expectancy, which can result in faulty planning. Two simple non-commercial retirement savings calculators are the American Savings Education Council’s Ballpark Estimate at www.choosetosave.org/ballpark and AARP’s calculator at http://www.aarp.org/money/financial_planning/sessionseven/retirement_planning_calculator.html.
When to Begin Social Security Benefits- From a purely mathematical standpoint, a key consideration is the “break-even point.” This is the age, generally late 70s to early 80s (depending upon assumptions used), where someone receives more from Social Security by delaying benefits to full retirement age (FRA) than they would by taking an early reduced benefit at age 62. Thus, one’s life expectancy and personal and family health history are key variables as someone would need to feel confident about living to break-even age to make postponing benefits an attractive option. Benefits are reduced 25% at age 62 for persons with a FRA of 66 and 30% for younger workers. Conversely, those who postpone taking Social Security beyond FRA through age 70 receive a yearly benefit increase of 8%.
How to Make Retirement Asset Withdrawals- While experts may disagree on the best method to calculate sustainable withdrawals so as not to outlive invested assets, all agree that retirement asset withdrawals require careful planning. A classic study of sustainable withdrawal rates by Bill Bengen found that a “safe” withdrawal method (i.e., one that will not exhaust assets in less than 30 years) is a first year withdrawal rate of 4% of invested assets followed by inflation-adjusted withdrawals in subsequent years. The analysis used historical investment returns and concluded that the best starting asset allocation for retirees was 50% to 75% in equities such as stocks and growth funds. Bengen’s conclusions have been widely recommended for the past decade. For example, if someone has saved $500,000 and they want it to last, they would withdraw $20,000 ($500,000 x .04) during their first year of retirement, $20,600 in year two ($20,000 + $20,000 x .03), $21, 218 in year three ($20,600 + $20,600 x .03), and so on, assuming a 3% average inflation rate.
Want to know more about life expectancy and, more importantly, get a realistic estimate of your own? The Purdue University Extension Planning For a Secure Retirement Web site, Module 1b, available at http://www.ces.purdue.edu/retirement/, has links to several helpful online life expectancy calculators.
