What is longevity risk?

And why is it critical to know how long you will live?

Back in 1908 when the Age Pension was first introduced in the Australian Federal Parliament there were two striking features. It was for men only. And the life expectancy of men who would receive this benefit at age 65 was 55.2. This social welfare program was designed to fund half the population only if they surpassed life expectancy by a decade!

Things have changed. Pension entitlement was widened to include women (aged 60) in 1910. And life expectancy has increased dramatically over the intervening 100+ years.

According to the Australian Bureau of Statistics (ABS) a baby boy born today has a life expectancy of 81.2 years, a girl 85.3 years. Those who are already aged 65 have even brighter prospects of a long life, with a 65 year old man expected to live to 85 and a 65-year-old woman likely to achieve 87.7 years of age.

Whichever way we look at it, this amounts to about 20 years of life post full-time work for most people – and another 20 years to fund compared to those retiring a century ago.

The reasons for longer lives are largely connected with advances in medical science, better public health programs and better nutrition. But individual lifespans are also closely related to socio-economic status, current lifestyle choices and the influence of parental genes. Lifestyle choices is the factor over which you have most control, with the three deadliest cancers directly affected by people’s habits.

Your likely longevity is also a critical factor when contemplating longevity risk, which can be defined as the risk of outliving your savings. This, according to Retirement Essentials surveys, is the single biggest concern in most people’s retirements.

There is a rather ironic twist here – most of us want to live longer, but no one wants to face the thought of running out of money before they pass away. Although this, in fact, is highly unlikely to happen.

Many people assume they can quickly calculate their longevity risk by dividing their total savings by their expected years left on this planet. This is a crude sum and will not provide an accurate answer. We explain why below.

But first let’s agree that having a better idea of your own longevity risk is one of the most important understandings you can have when it comes to maximising your retirement outcomes. More accurately gauging your life span and your related longevity risk will enable you to hit the retirement ‘sweet spot’ when you are withdrawing from your super and savings at a rate that comfortably covers your needs for the entirety of your later life. You can then avoid overspending – and underspending. An interesting finding in the recent Retirement Incomes Review (RIR) was that a majority of retirees actually underspend. This often means they have left their hard-earned savings to others, whilst living ultra frugally in their final years.

Back to the sums. The problem with many retirement income calculators is two-fold. Firstly they are based upon outdated life expectancy tables (current to the most recent census, which can be up to 5 years out of date). And secondly, and more importantly, they miss a major income stream which will affect 80% of retirees when they are in their 80s – the Age Pension. This means that crude sums which calculate how long your money will last by dividing your super and other savings by your expected extra years are wildly inaccurate in 80% of cases.

The most accurate way of calculating your own future income is to base your sums on all the facts of your current financial situation and to use tools or calculators which include a check on whether you will become eligible for an Age Pension sometime in your life. Our advisers have tools that can help with this.

Our team also believes that there is no substitute for a consultation with an adviser if you want to look at your current situation and the way that making simple changes might mitigate your longevity risk.

Such changes might include:

• modifying your rate of spending to suit different life stages
• applying for an Age Pension sooner than you had expected, or
• better utilising lump sums and mortgage options to move money to lower tax environments.

There’s a lot to consider here. Financial articles can only ever be general in nature. Knowing more about your expected lifespan and how the levers of:

• investment risk
• super withdrawals
• Age Pension eligibility and
• entitlement maximisation

can greatly enhance your ability to live more comfortably over the longer term.

Stressed about your longevity risk? Don’t sit there worrying. Why not make an appointment with one of our experienced retirement income advisers and see which levers you can move to improve your income?

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