Longevity Risk: The downside to the upside

One hundred years ago, when average life expectancy was about 50 years of age¹, living in retirement was a non-issue for most people. Since that time, life expectancy has increased dramatically, and a substantial period of time lived in retirement is now the norm rather than the exception. In fact, as the table below shows, for a 65 year old couple, there is now nearly a 50% chance that one spouse will spend 30 years or more in retirement.

Source: Annuity 2000 Mortality Table G, Society of Actuaries

Improvements in living and working conditions, medical care and preventive medicine have all contributed to increased longevity. Remember that roughly half of those healthy 65 year olds will live longer than the average.

The bad news in all of this good news is that this dramatic improvement in life span creates exposure to longevity risk--- the possibility of running out of financial resources in retirement.

Social Security and traditional pensions are the original safety nets which were created to address longevity risk. Unfortunately they can no longer fill the income gaps that long life spans and the potential to have over 30 years in retirement create. The reasons for this are numerous and complex, but the reality is that Social Security now provides less than 40% of the average retirement income, or about $12,000 a year² and traditional pensions are available to less than 32% of the current workforce³.

For the majority of future retirees, retirement savings in their 401(k) plans and individual retirement accounts (IRA) will be important sources of income. However, unlike Social Security or traditional pensions, income from personal savings is not automatically guaranteed to last for a lifetime.

In retirement, the traditional focus of investing shifts from growing the nest egg to preserving it. Although investing more conservatively during retirement may help reduce the uncertainty of investment returns, it will not solve the problem of longevity risk. In fact, investing too conservatively can actually increase longevity risk by lowering returns needed to fund spending targets 30 years into the future.

One of the ways to deal with longevity risk is to build a balanced retirement product portfolio. Part of this balanced product portfolio might assume enough risk to provide continued potential growth, and part of this portfolio might commit resources to providing guaranteed permanent income. There is no fixed formula for success. Your unique circumstances will dictate how your retirement investments are structured to meet both growth and income needs.

• Source: Department of Commerce, Bureau Census U.S. Life Tables, 1901
• Source: Fast Facts and Figures About Social Security, September 2005
• Source: U.S. Department of Labor: Bureau of Labor Statistics - Employee Benefits Survey, Table # 2, March 2008.

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