What is longevity risk? 5 ways to preserve your retirement savings

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As medical advancements extend life expectancies, many retirees are facing a new financial concern: longevity risk. This refers to the possibility of outliving your retirement savings, a situation that can have significant consequences on your financial stability later in life.

While this risk isn’t new, it’s become more prevalent as life expectancies have increased, making it essential for individuals to understand and plan for it. In this article, we’ll discuss what longevity risk is, its impact on retirement savings and strategies to mitigate it. Whether you’re approaching retirement or already in it, understanding longevity risk is important for ensuring a comfortable and secure financial future.

What is longevity risk?

Longevity risk is the possibility of living longer than expected and running out of money during retirement. This risk arises due to increasing life expectancies, which can lead to greater-than-anticipated cash flow needs. For retirees, this means their savings and income sources must last longer, potentially leading to financial strain if not properly planned for.

To mitigate longevity risk, you can employ several strategies, such as delaying Social Security benefits, using annuities, adhering to the 4 percent withdrawal rule and considering options like reverse mortgages or part-time work. Proper planning, including estimating life expectancy and incorporating guaranteed income sources, is essential to ensure financial security throughout retirement.

Impacts of longevity risk on retirement savings

As life expectancy increases, many retirees face the possibility of their savings getting depleted before the end of their lives. This risk is particularly pronounced for those relying on fixed income streams such as pensions or Social Security. Here are some potential impacts of longevity risk:

• Depletion of retirement savings: If you live longer than expected, you might run out of savings, especially if you have been withdrawing more than the recommended 4 percent each year.
• Increased health care costs: As people age, health care costs tend to rise. Without proper planning and insurance, these costs can drain your savings.
• Inflation: Over time, inflation can erode the purchasing power of your savings, making it harder to cover your living expenses.
• Market volatility: Market downturns can affect the value of your investments. If the market drops significantly and you’re forced to withdraw funds to cover living expenses, you could deplete your savings faster.
• Lower standard of living: If your savings run out, you may need to cut back on your spending drastically, leading to a lower standard of living.

5 strategies to mitigate longevity risk

There are a few ways retirees can mitigate the effects of longevity risk. These strategies aim to ensure a more secure financial future by maximizing your potential income sources, properly managing your withdrawals and preparing for potential health care costs.

1. Claim Social Security benefits at the right time

Deciding when to claim Social Security benefits can impact your retirement savings and longevity risk. Claiming benefits early, before reaching full retirement age (FRA), will result in a reduced monthly benefit. However, if you live longer than average, claiming benefits early results in lower monthly income.

On the flip side, delaying benefits beyond FRA increases your monthly benefits for life, thanks to delayed retirement credits. This strategy effectively acts as longevity insurance, reducing the risk of outliving your savings. So if you can wait to claim until you’re at least age 67 or older, the more money you’ll receive in retirement.

2. Consider the benefits of an annuity

An annuity offers key benefits in managing longevity risk. Annuities provide a guaranteed stream of income for life, ensuring that no matter how long you live, you’ll continue receiving regular payments. This can alleviate the fear of running out of money in retirement, allowing you to enjoy your retirement years without constant financial worry.

Annuities work by requiring an upfront payment or series of payments to a life insurance company, which in turn, guarantees regular payments to you either immediately or at a future date.

3. Manage health care costs

Planning for health care costs in retirement is crucial, as these expenses tend to increase with age. Using a health savings account (HSA) can be an excellent way to save tax-efficiently for health care expenses. Also, delaying Social Security benefits until age 70 can maximize lifetime income, which is a crucial strategy to handle longevity risk.

Another important step is to enroll in Medicare — the federal health insurance program for people ages 65 and older — when first eligible to avoid late enrollment penalties and coverage gaps.

4. Protect savings from market volatility and inflation

One key strategy to combat longevity risk is to shift your portfolios to more conservative investments as you age, which can help weather bear markets. Diversifying across asset classes, including stocks, bonds and real estate, can also help balance market volatility and counteract inflation.

Maintaining a proper mix of assets that historically don’t rise or fall at the same time is crucial. Rebalancing your portfolio periodically to keep the allocation consistent with your age and investment objectives is also essential.

Even as you prepare for retirement, regularly review and adjust your retirement plan with a financial advisor to ensure your strategy remains aligned with your changing needs and market conditions.

5. Purchase long-term care insurance

Investing in long-term care insurance can also mitigate the financial burden of extended care needs, which is a significant risk as people live longer. Long-term care insurance can help cover rehab services, daily living assistance and care for chronic illness. For those with limited resources, Medicaid can serve as a crucial safety net for health care costs but you will have to deplete assets to qualify.

Bottom line

Combating longevity risk and preserving retirement savings requires a multi-faceted approach. Key strategies include delaying Social Security benefits until age 70 to maximize payouts, utilizing retirement annuities for guaranteed lifetime income and managing health care costs in later life. Regularly updating your retirement plan to reflect changes in health, market conditions and tax laws is also essential for ensuring your savings last as long as you do.