How should we advise clients about investing and spending during retirement when their life expectancy is 150 years?

Developments in medical science suggest that humans, at least in the developed nations, may enjoy that life expectancy sometime during this century. It is thus possible that some of your youngest clients may live to see the beginnings of the 22nd century. You may not be there to help them then, but the advice you give them now may make a big difference to them a century hence.

I call such superlong-lived clients "Methuselah" clients, after the biblical personage who was reputed to have lived in excess of 900 years.

It is difficult to imagine how humans will adapt to such a long life expectancy. Much will probably depend on our physical and mental vigor. If those qualities can be augmented so that the average individual is alert and active well past the age of 100, then the term "retirement" may take on a different meaning. It is possible that individuals may move in and out of the work force several times during their lives, perhaps spending down accumulated wealth before returning to work to build it up again, then repeating this cycle again and again. Others may elect to work continually and thus accumulate vast wealth, as seen later.

How advisors will interact with such long-lived clients is also unknown. Can one expect to have a 100-year relationship with a client? Given all the succeeding generations of a client who will be alive simultaneously and in need of financial advice, perhaps future practices will be more like today's family practices, which serve primarily a small number of families with large wealth. Serving multiple generations of a family, even of modest wealth, could lead to more holistic planning, which is better for both client and advisor.

In my earlier writing on withdrawals from retirement investment portfolios (which appeared in the Journal of Financial Planning), I assumed that clients would retire at age 65, live "only" to age 95, and therefore require only 30 years of withdrawals from their investment portfolios. I determined "safe" withdrawal rates, which would allow retirees to stretch their resources, based on historical investment returns and rates of inflation, until at least age 95.

After much thought, I decided the most useful analysis I could perform for the Methuselah client would be to determine safe withdrawal rates for much longer periods of time, up to at least 75 years. This would permit the advisor to advise a client based on the length of time withdrawals were required, regardless of whether they were for permanent retirement, or some future quasi-retirement.

Models Of Security Returns

Even with this simple approach, I had to contend with an initial problem. The Ibbotson Associates data, on which I base my analysis, covers only 74 years of security returns and inflation, for the years 1926 through 1999. How should I model future investment returns (and inflation) to provide for time horizons as long as 75 years?

I decided to extend my model by using a past period of historical returns and repeat it over and over, as long as necessary. I settled on the 36-year period of 1964-1999 as being representative of my hypothetical future. Thus, for the period 2000 through 2035, I used the actual Ibbotson returns for large-cap stocks (LCS), intermediate-term government bonds (ITG), as well as the measure of inflation (CPI), for the years 1964-1999.

Admittedly, this approach is somewhat arbitrary. A Monte Carlo analysis would not have had to resolve this problem. However, my approach has been to use historical patterns of returns, and I ask the reader to accept it for now.

Maximum Safe Withdrawal Rates

Once the model for future market performance is adopted, it is a simple matter to forecast maximum safe withdrawal rates. For the purpose of the analysis, I used spreadsheet models of 86 retirement investors, each retiring on January 1 of the years 1926-2011. I chose this period because it embraces three major market declines, as well as succeeding bull markets. Since the models of returns and inflation are repetitious, extending the analysis for retirees beyond 2011 would not provide any new information.

Chart 1 exhibits the outcome of the analysis. A tax-deferred portfolio was assumed (in order to simplify the analysis), as was the asset allocation of 63% LCS and 37% ITG. This asset allocation was selected because it represented a near-optimal mix for retirement clients, as discovered in my earlier research.

Chart 1

As you might expect, as desired portfolio longevity increases, the safe maximum withdrawal rate decreases. It is also clear from the chart that beyond a certain portfolio longevity-about 65 years-there is very little decline in the safe maximum withdrawal rate, no matter how much the longevity is increased. In fact, the curve in the chart seems to approach an "asymptote," or ultimate value, of about 3.5%.

