Life Expectancies & Retirement Planning

The disciplines of financial planning include the careful evaluation and determination of critical assumptions relative to an unknowable future.  These are the input variables upon which all financial models and forecasts are predicated.  Care must be taken to ensure all estimates are reasonable and, to the extent possible, supported by verified data.

When it comes to planning for retirement, the length of the planning horizon (i.e., life expectancy) stands apart from the many other assumptions required in the modeling process.  Life expectancy is defined as the average number of years a person can expect to live at a given age.  The specific issue for planning is something called longevity risk, or the possibility an individual will live to such an advanced age that they will deplete their retirement savings and be forced to rely solely on Social Security and Medicare for their expenses.

An important distinction relative to life expectancy is understanding the difference between probabilities and possibilities.  While it is not probable that any given person will live into their 90s or even surpass age 100, it is possible.  Failure to consider the possibility of advanced age (merely because it may not be probable) can diminish the value a retirement plan and lead to trouble.

Another potential problem comes with the word “average” as it relates to life expectancy.  Most actuarial tables are based on aggregate U.S. mortality rates to arrive at life expectancies for the average American.  Such estimates do not consider additional information such as marital status, family history, lifestyle, education, and socio-economic information.  Client-specific factors need to be evaluated when estimating the retirement period in a proper retirement income model.

Smoking is a behavior that has a well-documented negative impact on life expectancy.  According to the Centers for Disease Control (CDC), life expectancy for smokers is at least 10 years shorter than for non-smokers.  Another interesting factor is income, which has a positive relation to life expectancy.  People who have higher levels of income tend to have longer life expectancy when compared to similar people who have lower income.  Researchers have also observed that these differences have been increasing over time.

Mortality estimates must be personalized to the individual’s fact pattern as even a five- or ten-year shift in the life expectancy assumption can materially impact the required savings or sustainable spending levels reflected in the retirement plan itself.

Factors having a positive relation to life expectancy should lengthen the retirement planning horizon.  Research suggests that adding five years to a personalized life expectancy estimate for individuals with one or more positive profile factors is appropriate, while eight years should be added to the longest life expectancy of a married couple with a similar profile (Source: Spencer, Stepner, Abraham et. al. Journal of the American Medical Association Vol 315).

Proper retirement planning is a complex and detailed challenge.  Many people have misconceptions about life expectancies along with other critical retirement planning assumptions and these misunderstandings can be the difference between a retirement plan that produces the desired outcomes and one that fails.

It is also very important to understand that retirement planning and lifetime income modeling are dynamic in nature and must be updated periodically.  Not only do the various input variables (i.e., assumptions for rates of return, inflation, taxes, etc.) change over time, but life expectancy increases with age.  A newborn male in 2016 had a life expectancy of 76 years according to the Social Security Administration 2016 Period Life Table.  A male reaching the age of 65 had a life expectancy to age 83 simply as a result of already surviving to age 65. 

The U.S. Social Security Administration, or SSA, now expects that 25 percent of the population will live to the age of 90, while 10 percent will live to the ripe old age of 95.  Life expectancy not only changes throughout your lifetime as you reach certain age milestones, but average life expectancy changes over times thanks to changes in healthcare, lifestyle and other factors.

There has been a proliferation of online retirement “calculators” in recent years.  Some are better than others, but almost all over-simplify life expectancy estimates along with other critical assumptions.  They also fall short of incorporating personal choices, values, and priorities.  Most people today have a different idea for what they want retirement to look like than did their parents.  A truly effective retirement plan integrates these considerations to produce a reliable path forward.

Clearwater Capital Partners has invested heavily in the resources, technology, and education necessary for advisors to assist clients in building and maintaining retirement plans.  Our models create the framework for intelligent decision making over time and inform investment strategies.