Financial Planning Challenge: Longer Lives, Less Money

A paradigm shift in the economy, society, and politics is arising from the current explosion of technological change. The World Economic Forum calls it the Fourth Industrial Revolution (4IR), and as a result people are living longer. We may not be prepared for what that entails financially: with longer lives comes greater expenses, and greater expenses by more and more people will put a great deal of pressure on individual savings as well as government-related health and social programs. This feature addresses longevity risk and what CPAs can do in a new world of retirement planning.

Population Trends Set the Stage

As the 2020 census takers prepare to deploy, the best data available at the time of this writing was from 2018; and as of 2018, there were 327.2 million people in the United States. Chart A (see end of feature) shows a breakdown by age groups.1

When the media discusses population trends, they often categorize by “generations” (boomers, Gen X, millennials, etc.). As the data in Chart A shows, however, there is a fairly even population breakdown by decade, which is probably less sensational than analysis by arbitrary social generation tags. (“Under 21” encompasses two decades, which is why this entry stands out.) The decades breakdown, however, is more appropriate for this analysis. Another useful comparison is the percentage of the population by age as presented in Chart B (see end of feature).2

The World Bank has data over a longer period of time that emphasizes the growth in the percentage of population in the United States over the ages of 65 and 80 from 1970 to 2018. This is illustrated in Chart C (see end of feature).3

Collectively, these charts show a reasonably healthy increase in the percentage of older Americans over time. There are a number of factors that significantly influence this longevity and the aging of America:

• Birth rates

• Infant mortality rates

• Access to health care

• Cost of health care

• Genetic diagnoses and therapies
  

• Health care shock risk (i.e., unexpected illness/accident or long-term care)

• Influence of the environment on disease and health care shock risk

• Lifestyle factors influencing longevity and probability of lifestyle related disease and concomitant health care shock risk

• Pandemic risk

A reasonable hypothesis is that technological and pharmacological advances are factors increasing longevity over time. Technology has been assisting biology for several decades now. Joint replacements are routine surgeries today, for example, as are the embedding of defibrillators.

That’s where we are. So, where are we going? Chart D (see end of feature) is a U.S. Census Bureau projection.4 The bureau forecasts a dramatic increase in the over-65 population through the next few decades, rising from about 16.8% today to about 23.4% of the population by 2060.

Research is occurring in nanotechnology to create even smaller and more precise diagnostic and actuating medical devices for insertion into our bodies; gene editing and therapy is moving forward at a rapid pace; and the potential for 3D printing of living tissue is rapidly developing. Those advances and more are all likely to alter mortality risks and extend lives in general.

Yet, life-advancing technology is not limited to the medical and pharmacology realms. Consider autonomous vehicles. Promoters of these vehicles suggest their deployment could save a substantial number of lives annually who are killed by human-driven vehicles. Data from the National Highway Traffic Safety Administration indicate that in 2018 there were 36,750 people killed in motor vehicle accidents.5 

The Economics of Longevity

There is the reality that access to technological and pharmacological advances in health care is not evenly spread across the population. Access to health care is largely driven by the cost of care and the financing thereof, and the public financing of health care is particularly at risk from a boom in longevity. The U.S. government continues to experience operating deficits that contribute to the overall deficit equity of the government. As of this writing, the financial statements for the fiscal year ending Sept. 30, 2019, had not been published; as of the fiscal year ending Sept. 30, 2018, the U.S. government reported $3.8 trillion of assets and $25.4 trillion of liabilities, yielding deficit equity of $21.6 trillion.6 

That balance does not include the liability for social insurance funds such as Social Security and Medicare. The open group social insurance net unfunded expenditures as of Sept. 30, 2018, was $53.8 trillion, up from $49.0 trillion the prior year. The lack of an audit opinion on those financial statements is important to note. The Government Accountability Office continues to disclaim an audit opinion as the result of material weaknesses in internal control.

Footnote 22 of those statements discloses important data regarding the calculation of the present value of the unfunded social insurance programs. The calculations consider demographic assumptions on fertility rates, age-adjusted death rates, net annual immigration, life expectancy, and economic assumptions. Life expectancy assumptions at birth from 2018 to 2090 will rise from 76.9 to 84.0 years for men and 81.5 to 87.3 years for women.  

But these are the assumptions now. What happens if 4IR technological changes impact longevity in such a way that life expectancy assumptions rapidly rise to 95 or 105 years?

Longevity and Financial Planning: Time to Think Differently

You may be thinking, “Isn’t living longer a good thing; something to be celebrated?” Of course, but there are now additional considerations if one is going to live longer … much longer. The longevity risk to retirement planning varies across income groups and gender, with the likelihood that the upper income and wealth segments are more likely to enjoy the benefits of increased longevity while the lower income and wealth groups may not fare as well. When it comes to planning out a retirement, CPAs must fully appreciate what “living well” means for each client:

• Financial considerations – Are there enough funds to live well in retirement?

- When should someone retire from their “first career”?

- When should a retiree start collecting Social Security (if it is available)?

- How much should individuals save for their retirement?

- Can retirees start the business they always wanted?

• Quality of life – Will the retiree physically be able to enjoy the extra years from enhanced longevity?

• Meaning in life – Will the retiree find meaning in a few extra years and be able to pursue their passions?

