Changes in longevity require changes in our expectations about retirement savings. In the early 1900s, the average life expectancy of a newborn American was about 50 years. In 1933, the year that Social Security was introduced as part of F.D.R.’s New Deal, the life expectancy of a newborn had risen to about 62 years. Today, the average life expectancy is up to 77. That is a 50% increase in life expectancy in roughly one century’s time. With the rapid advancements in health care and technology, we should expect similar increases over the course of the 21st century.
When Social Security was first implemented, it had roughly 35 workers paying into the system for every one retiree receiving benefits. Further, in the early 1930s, not many people were living much past age 65 which meant that benefits were usually only paid out for a few years. Over time, there has been a ten-fold decrease in the ratio of support as life expectancies have increased. Today there are fewer than four workers supporting each benefit recipient.
With increased longevity has come an increased risk of running out of money. According to the Social Security Administration, a man reaching age 65 in 2015 can be expected to live, on average, for another 19-20 years. A woman attaining age 65 this year can be expected to live another 21-22 years. One out of every four 65 year-olds today can be expected to live past age 90 and one in ten will live past age 95. The challenge of stretching retirement savings is being compounded by increases in longevity.
There have been two significant responses to the increased longevity risks. First, in 1983, the Full Retirement Age was increased so that those born after 1937 would need to be older than 65 to receive full Social Security retirement benefits. Under current law, anyone born in or after 1960 must be 67 before they can receive full retirement benefits.
Second, over the last forty years there has been a dramatic shift in the way in which companies provide retirement benefits for their employees. For the majority of the twentieth century, employees expected their employers to fund retirement benefits in the form of a pension which was an ongoing financial obligation of the employer to their employees. If an employer were to go bankrupt, the federal government would step in to pay the benefits up to a maximum amount per year. As a way to alleviate the financial and record keeping burdens related to pension plans, also known as defined benefit plans, the overwhelming majority of companies have moved to offering defined contribution plans. Defined contribution plans have a variety of different names (e.g. 401(k), 403(b), Savings and Incentive, etc.), but they generally allow both the employer and employee to contribute to a pre-tax savings plan. The employer is only responsible for making contributions to the plan while the individual is an employee. In addition, the employer has no responsibility for investing the retirement account of the individual. The employer need only provide appropriate investment options and some investment education. Upon leaving the company, the employee controls their account and can either roll it over to an IRA account, transfer it to a new employer’s retirement savings plan, or leave it in their former employer’s plan. Regardless of their choice, their former employer will cease making contributions. This change shifts the investment management burden/opportunity from the employer to the employee.
In 1974, the Individual Retirement Account (IRA) was introduced giving individuals a way to save for their retirements if they were not offered a qualified retirement account by their employer. The ability to use IRA accounts and the introduction of new tax-deferred savings accounts has continued to expand in the forty years since the introduction of the original IRAs.
The net effect of the government’s adjustments to what is deemed full retirement age and the shifting of the investment responsibility from companies to individuals requires each person to be more self-sufficient. These changes have left many people financially unprepared for retirement. In fact, for close to 40% of Americans, Social Security represents 90% or more of their income. With the increased longevity from improvements in health care, it is no wonder that financial concerns related to retirement are among the most common sources of stress among those over the age of fifty.
Our experience as financial advisors has been that most people still hold on to the retirement investment principles embraced by their grandparents such as “just live off the income from your investments” and “your investments should be divided between stocks and bonds and the percentage of bonds should be equal to your age.” The idea behind the second rule is that you should decrease the investment volatility in your portfolio as you get older.
While we approve of conservative investing and prudent spending in retirement, a portfolio consisting primarily of bonds with yields that are well below five percent is unlikely to provide the needed retirement income for a person’s entire lifetime. With interest rates having settled at much lower levels for the past seven years, we have been successfully utilizing the total return approach for providing needed retirement income to our clients. The total return approach focuses on making tax-efficient distributions and maintaining portfolio diversification by distributing the needed cash from different parts of the portfolio, not just the interest income and dividends. This approach has become essential for retirees needing their portfolios to last for 25-30 years, if not longer.
The good news is that meeting retirement income needs is not an impossible task. It requires some investment knowledge and the discipline to not become significantly more investment risk averse simply because you are retiring. One of the biggest mistakes investors make as they retire is to sell a large portion of their stock investments in favor of holding cash or bond investments. Most people would agree that 20-30 years is a long horizon for investing. It is likely that over this many years the stock market will experience many strong periods and a similar number of recessions. An important fact to remember is that there has never been a twenty year period of time over which stocks did not deliver a positive rate of return. While it is understandable that retirees do not want to jeopardize their retirement finances, they must remember that investing in stocks provides the greatest likelihood of growth over longer periods of time. In addition, the retirement period of their lives is likely to be at least 20 years and for many who are years away from retiring, their investment horizon can approach 30-40 years in retirement.
The longer investment horizon for retirees should be acknowledged and approached with proper planning. It need not be a period of fear and anxiety.
This update is intended for the use of Oak Wealth Advisors LLC clients. This update should not be viewed as personalized investment or financial planning advice from Oak Wealth Advisors LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to their individual situation, they are encouraged to consult Oak Wealth Advisors LLC. Past performance does not guarantee future results and all investments should be scrutinized before being implemented in a portfolio.