As a retiree, you may worry over the possibility of outliving your investments. This is called longevity risk. Here we discuss how to moderate your longevity risk.
Your post-retirement spending comprises living expenses, leisure and health care costs. Your retirement income portfolio should generate sufficient cash flows to fund these expenses. Risks, post-retirement, can arise due to several reasons. One, return on your investments is lower than the inflation rate. So, every year, you consume more money than you earn.
Two, you incur higher-than-projected expenses during your retired life. This can be due to your changing lifestyle. Occasionally, you may also want to help your children with their expenses. And three, your investment account suffers capital loss due to a market crash.
So, how can you moderate the longevity risk? You can buy a lifetime joint annuity from an insurance company. Then you or your spouse will receive fixed cash flows every month till either of you live. But you may not prefer an annuity because it carries lower yield than fixed deposit rates. You can instead moderate longevity risk by managing withdrawals from your retirement income portfolio.
To start with, do not stress your portfolio with additional cash withdrawals. And when the stock market is down, you should, if possible, consume only interest income from your bank deposits and hold on to your equity investments. But how will you meet your regular and occasional expenses?
Two-tiered approachYou should adopt a two-tiered approach to moderate your longevity risk.
First, create an emergency fund in addition to your retirement income portfolio. This fund should have at least one year's living expenses and carry liquid assets with zero tolerance to nominal capital loss.
You do not require large capital to create this fund. Why? You would have carried an emergency fund through your working life equal to at least six times your living expenses. As your living expenses would be lower in retirement, a factor of 12 may not require you to contribute too much additional capital at retirement.
You can use this fund for occasional cash flow needs or to pay for your living expenses when the stock market is down.
Two, you should monetise your home equity on your self-occupied mortgage-free house. You can do this by taking a reverse mortgage or using a reverse mortgage line of credit. If you take a reverse mortgage, the bank will pay you a sum of money every month for 20 years based on the value of your house.
During this period, you can supplement your cash flow requirement by withdrawing interest income and dividends from your retirement income portfolio. After 20 years, you can depend entirely on your retirement income portfolio to support your lifestyle requirement. That way, your portfolio will last longer and moderate your longevity risk.
In a reverse mortgage line of credit, you enter into an agreement with the bank to access bank funds within a certain period, but only when required.
If you need additional cash that your retirement income portfolio cannot support, you can draw from this line of credit. You can learn more about reverse mortgage from the National Housing Bank's website.
Typically, reverse mortgage is recommended for retirees owning large self-occupied houses but do not have enough money in their portfolios to sustain their post-retirement lifestyle.
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