Retirement Planning: If We're Living Longer, Do We Need More Money?

Back in 1960, the average American's process for retirement planning was a bit different than it is today. Most weren't expected to live more than 70 years. If you reached the age of 65, the picture was a little rosier: The average male could expect to live to age 77. Given all the variables, your nest egg needed to last for an average of 10 years.

Fast-forward to today, and the picture is quite different. Life expectancy is up to almost 80 years, and if you reach the age of 65 in America, you can expect -- on average -- to see your 86th birthday. Given the fact that the average retirement age has declined since 1960, your nest egg now needs to last you over twice as long.

It seems intuitive that since we're living longer, we need more money to last us over those years. This line of thinking is pervasive: Last year, The New York Times explained "why many retirees could outlive a $1 million nest egg."

In fact, a recent study (link opens PDF) by the Center for Retirement Research at Boston College confirms this is how many of us think. When the survey asked pre-retirees about their retirement planning processes, those who were most optimistic about living until 85 were also 24% more likely to be planning on working well into their 60s.

But is this really true? Do we really need more money because we're living longer?

The surprising answer
The answer to this question is a simple "No!" Before we go on, let's get one thing straight. Those who haven't been able to save throughout their working lives -- and that's a lot of us-- may need to continue working past the age of 62. But that's not because they'll live longer, but rather because they're catching up.

For those that have done a good job saving, a longer life expectancy does not, by any stretch of the imagination, mean that your working years must necessarily be longer.

The math is actually quite simple. Ask any retirement planner for a basic rule of thumb when it comes to your nest egg, and they'll tell you: Take out 4% of your savings in your first year of retirement and adjust that figure for inflation every year thereafter. The thinking behind this strategy is easy to understand: If you take out 4% of your savings, but the remainder of your nest egg is able to grow by a little more than 4%, then your nest egg should last indefinitely. And there are numbers to back this up.

Using historical data, Wade Pfau, professor of retirement income at The American College of Financial Services, was able to show the probability of running out of money after 40 years of retirement, given several different strategies.

Source: Wade Pfau.

As you can see, if you're able to 1) take a 3% withdrawal rate instead of 4% or 2) keep at least 50% of your nest egg in stocks, there is very little chance you will run out of money after 40 years of retirement.

These results should speak volumes to pre-retirees. Forty years is a long retirement, and these simulations assume that you'll make absolutely no adjustments to your spending habits as time goes on. If you fall in that unlucky 15% that could run out of money, you could easily take a few cost-cutting steps as you see the problems arising and reverse your fortunes entirely.

Retirement planning: the bigger picture
Of course, the problem is that this assumes everyone wants to stop working. For many, work provides a sense of purpose, a connection to community, and a social outlet. All of those are important for human beings, retired or not.

But if the prospect of financing a longer life is keeping you up at night, worry not. Start early, save often, and be mindful of your spending habits, and a longer life can unequivocally be a good thing.