Client Service September 27, 2022

Underestimating Longevity Risk

Americans’ projections about their own life expectancy often miss the mark, which can create problems in retirement.
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Art by Miriam Martincic


Life expectancy has been in the headlines lately—and the news is mixed.

According to the National Center for Health Statistics’ August report, Americans’ life expectancy at birth has been declining for the past two years. The U.S. life expectancy at birth for 2021, based on nearly final data, was 76.1 years, the lowest it has been since 1996. The report cites deaths from COVID-19 and increases in unintentional injury deaths, which were largely driven by drug overdose deaths, as the primary causes.

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But here’s the less distressing news: the life expectancy at birth number isn’t applicable to retirement investors. What matters for that group is, first, the actuarial life expectancy at an attained age, and second, the individual’s estimate of his or her life expectancy at that attained age.

Those numbers can differ significantly, however. Wenliang Hou, now with Fidelity Investments but previously with the Center for Retirement Research at Boston College, has researched retirees’ assessment of longevity risk, defined as the risk of living longer than expected and exhausting one’s resources. He cites the University of Michigan’s 2016 Health and Retirement Study, which asked individuals to estimate the probability that they would live to a specified age. The study found that both men and women respondents underestimated the actuarial values significantly.

The Society of Actuaries has found similar widespread underestimation. A comparison of 2011 survey respondents’ estimates of personal life expectancy with population life expectancy found that 54% of retirees thought they would not live as long as the average person of their age and gender. Only 31% cited a life expectancy that was longer than the population average.

“According to the Society of Actuaries, about 43% of retirees underestimate their own life expectancy by at least five years,” says Kate Beattie, senior retirement income strategist with Capital Group in Los Angeles. “We know that Americans are living longer than ever before, and everyone seems to know that except for investors.”

What Causes Underestimation?

There is no single, universally accepted cause for the underestimation problem. Research from Rawley Heimer at Boston College has found that the accuracy of estimations varies with age and flips from underestimation to overestimation as people grow older. People in their twenties, for instance, overestimate mortality risk due to concern over the chance of dying from events that are statistically rare. In contrast, older people—Heimer cites the example of a 78-year-old cohort—tend to overestimate how long they are likely to live.

Beattie cites the prevalence of the statistic concerning life expectancy from birth as a cause for underestimation. Even though that number is irrelevant for an adult, it can influence thinking. People also tend to use their parents’ and grandparents’ years of life for estimating their own, says Wade Pfau, professor of retirement income at the American College of Financial Services and author of “Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success.”

The age to which parents or grandparents lived becomes the person’s default estimate, even though it’s too small a sample from which to draw conclusions. Also, that approach overlooks the U.S. history, until COVID-19, of lengthening life expectancies. “In the United States, longevity’s been improving by about a year per decade for people in their sixties,” Pfau notes.

Why Underestimation Matters for Retirees

Beattie maintains that it is important to estimate the investor’s planning horizon reasonably accurately because a mismatch will influence retirement spending and lifestyle decisions. If investors plan for too long a life span, they likely will live more frugally than necessary. But if they underestimate life expectancy by too much, they risk depleting their funds prematurely, Beattie says.

Underestimation can lead to excessively conservative investment portfolio allocations, according to Matthew Eickman, national retirement practice leader with Qualified Plan Advisors. “They become focused on the shorter term, which leads them to be more conservative from an investment perspective,” Eickman explains.

The result, says Eickman, is a loss of purchasing power relative to inflation. “What we have seen is that as life expectancies have become longer, without more counseling, retirement investors have not proactively adjusted their sights to recognize they need that type of equity exposure over the long run,” he says.

An accurate estimate also helps investors clarify their retirement goals and match their lifestyles to those goals more appropriately. Pfau has been part of a research effort to create a retirement style analysis. This work has identified time-horizon lifestyle preferences among retirees that he labels front-loading and back-loading.

“An investor with a front-loading preference will want to enjoy their retirement while they are alive and healthy, even if that means making cuts later,” Pfau says.

Retirees with a back-loading preference will worry more about outliving their money, Pfau says: “I’m willing to make cuts today to make sure that I don’t have to do anything drastic in the future. And I’m really worried that if I live to 95 I won’t have any money left.”

Improving and Using Life Expectancy Estimates

Beattie and Pfau suggest using online life span calculators to get more accurate projections. The Social Security Administration’s calculator provides a point estimate of additional life expectancy based on attained age, but Beattie and Pfau prefer the Society of Actuaries’ Longevity Illustrator. In addition to considering age and gender, this site allows the user or a couple to enter data about retirement age, smoking history and a self-assessment of general health.

The Longevity Illustrator’s output includes both individual and joint longevity percentile estimates for every fifth year of age in retirement (70, 75, etc.) and a distribution of life expectancies. Pfau says the user’s preference for front-loading or back-loading determines which percentile to focus on. If investors are worried about outliving their money—a back-loading preference—they will look more at the 10th percentile, which will be an older age. Those with a front-loading preference, who want to spend more now, will look at the 25th percentile, a younger life expectancy, says Pfau.

For example, consider a nonsmoking husband and wife in average health who both retired this year when they reached age 65. The Longevity Illustrator’s forecast of their joint life expectancy at the 25th percentile gives them a 22-year joint planning horizon, to age 87. The 10th percentile gives them a 26-year joint planning horizon, to age 91.

Pfau cautions couples not to misunderstand the estimates. “Something people don’t always recognize is if you have a couple, their joint longevity is longer than a single person,” he explains. “It’s kind of obvious when you think about it, but people don’t necessarily always realize that the probability of one person from a couple living to an age is higher for them jointly than just one person by themselves.”

