Living too long - how bad is it for your retirement plan?
Introduction
A 2024 article titled "Longevity causes wealth managers to allocate more to growth assets"
suggested that increasing life expectancy has made wealth managers think more about longevity risk - effectively, the risk of living longer than expected and running out of money. The article states that life expectancy has increased by 4 years (from 77 to 81) over the last three decades. In this article, we examine how much risk this increased longevity creates for the sustainability of retirement income.
Ian and Janet
To help us investigate, we will use example clients Ian and Janet. Ian, 63, and Janet, 59, are both in good health and considering retiring next year. Together, they have a retirement portfolio of £1,000,000 and wonder:
How much they can spend in retirement
How much changing lifespans will affect this
We will make the following assumptions:
Both Ian and Janet will receive a full state pension.
Taxation and taxation optimisations are ignored.
They do not plan to gift to their children or leave a legacy.
They are not expecting any inheritances.
They do not want to plan for potential care home fees.
They are not planning to downsize.
Expenditure will increase by 1 percentage point below inflation each year.
They are not planning to purchase a secure income (e.g., an annuity) at any stage.
Fees are 1.2% per annum, covering advice, fund, and platform fees, and are typically what a client with this amount invested would pay with Pyrford Financial Planning.
Their portfolio consists of 70% equities and 30% bonds.
30-year baseline
Our baseline assumes Ian and Janet live for 30 years after retirement. We will assume spending starts at £75,000 per annum (a reminder that we are ignoring taxation for this exercise).
At a high level, we would consider this plan sustainable, succeeding in 89% of historical scenarios.
Digging a little deeper, we can observe the following.
The starting safe withdrawal rate is 5.53%. This has been boosted by:
The reduction in (real) income as Ian and Janet get older (1 percentage point less than inflation each year).
The two full state pensions.
The use of a diversified portfolio.
This emphasises why following the "4% rule" is unsuitable for most retirees.
As you might expect, given our starting withdrawal (7.5%) is higher than the safe withdrawal rate (5.53%), not all historical scenarios are successful, with the worst case having the money running out after around 12 years, not even halfway into the plan. Ian and Janet may be prepared to accept this, assuming they are ready to adjust spending using a framework such as risk-based guardrails.
For the purposes of this article, we will assume Ian and Janet are happy with the £75,000 starting amount and now want to see how this might change if we extend the time horizon.
A 40-year retirement
We are fortunate that Timeline, a retirement income sustainability tool, makes these scenario evaluations simple. The plan now succeeds in only 74% of historical scenarios, compared with 89% in the baseline scenario, while the safe withdrawal rate has fallen from 5.53% to 5.27%.
This reduction in the safe withdrawal rate might be less than expected (unless you read challenge six of our 4% rule analysis). Ian and Janet would only need to reduce their initial spending rate by around £4,500, to £70,500, to support an extra decade of retirement with the same starting success rate (89%) as our baseline.
Real-world longevity
So far, we've examined two fixed longevities: 30 and 40 years. In real-world retirement planning, we care about the chances of outlasting the money. The worst case from a sustainability point of view is:
Ian and Janet living a long time
The portfolio having a poor outcome and/or inflation being high.
As shown below, the chance of Ian or Janet being alive is much lower when Janet is 99 than when she is 90 (10% vs 58%).
Put another way, the chance of Ian or Janet living an extra 10 years (from 30 to 40 years of retirement) and the portfolio running out during this time is relatively small.
Conclusion
This article set out to:
"examine how much risk this increased longevity creates for the sustainability of retirement income."
Based on our example clients at the outset of retirement, adding 10 years to the plan has these effects:
The success rate falls from 89% to 74%.
The safe withdrawal rate falls from 5.53% to 5.27%.
Reducing spending from £75,000 to £70,500 gives the same success rate (89%) as the 30-year retirement.
The risk is real but manageable for this couple, and we believe other risks are more likely to derail a retirement plan.
This analysis comes with many simplifications/challenges that real-world retirees need to address.
A plan would need to be in place to adjust spending if a poor series of returns occurs early in retirement. In our worst-case example, the portfolio was exhausted when Ian and Janet were in their 70s, which many would consider unacceptable. Surviving on just the state pension would be a significant drop in their standard of living.
Both these points emphasise the need for ongoing retirement planning and robust processes.
About Pyrford Financial Planning
Pyrford Financial Planning is a team of Independent Financial Advisers based in Weybridge, Surrey.
We specialise in retirement planning and provide independent financial advice, including pension and investment advice, and inheritance tax planning.
We offer a no-obligation introductory meeting, which will be held over Zoom.
Our office telephone number is 01932 645150.
Our address is No. 5 The Heights, Wellington Way, Weybridge, Surrey, KT13 0NY.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
Although best efforts are made to ensure all information is accurate, you should not rely on this blog for your personal situation or planning.
The value of your investment can go down as well as up, and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
About the author
Noel Watson is a Certified Financial Planner and Chartered Wealth Manager, and co-founder of Pyrford Financial Planning. He specialises in retirement planning, has written a book on retirement planning and regularly publishes retirement research on this blog.
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