How long you are going to live (and spend) is an incredibly important number in your retirement plan. Unfortunately, we really have no way to determine this number when you are planning for retirement.
We certainly have ways of estimating your future longevity by looking at life expectancy numbers – essentially the likelihood that you will be alive out into the future. And for the “average” person, they aren’t half bad. But you aren’t the “average” person. These longevity assumptions can be helpful in planning, and can help you update your plan through time.
But we don’t necessarily need to try to know the unknowable by guessing at the end of our planning horizon.
The other approach to the question of longevity and sustainable spending is to simply leave the concept of planning horizons behind and to incorporate survival probabilities into our calculations.
Understanding Failure
As David Blanchett says: failure is really only failure if wealth is depleted while you are still alive, not just over an arbitrarily long time period. Implications of using mortality data directly include:
- a shorter average retirement duration than the standard thirty years,
- higher withdrawal rates for a given probability of failure,
- a lower allocation to stocks, and
- mixed results for the role of lifetime income guarantees, with shorter average retirements but some extremely long retirements in the tail of the distribution.
The argument for using survival probabilities is that for a typical person retiring at age sixty-five, conservatively assuming a remaining lifespan of thirty years or longer will needlessly cause you to underspend.
In this view, the probability of running out of financial assets should be defined as the probability of running out of financial assets before death rather than within an arbitrarily long period of time. This creates competing risks for what comes first: death or financial portfolio depletion.
Three Phases of Retirement
Dirk Cotton and co-authors studied these competing risks in a 2016 article in the Journal of Personal Finance. They found that retirement could generally be divided into three phases: a low-risk period in early retirement with few portfolio failures and few deaths, a middle period beginning around age eighty in which portfolio failures dominate, and then a late period starting in one’s early to mid-nineties when death becomes more likely than portfolio failure.
In other words, for those whose portfolios survive through the middle part of retirement, it becomes more likely that death will arrive sooner than a late-life portfolio depletion.
The American Academy of Actuaries and the Society of Actuaries prepared the Longevity Illustrator to assist users in developing personalized estimates for their longevity based on a few questions about age, gender, health status, and whether one smokes. This can provide a source of survival probabilities.
Planning Ages for 65-Year Olds from the Actuaries Longevity Illustrator
| Males | ||||||
| Smoking Status | No | Yes | ||||
| Health Classification | Excellent | Average | Poor | Excellent | Average | Poor |
| Chance of Survival | ||||||
| 90% | 74 | 72 | 70 | 68 | 67 | 66 |
| 75% | 81 | 79 | 76 | 73 | 71 | 69 |
| 50% | 88 | 86 | 82 | 80 | 77 | 74 |
| 25% | 93 | 91 | 91 | 86 | 84 | 80 |
| 10% | 98 | 98 | 95 | 92 | 89 |
84 |
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| Females | ||||||
| Smoking Status | No | Yes | ||||
| Health Classification | Excellent | Average | Poor | Excellent | Average | Poor |
| Chance of Survival | ||||||
| 90% | 75 | 75 | 72 | 70 | 69 | 68 |
| 75% | 84 | 82 | 79 | 76 | 74 | 71 |
| 50% | 88 | 88 | 85 | 83 | 81 | 77 |
| 25% | 93 | 94 | 91 | 90 | 87 | 83 |
| 10% | 98 | 99 | 95 | 95 | 93 |
88 |
Data collected as of 8/22/2024. For illustrative purposes only.
For instance, their website reports that a sixty-five-year old female nonsmoker in excellent health has a 50% chance of living to 88 and a 10% chance of making it to 98. These numbers are mostly consistent with the Society of Actuaries numbers reported before that provide the mortality data I use.
A sixty-five-year old male nonsmoker in average health has a 50% chance of living to 86 and a 10% chance to 98. For a male nonsmoker in poor health, the median life expectancy is 82, and there is a 10% chance of living to 95.
Meanwhile, a sixty-five-year old female smoker in excellent health has a 50% chance of making it to 83 and a 10% chance of living to 95. To put it mildly, smoking has a significant impact on these longevity statistics.
Fixed Horizons vs. Survival Probabilities
In practical terms, most individuals will probably be best served by using fixed time horizons that are sufficiently conservative to reflect their personalized concerns about outliving their wealth. Choosing planning ages for the tenth percentile from the previous exhibit is a reasonable approach for many.
Those who are more concerned about the implications of longevity will wish to assume a longer time horizon and behave more conservatively. This is a more straightforward way to incorporate longevity risk aversion into a retirement income plan. Trying to develop a plan around survival probabilities by age is more complex.
The use of survival probabilities is probably best limited to those working with more mathematical utility models to analyze retirement spending decisions. But the complexities of such models mean their insights are best used to describe potential caveats or adjustments to make to the conclusions derived from the more straightforward approach of using a fixed planning age.
When using survival probabilities, the risk of a long life is mitigated by planning to reduce spending with age to account for the reduced likelihood of living beyond a certain age. The extreme longevity found in the tail of the distribution may also provide more encouragement to consider contractual lifetime income guarantees as a way to manage this longevity risk.
Choosing Your Approach
Choosing between fixed horizons and mortality comes down to how averse you are to outliving your wealth, and how much you are willing to reduce spending early in retirement in order to protect against adverse outcomes later. Your appropriate planning age is an extremely personal decision. It also depends on personal health characteristics such as whether you smoke, personal and family health histories, genetic factors, and so on. What is the appropriate planning age? It is hard to say and there is no one-size-fits all answer. This requires careful thought about whether it is reasonable to plan for more or less than typical life expectancies. You also need to make a decision about how much you are willing to risk outliving your wealth by choosing a shorter horizon and a higher withdrawal rate.
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