Since you don’t know how long you’ll live, what is a sensible planning horizon for the length of your retirement?
Let’s imagine you’ve just stopped working. You’ve been diligent and saved money that will now be called upon to support your future lifestyle, in addition to any Pillar 1 and Pillar 2 pensions you are entitled to. (See Post #9 if you need to remind yourself what those are.)
As you plan for the future, there’s a fundamental question. How long do your savings need to last, as you draw down from them for spending? The answer is simple, but not straightforward. It’s simple, in the sense that it needs to last as long as you live. But that’s not terribly helpful, because (assuming you’re in reasonably good health) you have no idea how long that is.
So now, what do you do? Because if you don’t know, then you also have no idea how much you can afford to spend from your savings. (This amount, by the way, if often called your “sustainable drawdown,” in the jargon used by financial professionals. You’re drawing down an amount from your saved assets, and that level of drawdown should be capable of being sustained for as long as necessary, so you can go on living the lifestyle implied by that rate of spending.)
Fortunately, it turns out that the life expectancy discussion in Post #5 is really useful in thinking about this.
You’ll remember the concept. We start by considering a large group of people of the same age and gender. As we follow them through life, the number remaining will gradually decline. At some point, only half of the original group will be left. Some time later, only one-quarter of the original group will be left. Later still, only one in every 10 original members of the group will be left. And so on.
Knowing your gender and age (and that of your partner, if that’s relevant), I can show you how to estimate how far into the future those three points are.
How does that help you specifically, to know when you will go? Aha, that’s the point. You don’t know. In fact, if the rest of the group is like you, you can’t know. Any of you might go early, or go late.
But here’s how that thought process helps your planning.
Suppose you choose the halfway point as your planning horizon. You may live longer or shorter than that halfway point. They’re equally likely. So, if that’s your planning horizon, you’re as likely to fail to make your money last, as to succeed.
For most people, that’s too chancy. Running out of money before you run out of life turns out to be the biggest fear that retirees have. So you’ll probably want to make the money last longer than the halfway point.
How about the point at which three-quarters of the group have gone, and only one quarter still alive? Well, now you’re giving yourself three chances out of four, of succeeding to make the money last. That’s better. Or, if you’re very, very cautious, you’ll choose the point at which only one in ten of the original group are still alive.
Wouldn’t you naturally want to be as cautious as possible, with something like this? Not necessarily. Why is that? It’s because, the longer you plan to make your money last, the less you can draw down each year. That’s just common sense, not higher mathematics. If you have $1,000 and want it to last for 20 years, you’ll be able to withdraw less each year than if you want the same $1,000 to last for only 10 years.
So there’s a trade-off. What you might do, in practice, is two things.
The first is to ask someone to calculate (or maybe do it yourself) how much you can sustainably draw down from each $1,000 if you plan for the one-quarter or one-tenth points. See how that compares with your desired lifestyle. That could help you decide.
The other is to resolve to adjust, as time advances. For example, this is what my wife and I are doing. We’re using the one-quarter point for planning purposes. When the first of us goes, that’ll require a new calculation. If, as time goes by, we’re both still around and in good shape, we’ll re-examine our future life expectancy at some point, and adjust our planning horizon accordingly. Our hope is that by then we’ll have gone from the so-called “go-go” years to the “slow-go” years, and won’t need as much money to support our slow-go lifestyle. (And I have yet another approach for us, if we both live a long time. But that’s not relevant for the moment.)
For this post, all I’m trying to do is to help you understand how to select a planning horizon for your post-work lifestyle.
“But wait,” I hear you say, “where are the numbers?” You’re right, all I’ve done so far is talk about the concept. OK, here are the numbers.
The Sample “Joint and Last Survivor” Life Expectancy Table below is something I’ve compiled from a source called longevityillustrator.org, produced by the American Academy of Actuaries and the Society of Actuaries. It’s their estimate of the halfway, one-quarter and one-tenth points for the US population today, based on tables compiled by the US Social Security Administration. (If you can find estimates for your own country, do use those. I asked in Post #5 for any similar sources you may use or may have found, but got no responses.)
Sample “Joint and Last Survivor” Life Expectancy Table
All values are years.
Source: I filled in the numbers from my entries in www.longevityillustrator.org on October 16, 2017
Let me explain how to interpret the numbers. (By the way, the blue numbers are for single males, the pink ones for single females, and the grey ones are for a male-female combination.)
Suppose you and your partner are a female now aged 60 and a male now aged 65.
First, “joint and last survivor” means that at least one of you is still alive, so you’ll definitely want some money available for that!
Look at the portion of the table for those genders and ages, and you’ll see 30, 36 and 40. What that means is that the halfway point is 30 years from now. The point at which one-quarter of that kind of group will still be alive is 36 years from now. And 40 years from now, one-tenth of that kind of group is projected to still be alive.
So, if you use my own one-quarter point for your planning, your initial planning horizon will be 36 years. Get it?
If you’re single, then use the male or female blocks alone.
What if your current age doesn’t end in 0 or 5? Well, you can go to the original table and fill in your exact dates of birth as well as a couple of health-related questions, and get answers that fit your situation. Or, as a quick estimate, you can go “somewhere in between.” For example, suppose you want the number for “female 61, male 67.” That’s somewhere between female 60 and female 65, and somewhere between male 65 and male 70. That gives you four blocks of numbers. Gosh, this isn’t an exercise in precision: simply pick numbers somewhere in the middle of each set of four numbers! Perhaps 28, 35, 38. And then select your planning horizon from those.
Does that make sense?
Use a life expectancy table (such as the one here) that shows you what proportion of people or couples similar to you survive for what length of time.
I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.