Understanding Longevity Risk
One of the key assumptions in a financial plan is how long you expect retirement to last. However, the longer you expect to live, the greater the possibility you could run out of money in retirement.
This is what’s known as longevity risk. With longevity risk, the concern is not about dying early, but rather living longer than anticipated. For married couples, this means looking at the likelihood that one of the two of you will live much longer than expected.
Estimating Your Longevity with Software
A useful tool when estimating your, and your spouse’s, longevity is the Actuaries Longevity Illustrator (ALI) which was developed by the American Academy of Actuaries and the Society of Actuaries.1
Their projections are based on mortality tables used by the Social Security Administration in the annual Trustees’ Report and separate rates are used for males and females. They also assume the trend of improving longevity will continue when making their projections.
To account for individual differences, they make additional adjustments based on four other factors (age, gender, smoking, and health.) They have found that these factors account for significant individual variations in longevity.
Their models suggest a retirement period lasting 30 years (to age 95) would be appropriate for the average, non-smoking, 65-year-old male/female couple retiring today.
Longevity’s Potential Impact on Your Retirement Plans
Once you have a grasp on what your potential retirement horizon may be, you might begin to view some financial decisions differently. Some of these decisions include:
When you decide to retire
Knowing that your retirement may last 30+ years could cause you to rethink when you retire. This could be due to not having enough saved to cover your future expenses. Or it could be that want to gradually reduce how much you work over several years before finally retiring.
When you claim Social Security
Social Security is a source of retirement income that can help protect you from longevity risk. This is because your benefits are adjusted annually for inflation, and continue for your lifetime.
Additionally, if you’re married, your spouse could receive survivor benefit payments once you pass. With this in mind, it’s important to consider when you claim your Social Security benefits.
It may make sense to not receive your benefits as soon as possible since you will receive a larger benefit by delaying. If you can wait until age 70, you will receive what is considered the maximum benefit.
How you invest in retirement
With a retirement that could last decades, it’s important to invest your retirement assets with a goal of maintaining your standard of living throughout retirement.
This means you must have a mix of assets that allows you to fund your current needs while providing you the potential for long-term growth to meet your future spending needs.
Conclusion
Although longevity risk can pose a serious threat to your retirement plans, its impact can be mitigated with prudent planning and using reasonable assumptions for how long you and your spouse may live.
Endnotes
- See American Academy of Actuaries and Society of Actuaries, Actuaries Longevity Illustrator, http://www.longevityillustrator.org/ (accessed September 21, 2021).
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