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.
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.
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.
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.