Longevity risk: What it is & how to prepare for it in retirement

A long life is an amazing blessing to enjoy, but without proper planning, it can throw a wrench into your long-term retirement plans. Longevity risk is the chance of living longer than you expect and putting an unplanned strain on your retirement savings. In fact, running out of money is the most-cited fear among retirees.

In this article, we'll explore what longevity risk is, how it affects your savings, and what you can do to help protect yourself.

Living well in retirement is about balancing your income while making your savings last. Because you don't know exactly how long you'll live, estimating your life expectancy is important for retirement planning.

The Social Security Administration estimates that, among people who reach age 65, men will go on to live until age 82 and women until 85. That means, on average, the life savings of a 65-year-old retiree would need to last an additional 17-20 years. If you live longer, that's great—but not if your money runs out in 17-20 years. This is the central issue of longevity risk.

The best way to reduce longevity risk is to get ahead of it by planning. You'll need to estimate your expected retirement spending as well as your life expectancy and then add some extra.

Although you can't know for sure how long you'll live, you still can plan for retirement. But you need to make sure you account for the possibility of living longer than you expect to. Here are some strategies you can use to avoid running out of money if you live longer than you planned.

Social Security benefits can offer one small safeguard against longevity risk because you'll continue to receive those payments for as long as you live. Some people choose to delay claiming their benefit to maximize their lifelong monthly benefit amount because it offers some protection against running out of money.

For every year beyond full retirement age that you don't take Social Security—up to age 70—you can add between 3% and 8% per year to your benefit depending on the year you were born.

• For more claiming considerations, read: When to claim Social Security: Finding the right timing for you

Because you'll likely need to keep the majority of your savings invested, it's important to think about how you'll take regular distributions from your accounts. Strategies that focus on a withdrawal rate, such as the 4% rule, help ensure you don't withdraw too much at once and can be a guideline for pacing your money to last. A financial advisor can illustrate different scenarios and help you decide which withdrawal rate is best for your plan and goals.

• Read more: Systematic withdrawal plans: Help make your retirement savings last

The most direct way to reduce your longevity risk is by investing in income sources that are guaranteed for life. Annuities are designed with built-in guarantees to help make your income last. You can base payments on your own life or have income continue for a joint annuitant, such as your spouse. Here's what else to know about these options:

Fixed annuities offer a fixed interest rate on your investment and may provide you with a stream of retirement income that’s guaranteed for the rest of your life, or for a set number of years. Other than a traditional fixed annuity, there are other types of fixed annuities to choose from including:

• Fixed indexed annuities: Has an interest rate that fluctuates based on the performance of a market index. If the index has positive returns, you may earn more interest than you would with a traditional fixed rate annuity.
  
• Multi-year guarantee annuities (MYGA): A fixed-deferred annuity that earns interest at a guaranteed rate for a specified period, typically three to nine years.

Deferred income annuities provide payments that begin at a later time, such as on your 80th birthday, designed to provide lifetime income. This makes it a great choice for protecting against longevity risk.

QLACs are a type of deferred annuities purchased within a tax-advantaged retirement plan. Money used to purchase a QLAC is exempt from required minimum distribution (RMD) rules. Once you convert assets into an income stream, the payments continue for the rest of your life—regardless of how long you live.

Single premium immediate annuities (SPIAs) work by paying a lump sum of money up-front (the single premium), and the insurance company agrees to pay you an immediate stream of income while investing your money. Payments continue steadily until your death or for a specified amount of time, depending on the payment option you choose.

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For retirement with open-end dates

It can be tough to predict how long your retirement savings needs to last. Will you live to age 75? Or to age 105? The right type of annuity can help.

See the options

Don't forget about other risks to your retirement savings. Planning ahead for certain unexpected or unknown expenses and market volatility can lessen their impact.

• Health care costs. As you age, you'll likely spend considerably more on your medical expenses. Planning ahead for health care costs is important for protecting against outliving your nest egg. Specific health-related savings accounts and proper insurance, including Medicare supplements and long-term care, are all helpful approaches to consider.

• Taxes. Considering taxes in your retirement planning provides you with additional opportunities to be tax-efficient with your savings. It helps to not pay more taxes than you need to, further reducing your savings

• Inflation. Another key thing to consider as you're forecasting is inflation. Things inevitably will cost more in the future. You can reduce the negative impact of inflation on your plan by including an inflation estimate. This allows to you have a more accurate reflection of what the true cost of your future expenses might be and anticipate changes you might need to make.

• Market volatility.The stock market constantly fluctuates, and it sometimes can be drastic when looking at a short period of time. Including other assets such as bonds and annuities in your portfolio and holding sufficient cash you can withdraw from during downturns are excellent ways to protect your lifetime savings.

Consider equity investments to help achieve long-term growth. Stock market exposure can help your retirement savings keep up with inflation and could extend the life span of your savings.

Even with careful planning, your circumstances can change. You may find that your savings are dwindling too quickly. The good news is that a financial advisor can help monitor your plan and recommend adjustments, such as modifying your investments or cutting expenses to help you get back on track. This can prevent the need for more drastic changes later.

Some things you could do to adjust include:

• Cut your expenses. If you find that you are spending too much, you may be able to cut back. It may be that you are spending more than you realized on entertainment or gifts for family or taking more expensive trips than you planned. Some expenses may be harder to cut, such as your housing or utility costs. Reducing these likely would require you to make more significant decisions.

• Establish withdrawal guardrails. These can help you realize when you might need to reduce your withdrawals. For example, if your planned withdrawals for the year will be greater than 6% of your savings balance, you may decide to withdraw a lesser amount instead. This may relieve pressure on your investments and can have a big impact on how long your savings lasts.

• Take on some part-time work. Although the point of retirement for many is freedom from work, even a small amount of earned income from part-time work can go a long way in your retired years. You may find that working part-time is rewarding for social and emotional reasons as well.

Longevity risk in positive terms is the great possibility of living a long life. Enjoying that possibility just requires some planning along the way so you have the financial confidence to sustain your lifestyle through those years.

To reduce your longevity risk, start by estimating your life expectancy and considering how your spending needs will change over time. Incorporate guaranteed income sources like Social Security, pensions and income annuities into your plan to protect yourself.

For help figuring out how much you need or how to craft a retirement income plan that specifically addresses your situation, you can rely on a Thrivent financial advisor to offer their expertise. They can help you develop a realistic long-term retirement savings plan and share ways you can make the most of your resources.