Living longer may be a good thing on one hand but it can put a strain on your retirement assets. That the life expectancy averages are steadily rising makes it more likely that persons will spend a higher portion of their lives in retirement. Therefore, the danger of outliving your retirement assets is even more acute now than ever before. Given the inherent uncertainty about the future, you cannot eliminate longevity risk. However, there are several ways to minimize or reduce it.
Have a guaranteed lifetime income
The guaranteed lifetime income provided by defined benefit and defined contribution plans are an important dimension in avoiding descent into poverty during retirement. The expectation for the future is that emphasis will shift from defined benefit plans to defined contribution plans. Therefore, individuals will have to do more on their own to mitigate longevity risk. Having adequate guaranteed lifetime income does not preclude the risk of outliving your assets but it means that you will at least have income as long as you live.
Increase retirement savings
Safeguarding your income is just one aspect of longevity risk. Having an adequate retirement savings portfolio is critical as well. Focusing on accumulation in the pre-retirement phase is one way of minimizing longevity risk before retirement. However, continuing to save- especially in the initial stages of retirement- can give you the added boost to deal with expected and unexpected obstacles to a comfortable retirement.
Manage other retirement risks
There are several risks of retirement, besides longevity risk, that place your retirement assets in jeopardy. You may have a high withdrawal rate from savings (income risks) or a critical illness that depletes your retirement fund. All of these risks place additional pressure on the asset/longevity ratio that determines how long you can survive comfortably in retirement. Being prudent and minimizing retirement risks will help to safeguard your retirement assets. That could only reduce your longevity risk.
Maintain a diversified retirement portfolio
Conventional wisdom held that retirees should focus on investment income instead of accumulation after retirement. However, being too conservative can expose you to inflation risk and other risks that increase the danger of outliving your assets. Diversification helps you to balance the risks of absolute and nominal losses. Counter intuitively, retirees should conserve early in the retirement phase and be more aggressive later in retirement. The logic is that if you lose early, you will have less to invest later on. However, if you conserve early- especially in difficult economic conditions- you may have much more to invest and will be able to participate more in growth classes.
Minimize portfolio volatility
The volatility of your retirement investment determines how safe it is to withdraw periodically. A volatile portfolio makes it risky to withdraw from your investment or use it for retirement income. Investing more of your fund in volatile financial markets puts your retirement assets at risk. Beyond diversifying your portfolio, your must also invest in asset classes based on your investment horizon, which is influenced by your income needs.
Reduce withdrawal rate
Retirement planners normally recommend a maximum withdrawal rate of 4% from your retirement savings. A higher withdrawal rate increases your spending risk and depletes your savings at a faster rate- especially if done earlier. A high withdrawal rate has the same effect as losing through failed investments. Several retirees use lump sums received to purchase depreciable assets- almost as soon as they get it. This tendency also links to living above your means, which can increase your longevity risk in retirement.
Adjust your lifestyle to retirement means
Retirees may experience a drop in income levels because of insufficient planning or other reasons. Even so, they can take steps to keep their spending and lifestyle in line with their reduced means. Some retirees even move to more affordable homes. Retirees who experience a significant drop in income and do not have the luxury of money working for them should seriously reassess their standard of living. It is better to reduce your standard of living voluntarily than involuntarily descend into the ignominy of retirement poverty!
Although you can only minimize longevity risk, you must recognize that you have some control over it. It is a good thing that taking steps to address longevity risk just involves being prudent and applying the basics.