A reality check on longevity risk

Assuming age 95 or older is overdoing it, planner says.

Deanne Gage 9 May, 2013 | 6:00PM

Prominent U.S. financial planner Michael Kitces is no stranger to debate. His blog, Nerd's Eye View, is a mix of candor and research, and focuses on advanced financial-planning strategies. Kitces holds eight professional designations and is also a partner and director of research for Pinnacle Advisory Group Inc., based in Maryland.

One topic that intrigues him is longevity assumptions and financial planning. A few months ago, Kitces took to Twitter to say, "I'm astonished by the number of planners who assume EVERY client will live to age 95+ even though they have only zero or one client EVER reach that age."

You might call planning to age 95 sound financial planning. Kitces calls it something else --potentially excessive conservatism. Kitces recently spoke with Morningstar columnist Deanne Gage about whether advisors go overboard with their projected age assumptions.

Q: People are living much longer than they used to. So why do you feel advisors are being too conservative with their projected age assumptions?

Kitces: I'm not saying conservatism is never appropriate, but we also have a professional responsibility to acknowledge that most people don't actually live to age 95. Age 90 is a good benchmark because it's not far off the median, particularly for married couples. If we plan to age 95, we are creating the overwhelming likelihood that our clients will never spend the majority of their wealth and won't get to enjoy the money they spent a lifetime accumulating.

Q: Is this because advisors fear-monger or because clients are afraid of outliving their savings?

Kitces: I think it's both. You can't make a commitment to completely retire and not have that fear. But we advisors tend to stoke that fear quite a bit and fan the flames. As professionals, we never want clients to run out of money on our watch.

 
Michael Kitces

Q: Isn't it better to be safe than sorry?

Kitces: It's not an either-or decision. Would you rather die with millions or risk a 5% to 10% cut in your lifestyle when you're in your 80s? I think most clients would choose the latter. Single 85-year-old women do not spend the same way as 62-year-old married couples do in good health. That's just a reality.

Q: Maybe they worry about outliving their money. What if they needed the money for health-care costs or long-term care facilities, for instance?

Kitces: You're still implying the alternative is destitution. That itself is a failure of not planning and monitoring. Total success or sheer destitution is not the real choice.

Q: What's the solution then?

Kitces: People don't go from living 100% of their lifestyle today to being destitute under the bridge tomorrow. If we are really professional advisors who do annual monitoring for clients, then why are we so unwilling to introduce the possibility of mid-course adjustments to keep clients on track? There's a lot we can do along the way. It doesn't take much of a mid-course adjustment to take clients from a rising 5% withdrawal rate back to a 4% withdrawal rate. That's a 20% decrease in their standard of living. Why is it so impossible to suggest that clients might "just" need to cut their spending by 10 or 20% if there's ever a Great Depression?

Q: What if clients do understand the rarity of living to age 95 or 100 but still want you to plan to age 95 or 100?

Kitces: By all means. Some clients are deeply concerned whether they are going to live to age 100, and we can plan for them accordingly. But it's our clients' decision -- not ours -- about whether they want to give up on spending a huge portion of their wealth for the rest of their life.

Q: Some clients may care about leaving a legacy.

Kitces: Yes, some clients do. But advisors may also fear some clients into not spending their own money and justify it by saying, 'At least you'll have a nice gift for your grandchildren later.' That wasn't their goal! That was our goal. We imposed our professional fear on them and steered them into thinking the way that we do. But there's a difference between whether it's the client's goal or our goal, and we convinced the clients to do it our way even though they didn't need to. Mathematically, most won't need to.

Q: What about people who just haven't saved enough to retire?

Kitces: The issues overlap. How often does the advisor say the clients haven't saved enough to retire because they need a huge pile of money, in case the couple might live to age 95? This means the couple can't retire and enjoy their money today, just in case they're the one in 142 who happen to both still be alive after that long. In other words, not only do we tell people they could spend less than they could otherwise, but we tell them they have to work longer than they would have otherwise and can't retire, for the same reason.

Q: What about investment performance, though? The first 10 years of this century has been deemed the lost decade. This decade has been ho-hum in Canada, slightly better in the U.S.

Kitces: If you follow the 4% safe withdrawal rule, 96% of the time you'll never touch the principal and 50% of the time you'll have more than quadrupled your starting wealth by the time you die. That's actually what the historical statistics show. For this to be a disaster, you would have to be one of the people who lives to be over 95 and does so after retiring through a Great Depression. There's a fairly low likelihood that these are both on the table for people, yet we're using it as a default for everyone. I fear that's obsessively conservative as a baseline.

Q: So basically clients have a choice. Save a ton now just in case they'll live a long time or spend more during retirement and make adjustments as you need to along the way.

Kitces: That's it in a nutshell. Clients need to understand what kinds of tradeoffs would be necessary if they really do live a long time. But they are also entitled to make the decision. What is often proposed is that clients cut their spending by 30% for the rest of their lives just in case they fall into that 1% of couples who both live a really long life. That's the effect we have when we project everybody out to age 95 or 100.

About Author

Deanne Gage

Deanne Gage  Deanne Gage is a Toronto-based writer who has specialized in personal-finance issues since 1999. A recipient of several journalism awards, including one from the Investment Funds Institute of Canada, she is also a former editor of Advisor's Edge and Advisor.ca. She can be reached at deannegage@gmail.com.