Long life vs. good life: Income planning in the 21st century

One of the things we frequently do for community outreach and to attract new clients is Social Security workshops. These are held several times a year at various colleges and high schools in the area. (Our next series will be in October in the Nashua and Tyngsborough, Mass., areas.)

During these workshops, we discuss how and when people should take their Social Security benefits. By and large, barring any unforeseen events or circumstances, a married couple is almost always better off delaying at least the higher-earning spouse’s benefit as long as possible. The reason is that a married couple aged 66 has a 50 percent chance that at least one of them will live well into their 90s.

This frequently generates objections from people. Often, they are of the opinion that they would do well to have the money to spend earlier in life, while they are active, as opposed to later in life, when they are less so. To me, this brings into sharper focus the whole reason for doing really good financial planning in the first place.

First, the notion that you either have it now or you have it later is, in my opinion, a false choice. However, it is a paradigm that has been established and galvanized by the planning options most often presented to people. Here’s what I mean: Most often, the planning choices provided to people will be a mix of Social Security, a pension if they are lucky, and a mix of assets usually held in the market to increase returns.

For most people, the Social Security and pensions – or what we like to call “Know-So” money – won’t be enough. Therefore, they will have to rely on the market-based assets – or “Hope-So” money – for their income shortfall. The fallacy of this approach is that market-based assets rely on risk to promote returns. They higher the return, the more risk one must take to achieve it.

It should be noted that while the two are often correlated, they are not in any way directly connected. Regardless of what your planner says, you don’t just “dial up” returns by dialing up risk. What you actually do is put your assets in greater jeopardy, hoping that the result will be greater returns in the face of increased odds.

However, it can just as easily result in not only lesser returns, but substantial losses. This is particularly damaging to people who are relying on these accounts to live. Further, while longer life spans provide people with more time to recover from market downturns, they also increase the window of time in which they can occur.

So we have a bunch of unknowns that often work against us. First, we have no idea how long we are going to live. Not knowing for sure, and understanding that we could live for several decades, we are forced to make the assumption that we will live for decades, otherwise potentially creating real problems for our older selves.

Second, we have no idea what rates of return we will receive, or if indeed we might lose our hard-earned money right when we need it. This is why traditional planning provides such low rates of payout – usually in the 3-4 percent range.

Now, imagine what we could do if we eliminated those unknowns. If we could identify exactly how long we were going to live and how much return we can expect from our money, planning would be much easier. This is exactly what Social Security and other sources of “Know-So” (vs. “Hope-So”) income, such as annuities and pensions, do. They remove the market risk associated with securities, and they also eliminate the longevity risk associated with planning for only one or two lives.

Since Social Security, pensions and annuities spread longevity risk over many lives, they can actually plan for average life spans, which they can identify with pinpoint accuracy. Now, having taken the guesswork out of it, they are able to make a plan with a much higher confidence level and therefore a much higher payout rate.

What does this have to do with the “pay me now or pay me later” dilemma presented earlier? For most people, delaying Social Security and pensions is a relatively short time. If you work until full retirement age, you might only have to delay the income for three or four years, which would result in 32 percent more income for the rest of your life.

So, if you have other assets you were planning to stretch over an unknown lifespan with unknown returns, you might be better off to use them in the near term with a more predictable rate of return, allowing your maximized sources of “Know-So” money to take care of the great unknown that lies ahead.

Stephen Kelley is president of Safety First Financial Planners. He can be reached at steve@safety1 stfp.com. His website is www.safety firstfinancialplanners.com.