Plan to live to 100

We’re faced with two great uncertainties that have a profound impact on the amount of money we’ll have to live on between retirement and death. They are the future returns on our investments and how long we’ll live.

These uncertainties are known as market risk, the risk that we lose money on the share market or bond market, and longevity risk, the risk we’ll outlive our savings.

We became painfully aware of market risk through the GFC, with many putting their retirement on hold because plunging share markets depleted their Superannuation Funds.

We can be somewhat insulated from market risk if we’re fortunate enough to have built up sufficient assets through our working lives; assets that provide substantial returns we can live off, whether that’s the interest, dividends, or rental yield for a property. Even if the value of the investment falls, the income is generally not as affected.

If, however, you’re more representative of the other 90% of the population and will rely on both the returns and gradually selling some of your assets, then you will bear a degree of market risk. Avoiding market risk all together isn’t necessarily the right answer because it will generally lower the amount of future returns.

Even if markets are relatively benign and you don’t experience a market correction, you may consume all of your assets before your life is over. Matching the rate of consumption of your assets to the rate of consumption of life – as it were – is tricky.

The objective, assuming you don’t have a bequest motive, is to write your last cheque to the funeral director, and have it bounce. Very few of us will manage to do this. Many of us will run out of money first.

Australian’s have a high longevity risk

According to the United Nations, Australian life expectancy is ranked among the highest in the world. Life expectancy at birth for Australian boys is exceeded only by boys in Iceland, Hong Kong and Switzerland. Life expectancy at birth for Australian girls is exceeded only by girls in Japan, Hong Kong, France, Italy, Switzerland and Spain.

Now, life expectancy at 65 is a further 19 years and 22 years, respectively, for men and women. Based on this rate, life expectancy rises eight minutes for every hour we’re alive.

Estimating our retirement time horizon is critical

Correctly estimating how long we will live is vitally important when planning our retirement. However, if we plan based on life expectancy, we’ll be wrong one way or the other almost all the time.

By definition, half of us will live longer than average.  Rather than planning to live to your life expectancy, you should plan to live to beyond your life expectancy, particularly if you don’t want to run out of money, and in this you wouldn’t be alone.

In a survey conducted recently in the United States, but which would resonate here, 77% of individuals aged 44 – 49 years old feared running out of money more than they feared death.

The other consideration for longevity risk is that some of us have to account and plan for being in a couple. The way probability works is that 50% of individuals will live past average life expectancy, but for a couple, the probability that either one lives past average life expectancy increases to 75%. In fact, there is a one-in-ten chance one member of a couple will live to 100.

Let’s be honest, most of us aren’t planning to live to 100, or worrying about how to fund it if we do. Accumulators in their 40s and 50s expect to have about 20 years in retirement but this is still conservatively some 20 years too short.

Longevity risk has traditionally been difficult to address when managing retirement finances. The Age Pension provided by the Government is far and away the largest longevity ‘product’, with 80% of retirees receiving the full or part Pension.

Unfortunately the Age Pension in Australia is also one of the lowest public pensions in the developed world.

On average, equivalent schemes in other OECD countries are worth three times as much and in a survey of 25 countries, only Chile and Mexico had Pensions that were worth less. As a result, there is increasing interest in products that mitigate longevity risk.

In a survey of Australians aged over 40 conducted by Investment Trends, 60% of respondents haven’t considered a retirement income product, of which 41% agreed this was because they don’t know what they are, but 22% of respondents want advice on how to make their Superannuation last however long they live.

Above all else, it’s clear that even some basic advice would go a long way for many individuals. In the same Investment Trends report, 68% of individuals over 40 did not have a specific level of saving or income they were aiming for.

Advice can help form an objective for an income over a reasonable timeframe that will fund a comfortable retirement, something that is critical to good retirement planning. Speak to a Financial Adviser for assistance in planning your retirement income and ensure you have sufficient savings to live on.

Source: Edited Extract from Andrew Barnett, General Manager, Retirement Solutions at MLC.