Client Service September 27, 2022

Decumulation Is Personal

New income solutions are focusing on customization and flexibility, in recognition of the fact that spending in retirement is more complicated than saving for it.
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Art by Miriam Martincic


The passage of 2019’s Setting Every Community Up for Retirement Enhancement Act put a spotlight on the need for retirement income solutions.

With the SECURE Act, federal lawmakers made it easier for plan sponsors to consider using insured retirement income solutions within defined contribution plans. Investment advisers, plan sponsors and recordkeepers are now working to take advantage of the SECURE Act’s pro-income provisions. Sources say their goal is to deliver a more customized approach to income and to deliver solutions that will continue to evolve over time.

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Participants Feel the Pressure

According to the Schroders 2022 U.S. Retirement Survey, among nonretired survey respondents between ages 60 and 65, as many as 55% don’t believe they will be able to replace 75% of their last paycheck in retirement income. Many people anticipate needing less in retirement, but as much as one-quarter of respondents in this age group said they have no idea how much money they will need in retirement. A majority of respondents said they were concerned or “terrified” about losing their regular paychecks.

What’s more, approximately half of all retirees surveyed said they don’t have any strategies to generate retirement income and instead withdraw money as needed.

Survey data show that as a result of these concerns, there is significant demand for in-plan retirement income solutions and advice. Approximately half of survey respondents said their retirement plan offers some type of retirement income solution. Among those who have that option, 89% said they plan to use it and stay in-plan at retirement. Survey respondents further said the features they think would be most helpful for a retirement income solution include lifetime income, a consistent monthly check, low total cost, access to cash when needed and insulation from market volatility.

These findings are in line with what Wei Hu, head of financial research at Edelman Financial Engines, has been hearing from advisers, plan sponsors and individuals.

“There are a lot of issues that people can face in retirement that are very hard to plan for, so when you start asking them how much income they think they need, it’s not always clear,” he says. “Beyond just basic expenses, people worry about health care costs, and more recently they are worried about the impact of inflation. There are a lot of unknowns that individuals have to navigate.”

In June, Edelman announced the launch of a service called Income Beyond Retirement, a retirement income solution designed for 401(k) plan participants who are in or near retirement. The solution combines portfolio management with financial adviser support to create personalized retirement income plans and investing strategies to match the individual needs of employees. Near-retirees age 55 and older are offered a meeting with an adviser to develop a plan that manages their anticipated needs while planning for the unexpected. The results are individualized based on what a person has already accumulated and when they might plan to take Social Security.

Building the plan at around age 55 can provide enough lead time for participants to consider issues such as when to claim Social Security benefits to get the best paycheck they can. They may also begin thinking about whether and when they want to annuitize all or a portion of their retirement savings to provide consistent lifetime income.

“The core issue with retirement income is that no individual retiree is the same, so we wanted to be able to offer something that is very customized,” Hu says. “There are a lot of tools that can be used for retirement income, and we believe it’s important for participants to sit down with an adviser and determine what the right tools are for each situation.”

Transforming the Defined Contribution Space

While solutions like Edelman’s IBR are a start, they may not go far enough.

Mikaylee O’Connor, a defined contribution strategist at PGIM DC Solutions, says plan sponsors and recordkeepers will also have to transform how they approach retirement.

“Since its inception, the defined contribution space has been focused on accumulation and not decumulation,” she says. “When we talk about retirement income, we’re really talking about shifting the defined contribution plans from savings plans to retirement plans. That’s going to look different than what most people are used to.”

In O’Connor’s view, success on this front will involve a fair bit of education for plan sponsors and advisers. While investment-driven income solutions are not new to the advisory space, other products, such as annuities, are. In the past, many advisers have avoided this space because of its complexity and potentially high fees. This will change as the product set evolves alongside client demands, she says.

George Fraser, managing director of Retirement Benefits Group, agrees.

“It’s important for people to understand that there are a lot of options for how to handle the retirement phase,” he says. “Annuities have a bad rap because they are expensive and complex. In the past, they have come with a pretty hard sell. But the industry is working on cost and complexity, and we are seeing more flexibility make it into annuity contracts and structures.”

Retirement Benefits Group includes annuities as part of the retirement income solutions they offer to plans and individuals, and Fraser says that much of the work that needs to be done right now is educational.

“We have a lot of good options, but there isn’t always a lot of transparency, which can make it difficult for plan sponsors to evaluate everything that is available and make a choice for the plan,” he notes. “I spend a lot of time talking to plan sponsors about how to steadily increase retirement contributions within plans and then also provide people with options for what to do when they retire. There’s a lot of fear out there because people don’t know what’s available—but it doesn’t have to be that way.”

As PLANADVISER recently reported, Nationwide found that advisers are getting more comfortable with using a variety of annuity types as retirement income solutions for themselves. These include variable annuities with living benefit riders, in-plan income guarantees, single premium immediate annuities and longevity insurance/deferred income annuities. Each of these options can provide lifetime income, but there is more flexibility in terms of when people might choose to annuitize all or a portion of their retirement savings and how benefits are paid out to individuals. As the regulatory environment shifts to accommodate insurance solutions in 401(k) plans, more of these solutions could end up in individual retirement plans.

O’Connor says it will be important for plan sponsors and individuals to look not only at the annuity solutions but also at alignment of interests.

“Plan sponsors will have to think critically and make sure they are using trusted partners. They can engage with advisers to identify the best choices,” she says.

Hu adds that timing often plays into picking the right income solution.

“We do a lot of work looking at when people think they might want a lifetime income guarantee,” he says. “We provide a lifetime income solution that people can opt into, but they aren’t required. With the current offerings available, you could also wait until you are somewhat far into retirement and then use income solutions to manage longevity risk. People tend to worry when they feel like they locked into a given option. They want flexibility, so we emphasize the importance of looking at lifetime income within the broader portfolio.”

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