Live long and prosper: How to plan for longevity in retirement
Retirement planning is serious business and here’s why: While many find themselves “lingering” or living longer than they ever thought they would, some people have been left to wonder if they’re at risk of running out of money. The result is that “lingering” is becoming a hot term in the financial industry – and planning to the age of 100 is starting to become the norm.
Think back to one of the first-ever pension plans: In 1847, Germany set up payments to begin at age 65 when the life expectancy was 47 at the time. Fast forward to today when those reaching age 65 have a 60-per-cent chance of living until age 90, and financial planning obviously needs to change.
Planning assumptions take a lot of work. Putting in the heavy lifting before you meet with your advisor or planner will help to improve the accuracy of your planning strategy.
In computer science, garbage in, garbage out (GIGO) describes the concept that flawed, or nonsense input data produces nonsense output or "garbage." This alone is a great risk to retirement.
Here is a step-by-step process to at least secure more accurate assumptions for your retirement capital analysis:
First, figure out these general assumptions:
1. Retirement age
2. Valuation date of your assets
3. Base retirement after tax income requirement in current dollars
4. Base life expectancy until at least age 90
5. Base inflation rate of two per cent
6. Base rate of return (I will use four per cent to err on the side of caution
7. Ensure tax is calculated based on the current tax law and projected income
Then, break down your net worth assumptions into two categories: First, your lifestyle assets – such as your residence and possibly recreational property – including the current market value and your financial assets. Then, once you have done the background work and clearly know where your money is going to come from in retirement (ie. private pensions, government pensions, registered money, non-registered money, etc.), the fun begins.
Just because you have your assumptions around the rate of return and even inflation, it doesn’t mean that is what will materialize in retirement. To place a safer bet on your assumptions, incorporate something called a “Monte Carlo.” This is where you input numbers including your base case, higher and lower rates of return, higher and lower inflation levels, crisis events such as a market meltdown or you could even pull it all together and account for a worst-case scenario. In other words, you plan for lower returns, higher inflation, higher spending and greater longevity (which isn’t really a bad thing if you have planned for it).
You get where I’m going. Work through all the variables you can to take the guesswork out of retirement. By inputting a whole host of retirement variables you determine your Monte Carlo success rate. Here, I’m looking for a better-than-75-per-cent chance of being okay.
Finally, remember the order of returns in your portfolio really doesn’t matter as much when you are saving, but it is a big deal when you take the money out.
When wanting to ensure your money is going to last it isn’t the size of the tub that matters – it is the size of the drain.