How Long Should I Plan for Retirement To Last?

By Macy Jae Moore on April 19, 2023

Written by: Zeke Anders

Charlie Munger, Warren Buffett’s longtime business partner and friend, once said “All I want to know is where I’m going to die, so I can never go there.” If we knew exactly when we were going to die, retirement planning would be much easier. Figuring out how much you can spend over a defined time period is much easier than planning for an uncertain time period. Deciding when to claim Social Security would be easy, too. Unfortunately, none of us has that information. Thus, we have to evaluate the probabilities.

Everyone has a different view of their own life expectancy. Some have family member that lived into their 90’s, others had relatives that died young. Many people have both. We know our own habits and the relative healthiness of our lifestyle. That said, we often underestimate the odds of living to older ages. The Social Security program has a team of actuaries that constantly review data on life expectancy, to estimate the liabilities (benefits to be paid) of the program. The chart below comes from the Social Security Administration’s 2019 Life table. 

Source: author’s own calculations from the Social Security Administration 2019 Life Table, https://www.ssa.gov/oact/STATS/table4c6.html, accessed April 13^th, 2023

The chart shows the probability that a male or a female will reach a certain age, and the probability that one of them will reach a given age. There’s a 50% chance a male will reach age 84, and a 50% chance a female will reach age 86/87. As a couple, there’s a 50% chance one of them will reach age 90. That may be surprising, but statistically it makes sense. 

In planning, we often look for a 90% probability of success. In this case, that is like planning for a 10% probability of survival. A male has a 10% chance of surviving to age 94, and a female has a 10% chance of living to age 96/97. There is a 10% chance that one of them is alive at age 97/98. 

Again, these results may be surprising. The charts below show the subjective and objective life expectancies for males and females of different ages. The data comes from the Health and Retirement Study from the University of Michigan, which followed 20,000 people over 16 years, asking them questions along the way. The subjective estimates are the participants guessing at their own life expectancies, whereas the objective estimates are from life tables developed by other researchers. What this chart shows, is that younger men and women tend to underestimate their life expectancy, while older men and women tended to overestimate their longevity. 

Source: Center for Retirement Research at Boston College, “What Matters for Annuity Demand: Objective Life Expectancy or Subjective Survival Pessimism?”, January 2023

Why does this matter? Once we recognize we have a bias towards longevity pessimism when we’re young, we realize that we need to be more conservative with our planning assumptions, and we might evaluate decisions like Social Security and pensions differently. The breakeven age for delaying Social Security benefits versus claiming early is generally around age 83. For males there’s a 53% chance they’ll be alive at age 83, a 64% chance a female will be alive at age 83, and an 83% chance one of them is alive at age 83. Social Security is best evaluated using an Internal Rate of Return (IRR). The internal rate of return of delaying Social Security increases over time, as you collect more payments. The chart below shows the IRR calculations over time.

Source: authors own calculations, assuming 2.5% inflation

Delaying Social Security is like paying for a higher benefit. You forgo the early payments to “buy” a larger monthly benefit later. The internal rate of return of delaying grows over time, approaching and eventually exceeding a 7.6% rate of return. It is very important for a married couple it to consider joint life expectancies, especially when one spouse has a larger benefit than the other^[1]. A surviving spouse is entitled to 100% of the deceased spouse’s benefit, if it is larger than their own. For example, if the deceased spouse’s benefit was $3,000 per month, and the surviving spouse’s own benefit is $1,500 per month, the surviving spouse will be bumped up to $3,000 total per month going forward. Social Security and pension benefits are a valuable hedge for “longevity risk”, which is living longer than expected. Living longer should be a blessing, but if we’re worried about running out of money we may not be able to enjoy it.

Lastly, The 4% rule we’ve discussed before^[2] was based on a 30-year retirement, which from age 65 would be age 95. That approximately aligns with the Social Security life expectancy numbers. Those retiring earlier than age 65, however, should be aware that the 4% rule would not have worked in all periods historically beyond 30 years, and we should all remember, that past results may not continue in the future.This may have been a bit mathematical and technical, but the bottom line is that estimating longevity is central to financial planning. That can be difficult since we all have different habits and family histories. We tend to have a pessimistic survival bias when we’re younger, which can lead to using less conservative estimates for life expectancy, and lead us to undervalue benefits like Social Security and pensions. Everyone is different and using the same assumptions will not make sense for everyone. But adding some margin for error when estimating longevity may lead to better planning decisions.

^[1] https://twickenhamadvisors.com/blogs/unobstructed-thoughts/social-security-benefits

^[2] https://twickenhamadvisors.com/blogs/unobstructed-thoughts/whole-life-insurance-as-a-buffer-asset

Zeke Anders – Planning Specialist | zanders@twickenhamadvisors.com

Disclaimer

Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.