What can retirees do about longevity risk?
A recent National Seniors Australia report highlights that the majority of older Australians worry about outliving their savings.1 Much of this concern is driven by the fact that most retirees and pre-retirees don’t know how long they will live. As a result, they don’t know how long they need their savings to last and many under-spend because of this fear of running out. This fear can be alleviated with a good plan for retirement income .
Increasing life expectancy
At face value, a longer life is a good thing. It only becomes a problem when we don’t have a proper plan to pay for it. Planning is obviously a problem because the length of our life is uncertain. We are also living longer, and when it comes to life expectancy, older people don’t always know what number to use. Take the latest life expectancy numbers from the Australian Bureau of Statistics (ABS). The ABS estimates, based on data from 2015-172, that the life expectancy of an Australian male is 80.5 years and 84.6 years for a female. These are among the highest life expectancies in the world.
However, there are two problems with using these estimates for a retirement plan. One is that they are an estimate from birth, so the average includes people who die young from accidents or illness. As a result, these figures are irrelevant to retiree life expectancies. Having reached 65, you have a higher life expectancy because you are already a survivor. The other is that the ABS doesn’t consider improvements in health. A newborn today will benefit from the advances in medicine and health management over the past 80 years, so their life expectancy is actually longer. Fortunately, the Australian Government Actuary provides numbers that adjust for both these factors, but these important distinctions are not as widely understood as they should be.
Someone who has already made it to 65 has lived longer than someone who dies young. Add to thisthe mortality improvements from better health and the average 65-year-old will live up to seven years longer than an average newborn. Based on the improvements of the past 25 years a 65-year-old today will actually live, on average, to 88 for males and 90 for females. These numbers have been increasing for many years and are likely to continue to increase for some time, even though the rate of that increase might fluctuate from year to year.
Not everyone is average
We must remember that these numbers are only averages. In reality, there is a wide distribution of outcomes either side of the average. A plan that only lasts up to the average life expectancy will disappoint one in two retirees.
As most people worry about living longer, they adjust by reducing their spending to ensure that their money lasts. The risk here is that they miss out on enjoying the benefits of spending while they are young enough to enjoy it and endure a lower standard of living than they deserved. This might be good news for the ‘kids’ inheritance, but an earlier National Seniors report highlighted that most older people wanted to enjoy their own money, rather than give it all to the next generation.3
Building the right plan
It’s possible to build a retirement income plan that can provide retirees with some confidence to spend. Retirees need an understanding of essential spending and what are the ‘nice-to-haves’ that can be reduced if necessary. In simple terms, the essentials for a retiree are things that they would worry about missing out on, such as paying the electricity bill and outings with the grandkids.
Having identified these items, you can check if a retiree will be able to afford them no matter what happens to their savings. For most older Australians, the Age Pension will provide some help, but for many, especially those with a reasonable level of retirement savings, it won’t be enough.
For these people, a guaranteed lifetime income stream, such as a lifetime annuity, can bridge the gap. A lifetime annuity provides a guaranteed monthly income that is regular and dependable. It can help your client to cover their essential expenses and maintain their standard of living for as long as they live, even if their original investment has been fully paid out to them due to living longer than average life expectancy. Typically, this is done with part of the retiree’s savings, with the remainder invested to support their desired lifestyle.
The confidence to spend
Understanding their essential living expenses and having a plan to cover those expenses provides retirees with the peace of mind to confidently spend their savings on the things they really want to fully really enjoy their retirement. They can take the overseas holidays or do more socialising with friends while they are relatively young and can still get the most out of life. When life starts to wind down, these retirees will have cash flows for all the essentials that they need and can take comfort in the knowledge that they were able to enjoy life while they could.
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By Aaron Minney Head of Retirement Income Research Challenger |
[1] McCallum, J, Hosking, D. & Rahn, A. (2019). Feeling financially comfortable? What retirees say. Brisbane: National Seniors Australia.
[2] ABS Cat No. 3302.0.55.001 Life Tables, States, Territories and Australia 2015-2017
[3] National Seniors Australia & Challenger (2018). Once bitten twice shy: GFC concerns linger for older Australians. Brisbane: National Seniors
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