The AICPA Personal Financial Planning Division has terrific resources to help you advise clients about how to accomplish their vision of living well in retirement. A worthwhile note is AICPA Statement on Standards in Personal Financial Planning Services No. 1 (SSPFPS 1), which became effective July 1, 2014. SSPFPS 1 provides authoritative guidance and enforceable standards with respect to personal financial planning (PFP) services and implements a framework for delivering quality PFP services, which includes retirement planning services.7 SSPFPS 1 applies to any CPA or firm that makes personalized recommendations in any of the following PFP domains, and represents or advertises to the public or to clients that the firm or CPA provides any of these planning services:

• Cash flow

• Risk management and insurance

• Retirement

• Investment

• Estate, gift, and wealth transfer

• Elder

• Charitable giving

• Education

• Tax

We CPAs are the money folks, so the financial aspect is likely the most important advice clients will be seeking from us, at least initially. As with most PFP engagements, part of the science is asking the right questions. You need to complete a fairly detailed inventory of assets, liabilities, and income streams for your client, including documentation of the titling of those assets. In that process, you’ll interview your clients to determine their personal risk tolerance and possibly review their tax-advantaged retirement account and taxable investments to understand their respective asset allocation strategies.

Then, start making assumptions about portfolio growth and income generation, create a spending budget for retirement that includes consideration of lifestyle changes and applicable inflation, determine likely withdrawal rates from the respective portfolios and required minimum distributions, identify charitable giving goals, compute the Social Security income to be received and other sources of income. At this point, you hit the life expectancy assumption.

CPAs must go above and beyond textbook financial plans at this point; we must identify and address the numerous issues resulting from potential changes to longevity. And the longevity conundrum is the focal point of this feature. Will your client die at 84 or 87? What’s the longevity risk – in other words, how sensitive is the retirement withdrawal rate to extended longevity? Also, you must weigh the risk of shocks to the plan.

Sometimes planners think in terms of single shocks to a plan. Unfortunately, we must consider multiple, and sometimes simultaneous, shocks. Difficulties increase in retirement when shocks occur. Common shocks include home repairs and dental expenses. The death of a spouse is another. Uncovered health care shocks can be particularly devastating to retirees; particularly one that triggers the need for assisted living, loss of driving privileges, or a need for long-term care. Unexpected needs of other family members can present the retiree with particularly troubling choices. Lower income and wealth retirees are obviously less able to manage the effect of shocks than higher income and wealth retirees.

Generally, assets decline, and spending reductions may be necessary when a shock occurs. One of the best exercises a CPA financial planner can do is to test the resilience of the plan to shocks once the base plan is made. The 4IR certainly presents the need to test the plan for sensitivity to an extended life expectancy assumption (longevity risk) and health care shocks.

Going forward, PFP retirement planning engagements will need to seriously confront the growing financial risks of longevity. As you present a retirement plan to your clients, this may be an opportune time to encourage a financially sustainable lifestyle. Living within one’s means has become somewhat out of vogue in the United States as numerous Americans spend beyond what they should in their economic circumstances. To counter overspending during your clients’ earning years, encourage behaviors that will help increase the client’s marginal propensity to save (MPS). Economists think of consumer behavior as limited to two choices – spend/consume or save. The marginal propensity to consume (MPC) is a key factor in determining the amount of funds needed when entering retirement. For every $100 of income you earn, you can either spend it or save it. If you spend $90 of the $100, your MPC is .9 and your MPS is .1. If an MPC exceeds 1, that person is spending more than they earn and are either consuming wealth or, worse, borrowing money (claims upon future wealth). 

A focus on frugality must carry forward into retirement, too. Many retirees tend to spend more because they have more free time to do recreational activities, such as travel. While the MPS is a key element in amassing a portfolio while working, the MPC, modified by personal inflation assumptions over the planning horizon, is a significant determinant of the amount of assets needed at retirement. Helping clients develop spending patterns during their earning years that increase their MPS and providing assistance in investment planning to generate a sustainable return with the client’s risk tolerance are key elements to building the requisite asset base to facilitate a client’s desired retirement lifestyle. The discipline of careful spending patterns today will benefit future spending behaviors, thus reducing post-retirement MPC.

While not the CPA’s forte, recommending that clients consider healthy diet and exercise behaviors to increase the likelihood of a healthy retirement is something to consider, too. Good health enhances the quality of life in retirement and helps control the probability and cost of health care shocks. If you decide to venture into the good sense of good health, it may not be too big a leap for you to discuss personal engagement in their retirement years. Help your clients find their passion for a vocation or activities they want to pursue in retirement. Boredom quickly burns resources unfruitfully. Helping clients focus on their passions can help direct and budget for fulfilling expenditures that can add value to the gains in longevity.  

1 Graph derived from U.S. Census Bureau data. www.census.gov/data/tables/time-series/demo/popest/2010s-national-detail.html#par_textimage_98372960. Downloaded Dec. 31, 2019.

2 Id.

3 Graph derived from World Bank data downloaded from https://databank.worldbank.org/source/world-development-indicators%20on%20nDecember%2030 on Dec. 30, 2019.

4 U.S. Census Bureau, “2017 National Population Projections Tables.” Downloaded from www.census.gov/data/tables/2017/demo/popproj/2017-summary-tables.html on Jan. 2, 2020.

5 National Highway Traffic Safety Administration, “Early Estimate of Motor Vehicle Traffic Fatalities in 2018,” June 2019. Downloaded from https://crashstats.nhtsa.dot.gov/Api/Public/ViewPublication/812749 on Jan. 1, 2020.

6 Financial Report of the United States Government downloaded from https://fiscal.treasury.gov/files/reports-statements/financial-report/2018/FinancialStatements-2018.pdf on Dec. 31, 2019.

7 AICPA Statement on Standards in Personal Financial Planning Services No. 1. Downloaded from www.aicpa.org/content/dam/aicpa/interestareas/personalfinancialplanning/resources/pfppracticemanagement/professionalstandardsandethics/downloadabledocuments/sspfps.pdf on Jan. 1, 2020.