Retirement Planning – Longevity Risk and How to Reduce It

When it comes to retirement planning, most people would agree that the goal is to have a sufficient income that supports the lifestyle you want, no matter how long you live. The flip-side of that goal is the risk of running out of money – what we in the business call Longevity Risk.  We’ve talked about the increasing likelihood of living to well beyond age 100. Longevity Risk increases the longer you are expected to live. So the question becomes;  how do you reduce that risk as much as possible?

One way is to build up your sources of reliable retirement income.  This would include  private pensions, Canada Pension Plan, Old Age Security Pension (In the U.S. Social Security) and annuities.  The IDEAL form of retirement income is a lifetime income that is also  indexed to inflation and is paid from a secure source.  Government pensions fit the bill. And since governments can print money, they won’t likely run out.

Any private pension that is indexed should also be seen as gold.  However most private pensions are not indexed (or fully indexed) and most are subject to market risk.  That means they CAN run out of money.  Life annuities are lifetime incomes that you buy from insurance companies. You can also elect to get indexed payments where you would set an index rate of something like 2-5% per year. Insurance annuity payments are backed by the company who in turn is usually backed by an industry sponsored back-up fund.  So these should be looked at closely in your planning.

A 70 year old will get a much higher annuity income then a 50 year old for the same lump-sum payment – since the insurance company assumes they have fewer years to live.  However, if advances in life sciences start to radically change life expectancy, you should expect the cost to buy an annuity to go up dramatically.  This is one reason to look closely at annuities soon, before they get priced at unattractive levels.

Other sources of sustainable retirement income could come from your investments. Many blue-chip companies have paid dividends for decades with impressive histories of regular dividend increases that approach or exceed inflation rate increases. However, our world in just 10 years may change dramatically along with the scientific advances leading to the Singularity.

The traditional approach to buying and holding quality dividend paying stocks will have to be revisited. The engine behind some companies revenues may suddenly get replaced by a newer technology competitor. The investor of who appreciates the risks within our Retirement-Singularity will need to consider carefully what companies will suffer and which might survive or thrive.  … stay tuned!

Michael