Longevity: Don’t plan for an average retirement

Kate Beattie, Senior Retirement Income Strategist

July 13, 2021

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Capital Group | American Funds

Americans are living longer than ever before. Everyone knows that, it seems, except investors! Retirees frequently underestimate their life expectancy and the number of years they are likely to spend in retirement. It is critical we help investors understand their accurate life expectancy and the implications for retirement income planning. While the uncertainty of longevity cannot be eliminated, we can plan and manage for it. Let’s discuss why longevity, as well as life expectancy, needs to be top of mind in retirement income planning conversations.

Figure 1. Life expectancy of a 65 year old married couple

This is a bar chart with three bars illustrating estimated life expectancy for a 65-year-old heterosexual married couple. The top bar shows that a 65-year old male has a 50% chance of living beyond age 84 and a 25% chance of living beyond age 91. The middle bar shows that a 65-year old female has a 50% chance of living beyond age 87 and a 25% chance of living beyond age 93. The bottom bar shows the combined life expectancy of the married couple, showing a 50% chance of living beyond age 91 and a 25% chance of living beyond age 96.

Source: Capital Group and Society of Actuaries and American Academy of Actuaries, Actuaries, Actuaries Longevity Illustrator, as of May 10, 2021

What is life expectancy in the first place?

Life expectancy from birth tends to be the statistic we hear most often: a man or woman born in a certain year has X average life expectancy. This information has little relevance for someone reaching retirement age. For the purposes of retirement income planning, a more relevant statistic is life expectancy at attained age. In fact, an 84-year-old non-smoking woman in excellent health has a life expectancy of about seven years and a 10% probability of living for another 14 years.² At age 65, both males and females can expect to live into their late 80s (based on median life-expectancy probability). For a 65-year-old couple, one spouse can expect to live into their 90s, as shown in Figure 3.³ But this picture can also mislead planning for a retirement income horizon because these statistics are based on the median probability of the entire population. While the term “life span” refers to the maximum number of years an individual can live, “life expectancy” refers to an estimate or an average number of years a person can expect to live. Many of your investors may have a survival probability that is much greater than the median as there are large differences in life expectancy depending on various economic and demographic factors.

Figure 2: Planning horizon from attained age 65

This is a table showing the average life expectancy of male and female investors from the attained age of 65 with contributing factors that may increase or decrease the average life expectancy. The first row shows that a 65-year-old non-smoking female in excellent health has an estimated life expectancy of an additional 25 years, which is two years more than the average life expectancy for her demographic. The second row shows that a 65-year-old female smoker in average health has an estimated life expectancy of an additional 15 years, which is 10 years less than the average life expectancy for her demographic. The third row shows that a 65-year-old non-smoking male in excellent health has an estimated life expectancy of an additional 23 years, which is three years more than the average life expectancy for his demographic. The fourth row shows that a 65-year-old male smoker in average health has an estimated life expectancy of an additional 12 years, which is 11 years less than the average life expectancy for his demographic.

Source: Capital Group and American Academy of Actuaries and Society of Actuaries, as of May 10, 2021.

Consider contributing factors

To provide more perspective for clients, consider utilizing individual mortality factors such as gender, smoking choices and general state of health to sharpen the life expectancy estimate.⁴ This will help to ensure the planning horizon matches up with clients’ actual financial longevity risk and can provide your clients a more accurate picture of their retirement income planning horizon. For instance, suppose your investor is a 65-year-old woman who smokes and self-reports average health. Utilizing the Longevity Illustrator,⁵ she has a 50% chance of living at least another 15 years (to age 80), compared to age 88 if she were a non-smoker. But she also has a 25% probability of living at least another 22 years (to age 87). And if she were a non-smoker, she would be likely to live another 29 years (to age 94). This range illustrates the uncertainty surrounding how long someone might live. These results may surprise many, considering that 43% of retirees and 38% of pre-retirees underestimate life expectancy by at least five years, according to a survey from the Society of Actuaries.⁶ Underestimating life expectancy, together with having too short a planning horizon, can result in inadequate planning for retirement income needs. Consider discussing these contributing longevity factors and median statistics as part of your client conversations.

Figure 3: Probability of living past of age 65

This is a bar chart showing the probability of a 65-year old female living beyond the current age of age 65 based on smoking or non-smoking status and average health. The first bar is a grey bar representing the base case of 65 years old. The next set of bars shows that a 65-year-old non-smoking female in average health has a 90% probability of living an additional nine years to age 74, while a 65-year-old female smoker in average health has a 90% probability of living an additional four years to age 69. The next set of bars shows that a 65-year-old non-smoking female in average health has a 75% probability of living an additional 16 years to age 81, while a 65-year-old female smoker in in average health has a 75% probability of living an additional eight years to age 73. The next set of bars shows that a 65-year-old non-smoking female in average health has a 50% probability of living an additional 23 years to age 88, while a 65-year-old female smoker in average health has a 50% probability of living an additional 15 years to age 80. The next set of bars shows that a 65-year-old non-smoking female in average health has a 25% probability of living an additional 29 years to age 94, while a 65-year-old female smoker in average health has a 25% probability of living an additional 22 years to age 87. The last set of bars shows that a 65-year-old non-smoking female in average health has a 10% probability of living an additional 33 years to age 98, while a 65-year-old female smoker in average health has a 10% probability of living an additional 28 years to age 93.

Source: Capital Group and American Academy of Actuaries and Society of Actuaries, as of May 10, 2021.

Reframing longevity with your clients

While the uncertainty of how long someone may live cannot be eliminated, you can help investors better understand their own unique probabilities and develop plans to reduce the likelihood they will outlive their financial resources.

Kate Beattie is a senior retirement income strategist with 12 years of investment experience. She earned a bachelor’s degree from Colorado State University and holds the Certified Financial Planner™ and Certified Fund Specialist® designations.