Are You One of the Many Retirees Who Hoard Their Savings? Here's How to Stop Underspending
Many retirees restrict their spending because they fear they'll run out of money, but using a charitable remainder unitrust (CRUT) can turn living longer into a financial advantage rather than a risk.
Much has been written about longevity risk. Retirees are warned that they might outlive their savings, and financial plans often stress-test spending through age 95 or beyond.
That caution is sensible. But it can create a second problem: Underspending.
Research suggests that retired households, particularly wealthier ones, draw down assets surprisingly slowly and often die with substantial wealth remaining.
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David Blanchett and Michael Finke, using Health and Retirement Study data, found that retirees consume about 80% of lifetime income but only about half of other available savings and income. At age 65, withdrawal rates from savings were only about 2.1% for married households and 1.9% for singles — far below the familiar 4% general rule. (Blanchett and Finke are also Kiplinger Adviser Intel contributors.)
Some restraint is intentional. People want reserves, flexibility and to leave an inheritance. But it's hard to measure how much of that restraint reflects anxiety about outliving their resources.
One point is clear: People spend income more readily than savings. A pension or Social Security check feels renewable. A withdrawal from a brokerage account feels like depletion.
How do you turn savings into income?
One answer is centuries old. In the 1330s, Barcelona raised money by selling life annuities: A citizen paid the city a lump sum, and the city promised annual payments for as long as a designated person lived.
Modern insurers now offer a bewildering array of annuity products, but the basic idea is unchanged. Retirees can diversify not only among stocks, bonds and other investments, but also between assets they own and income they can't outlive.
Some hesitate to take this path
Annuities aren't universally popular. Economists call this the annuitization puzzle: Although lifetime annuities ensure precisely the risk retirees worry about, relatively few people voluntarily annuitize much of their wealth.
Those who do buy annuities are also not a random cross-section of the population. Jane Austen recognized this more than two centuries ago. In Sense and Sensibility, Fanny Dashwood complains that "people always live for ever when there is an annuity to be paid them."
Modern actuaries call the phenomenon selection. People who choose lifetime annuities tend to live longer than the population as a whole. That matters greatly to an insurer: Price an annuity using average population mortality, and the customers who actually show up might collect payments for longer than expected.
Insurers therefore rely on mortality assumptions reflecting annuitant experience.
Getting paid while doing good
There is another vehicle that can create a lifetime payment stream: A charitable remainder unitrust, or CRUT.
In simplified form, an investor transfers appreciated property to an irrevocable trust. The CRUT can sell and re-invest the property without paying federal capital-gains tax at the trust level at the time of sale. The gain doesn't disappear; it generally comes out later to the beneficiary under special tax-ordering rules.
The donor might also qualify for a current charitable income-tax deduction. In return, the trust pays a stated percentage of its annually revalued assets to the donor — or to the donor and spouse — for life. When the last measuring life dies, the remainder passes to charity (IRC Section 664).
There is much more to know about CRUTs, including when they're economically attractive even after accounting for what ultimately goes to charity. But for present purposes, focus on mortality.
Crunching the numbers
The IRS must value the charitable remainder when the trust is funded. That calculation determines the charitable deduction and whether the CRUT satisfies an important statutory guardrail: The actuarial value of the charitable remainder must equal at least 10% of each contribution.
For a lifetime CRUT, the calculation uses a prescribed mortality table — currently IRS Table 2010CM — together with the Section 7520 interest rate.
That mortality table is deliberately impersonal. It's based on general U.S. population mortality and is gender neutral. The IRS does not ask whether you are unusually healthy, whether longevity runs in your family or whether your socioeconomic circumstances are associated with longer life.
For evaluating the actual economics of a CRUT, however, researchers have used a different assumption. In a 2014 study of CRUTs as retirement vehicles, University of North Georgia Professor Emeritus John Yeoman used the Society of Actuaries' 2012 Individual Annuity Mortality table. Later researchers expressly defended that choice, arguing that IRS population mortality might understate the longevity of wealthy taxpayers.
The difference can be substantial. One published comparison found that the probability of death by age 85 was 65.5% under the then-applicable IRS mortality table but only 45.8% under the annuitant table.
That creates an unusual asymmetry.
The IRS determines the actuarial value of the charitable remainder and applies the 10% test at the outset using population mortality. But the payments you actually receive continue for as long as you live. If your longevity more closely resembles the annuitant population used to model CRUT economics, you might receive years of additional payments beyond what the tax valuation assumptions anticipate.
A CRUT is not an annuity. Its dollar payments are not guaranteed; because a CRUT pays a percentage of assets revalued annually, payments rise or fall with the trust's value. The arrangement is irrevocable, and the remainder is committed to charity.
But it changes the way longevity works.
With an ordinary portfolio, another year of life means another year your savings must support you. With a lifetime CRUT, another year of life also means another year of participation in the trust's payment stream.
Living longer is no longer only the risk. It can also be part of the return.
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