Hungry for a conundrum? Think about what would be a reasonable amount to be taking from a nest egg to pay for living expenses in retirement.
The magic number, popularized in recent years, has been 4 percent. For many people, that doesn't sound like much. On a $500,000 retirement account balance, it would amount to $20,000 per year in income added to Social Security benefits. We're basically taking out just interest and dividends on some combination of stocks and bonds -- probably a 50-50 mix. We're being careful, in this instance, to avoid invading the principal because we don't want to outlive our money.
Unfortunately, we're up against something called "longevity risk aversion." This is the fear that we will outlive our resources. What legitimizes this fear is that, at age 65, we have a 17.6 percent probability of reaching age 95. There's even a 5 percent chance that we'll hit 100. Running out of money is certainly something to worry about even if the chance of living that long is remote.
What I suggest for today's 65-year old retiree is to start at the end and work back to the present. Let's assume that the last 10 years of life, from 85 to 95, will be in some form of independent living with a transition to assisted living for a few final years.
Just so you know -- independent living involves an apartment in a facility that offers meals, housekeeping, activities, transportation and at least some level of health monitoring.
Assisted living, by comparison, offers just a room but with an army of staff, including registered nurses, to meet a far greater demand for physical assistance.
Let's take a look at what this will all cost: Today's independent living (at the high end) costs about $2,500-a-month per person and assisted living runs about $5,000-a-month per person. Religious organizations and other resources offer less expensive options, but for planning purposes, we'll use the higher numbers. If you're 65 today, and we apply a 3 percent annual inflation rate, then these costs in 20 years (when they start at age 85) will have bumped to $4,515 for independent living and $9,030 for assisted living. The only encouraging thing to say about these expense projections is that the money covers most of what any senior needs to spend. About all that's left might be Medicare supplementary insurance, the phone bill, newspaper and car expenses for anyone still driving.
When we get to age 65, we will want to have our ducks lined up to make sure that when we reach 85 we will still have enough of a nest egg to get us through our remaining life. Assuming a move to independent living at age 85, the purchase of an annuity paying $5,000 per month for the rest of our life from 85 on would cost between $400,000 and $500,000 depending upon annuity rates 20 years from now.
Turning to the annuity to fund the entire cost is unrealistic, however, because we will presumably have Social Security benefits that will be increased by inflation increases over the years. Today's $2,000 social security check will be $3,600 in 20 years with 3 percent inflation. Since $3,600 of the $5,000 might be paid by Social Security, we only need the annuity to pay the remaining $1,400. To be on the safe side, let's consider an annuity that will provide an additional $2,500. This cuts the purchase price down to between $200,000 and $250,000. Between Social Security and the annuity, the payments for senior living are guaranteed.
So far, we have provided for just independent living. The additional cost of assisted living, typically for a much shorter time period, would be funded by accessing both principal and interest on yet another fund that should have roughly $200,000.
If we make it that far, the important part of the plan is to arrive at age 85 with enough principal in a total of all retirement resources to meet the cost of an annuity purchase at that time. While it wouldn't be prudent, it would be safe to blow almost all of our retirement resources (including home equity, IRA accounts, etc.) during the 20-year period as long as we keep enough to buy the annuity that would be called for at age 85. After all, the first 20 years of retirement represent the "golden years" that retirees have been saving for, so why not enjoy them? By their mid-80s, however, most retirees are looking for the type of support offered by senior living facilities and a smooth, trouble-free life.
The goal is to preserve enough principal to be able to "set it and forget it" by the time we reach age 85. Many people would have enough in assets and income at 85 to ignore the annuity purchase and just use a combination of income and principal to pay the costs of retirement care. Reviewing the cost of an annuity purchased at age 85, however, offers a simple way to indicate the scale of what needs to be saved to guarantee care through the end of life.