Financial Savvy – the Financial Perils of Living Too Long

Recently, I’ve been involved in a Society of Actuaries project on post-retirement risk. One of the components is a biennial phone survey designed to determine how people estimate and prepare for the health and financial risks they face in retirement.  

Reviewing the results of previous years’ surveys, I found the answers related to life expectancy particularly interesting. Individual beliefs about how long they expect to live critically impact their financial decisions related to funding future health and retirement needs. Despite optimism on many other issues, on average, people tend to underestimate how long they will live.

Before you read on, answer the following question:  What age to you expect to live to? Your answer to this question is likely to be influenced by a number of factors, including gender, lifestyle choices (such as tobacco usage), and your parents’ and grandparents’ lifespans.

Perhaps placing too much emphasis on family history, most people tend to underestimate. At birth, the overall average life expectancy is 77 years for men and 81 for women, but as you survive to each successive year, your life expectancy increases. For example, a nonsmoking woman of my age has almost 10 years greater life expectancy what I had at birth.

What about genetics? Although family history does make a difference, the odds are that you’ll live longer than earlier generations. The average today represents a gain of about 6 years from our parent’s generation and 18 years from our grandparents’ generation.

So what’s the financial issue here? Clearly, mortality is a very real risk-in any year of your life, you could die, so you have to plan to meet your family’s needs in the event of your premature death. This implies that you shouldn’t delay taking care of your life insurance and estate planning needs.

But I believe that longevity is actually going to turn out to be the most important risk of the future. If you estimate your own lifespan based on the averages, you have a 50/50 chance of being wrong. And if you’re healthier than average, your estimate will be way too low.

In today’s world of medical advances, we are living much longer and healthier lives, and many people will live to be very old. In fact, about 12 percent of all men and 25 percent of all women will now live to be 90 (and a higher percentage for non-smokers). For an eye opener, you should google the longevity calculator at which estimates your maximum life expectancy based various known effects of health and risk factors. (Mine was 102!)

If you plan to live an average lifespan, you run a serious risk of underestimating your financial needs in retirement: you may save too little during the working years and run out of money too soon during the retirement years. For example, at 6 percent interest, you’ll need to have saved about 50 percent more by the time you retire to generate the same income for 20 years instead of 10 years. Similarly, given a beginning level of wealth at retirement, you’ll have to spend about one-third less per year in order to make your money last 20 years instead of 10.

Misestimation of longevity at least partially explains the large percentage of people who choose to take their accumulated retirement fund balance in a lump sum instead of annuitizing it, despite financial advice to the contrary. A lifetime income turns out to be a great deal if you live longer than average.

The financial planning lesson in this is that is that, while you still need to plan for mortality, it’s wise to invest for longevity.