How to Cope With Retirement's Growing Price Tag-Fishers investments

Longer lifespans cost more than you may think.

Assuming you aren't on the Forbes list of global billionaires, you might be planning to tap your savings and investments to fund retirement. Here is a question many people don't bother asking until it's too late: How long should you plan for your savings to last?
It has been well documented that there is an epidemic of under-saving for retirement in the U.S. Retirement's price tag is growing. Why is it growing? Americans are living much longer than their parents or grandparents. In some ways, that's a sign of our nation's prosperity and a tangible, direct way to see the positive impact of technology in our lives. However, it does come with costs.
According to the most recently updated version of the Centers for Disease Control's (CDC) U.S. life expectancy tables, the average American born today will live to see age 78.5. Since there are those who (tragically) die young, Americans who reach a rough approximation of retirement age (65) have even later life expectancies -- 84.1. (A 65-year-old man will live to age 82.6 on average, and a woman to age 85.3.) CDC data shows a whopping 41.1% of babies born in the U.S. live to age 85 and 23.6% to age 90. By this measure, nearly 30% of women will define their "later years" as ages 85-90.
The implications for retirement investing are enormous. Put simply, you likely can't afford to have your money cease growing when you stop working. If you retire at age 65 and are one of the nearly quarter of Americans who will live to age 90, you have more than 25 years of retirement to fund, and inflation makes those needs greater as time goes on. Let's hypothetically explore what happens if you plan to draw the inflation-adjusted equivalent of $40,000 a year to cover your expenses. Exhibit 1 shows an estimate of the annual withdrawal and the total sum needed to fund these 25 years.

Exhibit 1: Estimated Inflation Impact on Initial $40,000 Withdrawal Need Over 25 Years

Source: US Bureau of Labor Statistics. Amounts inflation-adjusted by increasing initial amount at the median 2.75% annual rate of the Consumer Price Index, 1983-2013 (seasonally adjusted).

That's right -- the hypothetical price tag of this retirement is just over $1.4 million. And those aren't using particularly high inflation rates -- they're using the median rate seen in a relatively benign inflation period. And they're based on the headline rate, which would apply only if you buy goods and services in the exact quantities the BLS uses in the basket of goods and services that comprise the CPI. Few do.
Retirees tend to spend more than younger people on items that rise far faster than the headline rate - such as health care. Since 1983, headline CPI excluding medical care rose at a median 2.60% annual rate, while medical care increased at 4.05%. That difference may seem small. But it isn't. Exhibit 2 re-runs the earlier analysis again using $40,000 inflation-adjusted with a twist. This time, we assume $10,000 increases at medical care's higher rate and $30,000 at CPI excluding medical care. This tiny tweak increases the hypothetical retirement's price tag by $45,951, or nearly exactly the current sticker of a BMW 435i coupe.

Exhibit 2: Est. Inflation Impact on Total $40,000 Withdrawal, Medical Care and CPI Less Medical Care

Source: Bureau of Labor Statistics. Amounts inflation-adjusted by increasing initial amounts at the median 4.05% annual rate of the CPI Medical Care and the median 2.60% annual rate of the CPI Less Medical Care, 1983-2013 (seasonally adjusted).

Your retirement plan must account for these changes in prices. It should also account for the fact that your spending won't stay static over time -- most people spend far more on health care at age 90 than at age 65. But too many plans don't. Many annuities provide non-inflation-adjusted payouts. Strategies heavily reliant on fixed income and cash are also at risk. In many cases you'll need to get some growth to make your portfolio last your lifetime.
There are many risks facing retirees, but it isn't so hard to learn the basic factors you should consider when you're crafting your retirement plan.
If you have a $500,000 portfolio, download the guide by Forbes columnist Ken Fisher's firm. Even if you have something else in place, this must-read guide includes research and analysis you can use right now. Don't miss it!

Culled from the Wallstreetcheatsheet