Managing longevity risk
Longevity risk – or the risk of outliving your savings – is one of the biggest risks facing retirees today
Longevity risk refers to the risk of outliving your savings. Longevity risk is a big issue for retirees because they face two big unknowns:
- how long they will live
- how investment markets will perform.
People are living longer
According to the Australian Bureau of Statistics, the life expectancy of a new-born boy has increased by 14 years over the last 50 years – from 66.1 years (for those born between 1946-48) to 80.1 years (for those born between 2011-13).
Similarly, the life expectancy of a new-born girl increased from 70.6 to 84.3 years during the same period.
The increase in life expectancy at birth is due to declining death rates at all ages. Advances in medical treatments and drugs, as well as a reduction in some risk factors, have contributed to people living longer.
“ It’s important to understand that life expectancies are based on historical averages. ”
It’s important to understand that life expectancies are based on historical averages; it doesn’t mean that a 65 year old male should expect to live until age 80. What it means is that he has a 50 per cent chance that he will live beyond age 80, and a 50 per cent change that he will die earlier.
How can longevity risk be managed?
There are very few products in the Australian market that specifically manage longevity risk. Two of the most popular income stream products are account-based pensions and annuities, and both manage longevity risk in different ways.
Account-based pensions are the most popular type of income stream product and provide an income source during retirement years, although it is not guaranteed for life.
As account-based pensions are linked to the market, your investment, and therefore the income payments you receive, will be affected by market fluctuations.
How long it lasts depends on the initial capital invested and the return from the underlying investments. Longevity risk, however, can be managed to a certain degree by setting and adjusting the:
- underlying investments
- asset allocation
- level of income drawn each year from the pension.
A product that does protect against longevity risk is a lifetime annuity or pension.
Unlike account-based pensions, a lifetime annuity provides a guaranteed income for life. Also, because it's not exposed to market returns it does not suffer as a result of a downturn in the market.
Despite the certainty they provide, lifetime annuities are unpopular because:
- the rate of return is locked in at the time of purchase
- access to funds is restricted.
Your financial adviser can help
Your financial adviser can help you manage the risk of outliving your savings. If you don’t have a financial adviser, we can help you find one.