Miscalculated Longevity Risk
Art by Miriam Martincic
There is mixed news for many retirees. “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. “We know that Americans are living longer than ever before, and everyone seems to know that except for investors.”
There is no universally accepted cause for underestimation. 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 20s, for instance, overestimate mortality risk due to concern over 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.
Underestimation’s Impact
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 too much, they risk depleting their funds prematurely, Beattie says.
Underestimation can lead to excessively conservative investment portfolio allocations, says Matthew Eickman, national retirement practice leader with Qualified Plan Advisors. “[People] become focused on the shorter term, which leads them to be more conservative from an investment perspective,” he says.
The result is a loss of purchasing power relative to inflation, he says. “What we’ve 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 lifestyle to the goals more appropriately. 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,” has been part of a research effort to create a retirement style analysis. This work has identified time-horizon lifestyle preferences among retirees; he labels the preferences front-loading and back-loading.
“An investor with a front-loading preference will want to enjoy his retirement while he’s active and healthy, even if that means making cuts later,” Pfau says.
Retirees with a back-loading preference will worry about outliving their money. “‘I’m willing to make cuts today to make sure 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 money left,’” he says.
Using Life Expectancy Estimates
Beattie and Pfau suggest using online life span calculators to get more accurate projections. The Social Security Administration’s tool provides a point estimate of additional life expectancy based on attained age, but Beattie and Pfau prefer the Society of Actuaries’ and American Academy of Actuaries’ Actuaries Longevity Illustrator. Besides considering age and gender, it lets the user or a couple enter data about retirement age, smoking history and a self-assessment of general health. The output includes individual and joint longevity percentile estimates for every fifth year of age in retirement and a distribution of life expectancies.