Most people think of retirement planning as determining how much money they need to save up in order to spend it over a fixed, or set predetermined, number of years in retirement. This is wrong! The number of years one may have in retirement is not fixed!
So the profession works around the dilemma of uncertain time by using a rule of thumb for an end age such as age 95. If you retire at age 65, then the spending period calculated under this rule of thumb is 30 years (95 – 65). What’s the problem with that?
(To enlarge image, please Hold Shift key, and then click on the image, to open a new window).
Looking at the bottom of the chart above at age 65 (second section), you can see that only about 1 out of 5 people as individuals are likely to outlive age 95 (20% female; 18% male). This means that 4 out of 5 don’t reach age 95! The consequence of planning spending, from an early age like age 65, in retirement to last so long is that this constrains spending too conservatively precisely during the years when you may like to be able to spend more, on travel for example to see the grandkids, or for other reasons.
So to what age should one plan spending on? For a more complete answer you may see a prior blog on the topic: What is expected longevity? And why should you care? Basically, in summary here, simply plan on spending over the time frame of your expected longevity. You can see from the chart above, and below, that time frame changes as you age. So simply redo the calculation each year during an annual review and update the time frame along with all the other data (this is called an annual review).
Looking at the bottom section of the above graph again, clearly planning spending from age 65 to age 80 (third section) means that about 3 out of 4 people age 65 may outlive age 80 (78% female; 69% male) … so age 80 is a bit too early to plan on stopping spending (a.k.a. deceased or running out of money if you’re not). Therefore retirees should plan on being able to spend the portfolios beyond age 80. But how much beyond age 80?
The table below provides some suggested ages based on expected longevity that half or your cohorts may outlive, or for a more conservative longevity that only 30% (in this case females) may outlive.
From the first graph above, you can see that 50% of people at age 80 now live beyond ages 89 (M) or 90 (F). This means that 50% do NOT. This is why I suggest using shorter periods from the second table because shorter periods mean you can spend more when you are more likely to be around to spend it!
Now notice in the first graph that after 5 years have gone by … the 80 year old is now 85 … that instead of there being 9 or 10 years (from age 80), minus the 5 years that they’ve aged from 80 to 85 (in other words, 4 to 5 years expected remaining at age 85), there are actually 6 to 7 years expected … or two years more compared to what simple math suggests.
Now the 85 year old has aged another 5 years to age 90 and one would expect to subtract 5 years from the 6 to 7 years expected at age 80 (in other words 1 to 2 years remaining). But no … at 90, 50% of those at age 90 are expected to outlive 4 to 5 years longer … a full 3 years longer than they expected just 5 years earlier.
The same phenomenon happens between ages 90 and 95 where 50% of those now at age 90 outlive expectations just 5 years earlier. 50% of those at age 95 are expected to outlive age 100!
Moral of the story: The older you are – the older you may expect to get!
The above may be a bit confusing … here’s a prior post that shows how aging though longevity tables actually appears when graphed in a different form as one ages from one age to the next and then to another, etc. That post is more in story form explaining the dynamics of the effects on time remaining as one ages through the life tables.
So why NOT just plan on age 95 or 100? Again, because you don’t need to until you get older! Only about 10% of 80 year olds expect to outlive age 100! So how do you plan spending as you continually insist on being around to spend it into an older age and surpassing your peers (called age cohorts or those during your same birth year)?
Simply by updating the facts each year during your annual review and redoing the calculations about what is the prudent amount to spend over the revised time period you now have at your present age. The mechanics are described in this paper in the Journal of Financial Planning: Transition Through Old Age in a Dynamic Retirement Distribution Model.
Note: The above discussion covers what I call Probability of the Person. A blog that discusses how to manage what I call Probability of the Portfolio uses the waves on the ocean, as an analogy that represents your portfolio values. Most retirement focus is on the portfolio with very little consideration of the effect of using a set, and often too conservative, retirement time period for how long the money should last. Retirement is too dynamic for set and forget calculations.
Management of prudent retirement income requires annual reviews that measure and monitor progress along the way.