How does longevity affect your plan? If you run out of money, then what?
People live longer now than their predecessors. From 1930 to 1970 the expected life of a 65 year old male barely changed. By 2010 it had increased by more than 5 years, to about 18 years. For a couple there is now about a 50% probability that at least one will live to 90 and a 10% chance that at least one will live to 99. The future could be profoundly different.
How should that affect planning?
- Duration of income is now as important as the quantity of income.
- Pensions and other income producing vehicles will require more capital especially given the low interest environment where the present value of a pension payment due at 90 is still quite large
- Governments may feel remorse over their grand promises
- Employers will find ways to change the pension structure by amending their rules.
All considered, many people will adjust their lifestyle more or sooner than they may like.
Longevity is a difficult problem. If you get what you want, long healthy life, you lose out because money is a problem. If you die early, your estate will be bigger than planned and that is all.
No win either way. Where is breakeven?
The defence involves three steps.
First understand your lifestyle. What parts are there that will go away anyway? What spontaneous financing exists? Government and employer pensions primarily. Your requirement is to finance the difference between lifestyle and the income that will happen automatically.
Second understand how your assets and income are attached. Assets you use like your home, cottage or ski chalet are an annual cost but may be disposable. On disposition they automatically provide new investment income.
Third understand average yield and the effect variations from the average may have. If there are withdrawals, early losses are enormously costly even if the average rate of return works out. If you want to withdraw a constant amount plus inflation, you assume very much larger risks than you might expect. If you draw a fixed percentage of the fund, you run less investment risk, but more cost of living risk. You will be asked to choose between the risks.
A mid-January report from the OSC pointed out that while seniors may be less cognitively skilled than they once were, they are no less confident in their decision making ability. That can make for a very tense environment for advisors, clients and their families.
You can overcome it by starting the discussion much earlier. The withdrawal amounts and their tactical application is a discussion that makes sense 15 years before retirement.
Best practices only work when the client goes along with it.
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.