Wednesday, August 15, 2012

The Life Expectancy Problem: How Long Will You Live?

Being realistic about how long you will live, your life expectancy, can increase your chances of a successful retirement.

Life-expectancy: People are Living Longer

U.S. Life expectancy at birth (lifespan) since 1920
Life Expectancy In The United States

There is both good news and bad news about life expectancy. The good news is life spans are getting longer; life expectancy at birth has increased more than 15 years just since 1930. (see graph above. Click to expand.)

Increasing Life Expectancy is a Double-Edged Sword

The bad news is ... life spans are getting longer. One result of the dramatic decrease in mortality rates over the last century or so, is that retirees are spending more and more years in retirement. And, that means they are spending more and more years living off their retirement savings. While living longer is generally a good thing,
living longer than your money is not.

One of the goals of retirement planning is to have enough money to live comfortably for the rest of your life. This planning is complicated by the inconvenient fact that you don't know how long "the rest of your life" will be. Furthermore, you are dealing with a moving target.

Life Expectancy is a Moving Target

U.S. males mortality rates, lifespans & life expectancy in 2007
Average Life Expectancy

As you can see from the chart above (click to expand), the remaining lifespan (green) line slopes downward. Every year we live results in having fewer years left to live. No surprise there. However, notice that the total expected lifespan (blue) line slopes upward -- especially later in life. That is, every year we live actually increases our total expected lifespan.

Retirement Planning Example

Suppose some conscientious 30 year-old decides to do a retirement plan. He looks at the chart and determines that he is expected to live another 47 years -- to age 77. Suppose further that he develops a detailed plan of how he will retire at age 65 and live comfortably until age 77. Finally, assume that everything goes exactly as planned until age 65. He retires at age 65 having accumulated exactly the retirement savings he needs to live comfortably for another 12 years.

This retiree is in trouble. Why? Partly because now that he is 65, he is expected to live until he's 82 -- five years longer than the original projection. And, if he makes it to 82 he'll find that the target has been upped to 89!

What's Going On?

If you take 100,000 30-year-olds, on average we expect they will live for an additional 47.13 years. That is, we expect that half of the 30 year olds will die before age 77.13, and half will not.

By age 65, many of the original group have expired. If the average for the whole group is 77.13, and we remove a sub-group with lifespans less than 77.13, then we would expect that the average for the remaining group would be more than 77.13.  The surviving group has a life expectancy that is greater than the original group since it does not include the members who have already passed away.

The point to remember is this: no matter when you calculate your expected termination date, if you actually reach that date, it will have moved.

Impact of Increased Longevity On Retirement Savings Needs

Obviously, the longer you live, the more money you will need. Less obvious is the fact that the longer you live  the less your pension and annuity income will buy.  In fact, with average inflation, over a 25 year retirement a pension will lose about half of its value. (See What Will $100 be Worth in 1-50 Years?)



Note: I don't mean to suggest that you do your retirement planning based upon average lifespans; fully half of the population is expected to live longer than the average. To be safe, you need to plan on longer than the average. This post is just trying to give you a feel for how mortality tables work. Note also that in order to simplify the calculations and discussion, 2007 mortality rates for U.S. males have been used for all calculations.

Related Materials

Build Your Own Pension Using Immediate Annuities One approach to dealing with life expectancy uncertainty.
What Will $100 be Worth in 1-50 Years? What long life can do to the value of your pension.
How Much Money Will You Need To Retire? Using the "4% withdrawal" approach to retirement.
My SIMPLE Retirement Spreadsheet Simple Excel spreadsheet
A Retirement Planning Spreadsheet calculate the impact of life expectancy on needed retirement savings.
The historical life expectancy graph is from Obesity Myths
The source mortality rate data for the 2007 life expectancy graph is from the Social Security web-site.
For lists of other popular posts see the sidebar to the left or the blog header at the top of the page.
Copyright © 2012                     Last modified: 1/27/2013

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