A key part of retirement planning is estimating your life expectancy, but barring a crystal ball, we can’t know how much time we have left on this planet. Meanwhile, the major retirement decisions—how much to save, how long to work, when to retire and how much to withdraw each year from your retirement funds—hinge on how many years you can reasonably expect to be around.
It’s a tough thing to think about. On the one hand, you hope to live a long and healthy life. But what if you live too long? Will you have enough money saved to take care of yourself until the end of your life?
When you live longer, your money needs to last longer, but a big problem is many people still hold fast to a retirement model based on a much shorter life span. They don’t consider that their retirement could last three decades or more, and so they don’t plan how to pay for that.
Life expectancies have been increasing over time due to several factors including improvements in health care. What would living longer mean for you in terms of retirement planning?
Using the traditional retirement age of 65 as an example, if you were to live to 105, you would be retired for 40 years versus having worked for 43 years (assuming you started your first job at age 22 after graduating university). This would certainly put stress on anyone’s retirement nest egg in terms of making your money last over the course of your lifetime.
For example, the iconic 4% rule for retirement withdrawals is based upon an assumed 30-year time horizon in retirement. The rules say a balanced portfolio should support a withdrawal for 30 years of 4% per year of the initial amount of your nest egg. While the 4% rule is just a guide, it does show that many traditional assumptions about retirement don’t consider increased longevity and a retirement that may be as long as (or longer than) your working career.
In its most basic sense, inflation is defined as "The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling." Due to inflation, the purchasing power of the Rand will fall over time. While just a few cents per year may not appear to be troublesome, over time, rising prices can add up.
Over a retirement that lasts for 30 to 50 years, it can end up being a substantial amount of money down the road. How much will fuel, and thus the cost of goods, cost in 50 years? Is your nest egg planning for this?
Dealing with it
If you start your retirement planning as early as in your 20s, investing in equities can help you beat inflation. It is a no-brainer. Equities can give you higher real returns. The real return is the return you receive after the rate of inflation is considered. The earlier you start, better off you are. It’s as simple as that. As soon as you start earning, start investing 10 percent of your income in high return assets like equities. You should do this consistently over multiple decades whilst increasing the quantum of your investments as and when your income rises.
Even if you start in your early 40s, you can still bet on equities since you will still have a minimum time horizon of 15-20 years and you can reap the benefits of compounding. However, if you start when you are in your 50s, then you should look at a mix of large-cap diversified, balanced funds and fixed income products.
To cover your income needs, particularly your essential expenses, such as food, shelter, and insurance, you may want to use some of your retirement savings to purchase a life annuity. It will help you create a simple and efficient stream of income payments that are guaranteed for as long as you (and possibly your spouse) live.
Certain annuities help keep up with inflation through annual cost-of-living adjustments or market-related performance. Choosing investments that have the potential to help keep pace with inflation, such as growth-oriented investments, may also make sense to include as a part of an age-appropriate, diversified portfolio that also reflects your risk tolerance and financial circumstances.