The decline in safe withdrawal rates from 4.1% at 30 years of portfolio longevity to 3.5% at 75 years of portfolio longevity is only about 15%. This means our Methuselah client need not suffer too much in lifestyle if he or she has an extended period without earned income. So you can tell your clients that if they want to take half a century off from work, no problem!

For taxable accounts, withdrawals must be reduced about 10% to 20% (depending on the income-tax rate) from the corresponding withdrawal rates for tax-deferred accounts to achieve the same probability of success.

Higher Withdrawal Rates

Some of my clients opt to withdraw money at a rate higher than the safe withdrawal rate. I advise them of the historical risk of doing so through probability charts such as Chart 1. For this segment of my research, I created a number of such charts for extended portfolio longevities. Chart 2, as an example, was constructed for 75 years of portfolio longevity. This can be considered the "forever" chart, as we saw above that its corresponding maximum safe withdrawal rate of 3.5% would probably allow a portfolio to last 100, 500 or even 1,000 years, if history is an accurate guide.

Chart 2

It would seem that for each desired portfolio longevity, an additional chart would be required. However, the progression of probability bars in each chart is so similar when viewed across charts that some simple rules of thumb can be developed, as reflected in Table 1.

Table 1

Let's consider an example to see how this works. Assume you have a Methuselah client who would like to make withdrawals for 50 years without exhausting her portfolio. From Chart 1, you learn that the maximum safe withdrawal rate for the first year is about 3.7%. So, if the client has a $1 million portfolio and wants to be safe, she should withdraw no more than $37,000 the first year. That corresponds to the first line in Table 1.

However, let's say your Methuselah client is more aggressive, and wants to withdraw 5%, or $50,000, the first year. That's about 35% more than the safe withdrawal level of 3.7%. Table 1 tells you that a 35% increase over the safe withdrawal rate is accompanied by only a 61% chance of success-that is to say, the probability of her exhausting her portfolio before 50 years is almost 40%. She can then determine her comfort level with those odds.

Using Table 1 and Chart 1 in tandem this way, you don't even need the probability charts to determine the odds of success of a particular withdrawal strategy. However, the probability charts contain another vital piece of information-the "worst case" longevity for a particular withdrawal rate. For example, on Chart 2 you can see that a retiree withdrawing 5% the first year and increasing the withdrawal amount for inflation each year could run out of money in only 20 years-quite a bit less than the planned 75 years.

Note that the worst case bars are the same on all probability charts, for any given withdrawal rate. Thus, you need only one probability chart to demonstrate the worst case longevity possibilities.

Wealth Building For Methuselahs

It is truly fascinating to consider the consequences of wealth accumulated by an individual not just over 30 years, but also over 50 or 75 years. The power of compounding can generate tremendous wealth, even in the face of withdrawals.

Consider the wealth accumulated by our 86 retirees. I looked at the value of their portfolios (which begin at $100,000) after 30, 50 and 75 years respectively. During retirement, each portfolio is subjected to the appropriate maximum safe withdrawal percentage we learned in Chart 1: that is, 3.5% for the 75-year portfolio, 3.7% for the 50-year portfolio and about 4.1% for the 30-year portfolio.

The wealth accumulated is truly staggering. Many of the 75-year investors increased their wealth over a thousandfold, from $100,000 to $100 million. A few had as much as $200 million!

Of course, with such vast wealth accumulation, perhaps Methuse-lah clients will eventually be tempted to increase their annual withdrawals just a teensy bit! But seriously, the impact of such wealth on planning for the estate tax, charitable gifting and many other aspects of financial planning will be enormous. The Methuselah client might well force a re-thinking of many of our ideas on wealth management. Perhaps never again, when asked by a client if he can buy something he clearly cannot now afford, will a planner be able to counsel: "Not in your lifetime."

William P. Bengen is owner of Bengen Financial Services, Inc. in El Cajon, Calif.