Most middle class baby boomers in their 50s and 60s share one big financial concern: Can they sustain their lifestyle in retirement? This has been driven by two things: the stock market crash of 2008 and the sense among many investors that today neither stocks nor bonds offer attractive returns.
In fact, many boomers should be concerned about funding retirement spending, but not for those reasons. Three poorly understood developments threaten secure retirements – without wishing to be alarmist, I will call them time bombs. These developments will change the retirement dynamic for many Canadians: increasing lifespans, escalating medical costs as people age and safe withdrawal rates on savings dropping from historical levels.
Time bomb One: Lifespans that continue to grow
Most people are unaware of the remarkable improvement in life expectancy that’s taken place in the developed world over the past 200 years.
Much of the gain in the last century took place in the first 50 years, due to huge improvements in death at childbirth and in vaccines and antibiotics that dramatically reduced the most common causes of death. In 1900, maternal deaths at childbirth in the United States were 1 in 100, today they’re 1 in 10,000. At the same time, the top three causes of death were pneumonia/influenza, tuberculosis and diarrhea/diseases of the intestine.
But that was then, when it was easy to address many causes of death. Fifty years ago, there was broad consensus that we’d see significant deceleration in expansion of lifespans. In fact, it hasn’t worked out as expected, as the current view is that average lifespans will continue to increase, the only question being how fast.
Projections for future increases in developed countries vary from the OECD’s relatively conservative one year per decade projection to more aggressive estimates of as much as three months per year, much of that coming at the back end. If that latter forecast were to materialize, today’s typical 65 year old client could be expected to live five years longer than that same client 20 years ago.
This has a very big impact on retirement plans and on sustainable withdrawal rates. That’s the first time bomb: Retirement plans that don’t account for the new reality of expanding life expectancies.
Here’s an excerpt from science writer Josh Mitteldorf’s blog on expanding life expectancies:
In 1970, in the developed world, the low-hanging fruit had already been picked clean: infectious disease, childbirth, and infant mortality were no longer major factors in actuarial risk. Most people could expect to live out their full life span of about 70 years. Everyone expected – that is, demographers, epidemiologists and policy-makers – everyone expected that the life expectancy had risen to a natural limit, and that any further progress would be slow and difficult.
But surprise! Since 1970, countries with the longest life expectancies have continued to improve just as fast as before, even though the progress is now all “at the back end”. Increase in life expectancy since 1970 has been more than 10 years in Japan, 9 years in Europe. For every year that goes by, 3 months are added to life expectancy. And this progress applies almost entirely to people over 70.
And click here to read more about the history of expanding life expectancies and the new science of living a more healthy life into the 90s.
Time bomb two: Escalating costs for health care as people age
One of the implications of longer lifespans is that many people will spend their final years in retirement and nursing homes, needing costly healthcare.
Dementia is especially troublesome. Not only is it crippling for family members, but it’s one of the fastest growing conditions among seniors; Harvard economist David Laibson has pointed out that after age 70 the risk of dementia doubles every five years. And in April the New York Times ran a story highlighting that today’s cost to care for Americans with dementia is higher than heart disease or cancer; further.
About the same time, the National Post ran a story with the headline “We’re living longer not better: The average Canadian will spend more than a decade suffering from serious illness.”
We’re living longer, but not necessarily living better,” said one academic quoted in the article. “We have turned things that used to be fatal into chronic disorders.… We do have better life expectancy, but it has not been matched in terms of quality of life or absence of disability in those later years.”
And it’s not just dementia and crippling diseases at issue here – state of the art developments come with big bills, such as a new treatment for prostate cancer at $100,000. That’s time bomb two: The growing view that the medical system will struggle to pay for more than the basics – and that in many cases people who want advanced treatments will have to fund them directly.
Advisors have an obligation to raise these issues with clients and to incorporate them into retirement plans. This is especially the case given the escalating cost of care in retirement and nursing homes; a recent article pointed to research from Genworth Financial indicated that in 2013 the median cost of a private room in an American nursing home approaches $85,000 annually.
The challenge is to have this conversation in a way that is doesn’t appear negative or alarmist; we’ve all read accusations that the financial industry creates anxiety among average Canadians by using an overstated 70% as the percent of pre-retirement income needed in retirement. It’s also important to come with solutions; assuming their health is good enough to qualify, a strategy with some clients might be to discuss the possibility of long term care insurance,
Engaging clients in conversation
The first responsibility for financial advisors is to ensure that the retirement plans you develop with clients reflect the most accurate assumptions with a margin of safety should they end up being optimistic. There’s a third time bomb that I’ll cover in Thursday’s article: increasing doubts that withdrawing 4% of savings annually to fund retirement, seen for the past 20 years as a “safe” rate at which to deplete savings, will be sustainable in future.
Taken together, these three time bombs may result in changes to how long clients work, how much they save, how much they spend in retirement and how they invest. Once you’ve addressed these issues with existing clients, there’s an opportunity to talk to prospective clients about the state of their retirement planning. There appears to be an anomaly in the marketplace today. On the one hand you have middle and upper class Canadians approaching retirement hyper-concerned about their financial situation. On the other, most haven’t invested the time to develop a solid, well-thought through retirement plan.
But this isn’t an anomaly at all – arguably, the reason for the concern about retirement among many boomers is that they lack a clear roadmap that lets them approach retirement with confidence. And it’s your ability to talk to prospects about your track record developing that roadmap that creates an opportunity for useful conversations about how you can help them plan for a secure retirement as well.