Measuring longevity risk
In 1994, the grandfather of retirement income planning, William Bengen, chose thirty years as a conservative planning horizon for a sixty-five-year-old couple, when he came up with the idea of sustainable withdrawal rates.
But as mortality improves over time, this planning horizon is becoming less conservative, especially for non-smokers, in reasonable health, in our part of the country.
One of the significant risks of retirement put bluntly is that we might run out of assets before running out of time.
The Office of National Statistics provides us with some handy statistics about life expectancy. The average life expectancy for a 65-year-old man in the UK is 20 years; for a 65-year-old woman, it is 22 years.
However, most people arrive at retirement as a couple, with the man typically being three years older than the woman.
If we combine the life expectancy figures for men and women and assume that our assets will need to last until the second member of a couple dies, the statistics change substantially.
If the male partner is 65, and the female is 62, there is a 50% chance that one of them will be alive in 30 years. There’s a 29% chance that one of them will still be around in 35 years (when the man would have been 100).
It makes no sense to assume that everyone will have a retirement that lasts the same amount of time or runs to a particular age (many financial planners work on the basis that every retirement will continue until 100, for example).
Under-estimating longevity results in an increased risk of running out of money. Still, it’s just as harmful to over-estimate longevity, as this means that you will spend less (or give less away) than you might have wanted during your retirement.
If nothing else, we should be using different lengths of retirement for single retirees than we do for married couples.
The availability of better data and greater computing power mean that we can now help you to decide how much longevity risk you might want to take, similarly to how we can help you to decide how much investment risk you can take.
If our example 65/62-year-old couple were happy with a 50% chance that they might outlive their money, we can base their plan on a 30-year retirement.
But if they want to reduce that risk to 25%, we’d plan for a 36-year retirement; if they wanted to reduce the risk to 10%, they would have to prepare for a 40-year retirement.
In the USA, it’s now possible to adjust your life expectancy for the state of health and smoking status (take a look at longevityillustrator.org for more information); it wouldn’t be a surprise to see a UK calculator developed along similar lines (perhaps including geographical factors too) soon.
Bill Bengen’s assumption of a 30-year retirement is looking increasingly dated, and there are plenty of other reasons why it’s just not relevant in the UK.
Personalised safe withdrawal rates are the future, and the more accurate we can make them (taking account of your view of longevity risk), the better.
The app we use, the Timeline, allows us to discuss your view of longevity risk accurately with you, and help you to determine how much of this risk you are prepared to take.