Tips to estimate the length of retirement

By Morningstar |  14-09-20 | 

No one wants to talk about the “end” of retirement, because the end of retirement means the end of, well, us. However, bleak as it may be, thinking about how long retirement will last and metrics like life expectancy after retirement are critical when it comes to financial planning and making it our goal to ensure people can enjoy their life and retirement to the fullest. So, “the end” of retirement is something we should do our best to measure as accurately as possible.

David Blanchett, head of retirement research at Morningstar, decided to take a deeper dive into the subject. Here he shares a few points from the research. But you can access the full research report too.

  1. People aren’t great at estimating their own life expectancy.

People aren’t very good at estimating their own mortality. Using responses from a public survey (the Health in Retirement Study), I was able to gauge the accuracy of predictions related to the probability of an individual living to age 75.

I found that while the average response across all households was reasonably in line with standard mortality predictions (think "wisdom of the crowds"), there were significant errors at the individual household level.

For example, individuals who said they had a 0% probability of surviving to a given age (75) actually had about a 50% chance of surviving, and those who said they had a 100% probability only actually had about an 80% chance.

This means personal opinions aren’t that useful when it comes to estimating life expectancy, and that using objective information like health status, in my opinion, is a better way to go.

  1. There’s no average length of retirement--rather, retirement periods should be personalized.

Retirement periods need to be personalized based on each household’s situation. A number of attributes can have significant impacts on life expectancy, such as income and health status (especially whether someone smokes).

Incorporating this information can result in retirement periods that vary by more than 15 years, which can significantly affect the required savings and/or optimal spending levels in retirement. For example, the average person who overestimates their life expectancy after retirement would be forecast to save 38% more than required; the average person who underestimates their life expectancy after retirement would be forecast to save 30% less than required.

In other words, the potential costs associated with getting the estimate wrong can be significant.

  1. Many planners apply a “one size fits all” approach to identify an average length of retirement.

After reviewing life expectancy assumptions in 31,211 financial plans, I found that about 70% of plans used a retirement end age of 90 and about 20% of plans used age 95. This suggests that most planners are using a “one size fits all” approach and identifying an average length of retirement, rather than personalizing retirement period estimates for each client.

On average, financial advisors also didn’t appear to be incorporating the additional “tail risk” associated with the longer potential retirement periods for married couples (that is, planning for the longest survival).

Retirement is the “great unknown.” We don’t know when it’s going to start or end, or how much we’re going to spend each year.

  • The length of retirement is extremely crucial because it really defines its cost. So, if you have to live in 10 years in retirement versus 40, the estimate is very different.
  • Try to make an educated guess. Do not rely on the average life expectancy of the nation. There's a 50% chance you could live beyond the target period, so you've got to add on a margin of safety.
  • Start with what you believe to be an accurate estimate of your life expectancy after retirement based on your individual situation.
  • Consider the shortfall aversion metric (for example, probability of success) to ensure recommendations are not overly conservative.
  • Adding 5 years to projected life expectancy for a single household and 8 years to the longest life expectancy of either member of a joint household (or to each member if separate end ages are used) at retirement is a retirement-appropriate end age assumption.
  • This approach suggests a retirement period of 30 years (to age 95) is a reasonable assumption for the average 65-year-old male/female couple retiring today in the U.S.
  • Retirement period assumptions should be revisited regularly to ensure they are timely, similar to other key assumptions in a financial plan.

Download the research paper.

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ninan joseph
Sep 16 2020 07:17 PM
 This article is basically asking "Estimate as to when you will die". There are certain things which is better left alone, we as humans should do what is rational but not irrational. We need to be careful be should not be scared of our own shadows. Retirement and all that goes has become a fancy fad. Each one is trying to outdo the other in trying to tell people what they should do and should not do. In the end, a Virus Called Corona will sweep the world and end it without too much analysis. This also reminded me of a lecture where group of fund managers had to choose winning stocks along with school children. The funds which school children chose outshone than the fund managers. The answer is be simple, live your life, do not start thinking when you will die and try to save for it. At the same time be rational. No projection, no budgeting will help.

Understanding finance and be conservative is fine but not to the extent of trying to outsmart the unknown. Do charity if possible, pray, there will always be someone to take care of you.. God Bless.
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