WTF (What the Finance) is Life Expectancy?
Life expectancy is a concept that seems basic but is not well understood. If we all knew the exact date of our death, the whole financial advice industry could cease to exist. After all, if you know exactly how many more days you need your money to last, all planning can be done with an abacus.
It’s the uncertainty of lifespans (and investment markets) that allow me to have a job.
What does “life expectancy” mean?
Technically, life expectancy is that age at which half of a population (generally defined by country) born in the same year are dead and half are still alive. It’s not an accurate predictor of your age of death because it’s an average including children who died very young in freak ice fishing accidents or from small pox and those who died very old repeating the same story for the thousandth time to their great-grandkids.
Therefore, Life Expectancy is not a number that is very helpful in your spending plan during retirement.
What do financial planners worry about?
My colleagues and I worry about Longevity Risk. What is the risk that you will run out of money if you live to age 95 or 100? Truly, the healthy retiree is a nightmare for a financial advisor. We’d prefer you take up smoking and heavy drinking, so we don’t have to worry about stretching your asset pool for 40 years.
If you have some sort of medical condition that will likely shorten your life, tell your financial advisor so he or she can adjust those expectations. You will be able to spend more money each year if you know your life expectancy is shorter.
Conversely, if you are a woman who is healthy and has a history of old women in the family, you may be more comfortable planning for your assets to last 40 years in retirement. Yikes! This means less spending now to support that nonagenarian of the future. You may be a candidate for certain types of longevity annuities, long-term care insurance, or to take a lifetime pension instead of the lump sum option.
I hope this little statistics lesson hasn’t been too boring and gives you a peek behind the curtains of one of the many aspects of retirement income planning.