Why a Long Life May be Hazardous to Your Retirement

Oct 17, 2017
people-2606144_640Somewhere in my desk there is a list, probably in an old tattered file folder, of the top 10 mistakes people commonly make when thinking about their retirement. Maybe it’s because I’m now 60, or maybe it’s because I’m just smarter with age, but there are really only two things to consider carefully as we plan for a life without work and the income that comes from that work.

Living Long is Risky

We are living longer – a lot longer compared to our grandparents. Well, that’s not exactly true either. My maternal grandfather passed away peacefully at 96. His spouse, my dear grandmother, died 10 years later at 98. And my paternal grandmother, the rock of the family, left us at 104 with a mind as sharp as a tack.

Maybe your gene pool is also full of such nectar, which is why longevity risk is something you need to consider carefully with the help of an advisor. Consider this: in a recent poll by the Financial Times, 1,000 people were asked about their knowledge on a broad range of retirement and financial topics. Nearly three out of four respondents didn't know that an average 65-year-old male can expect to live another 20 or more years.

More than 60 per cent underestimated his life span by five or more years. And, more concerning, they misunderstood the nature of average life expectancy. Will you be among the 50 per cent who will live much longer than average? Will you be ready if you are?

This miscalculation is very common, and if it happens to you it can really mess up your retirement planning. For example, if you base your planning on living to 75 or 80 but then you live to 90 or 95, those final years, even those final decades of life could be deeply stressful. Throw in the inevitable health issues that come with aging and your plan can quickly develop holes.

You might say I’m being alarmist. Not so. In fact, the American Academy of Actuaries, a group not typically known for raising alarm, has one of the best calculators used by advisors today and it goes well beyond just average life expectancy. For example, it shows that a 60-year-old non-smoking woman in average health has a 46 per cent chance of living another 30 years to age 90 and a 26 per cent probability of living another 35 years to age 95. If you’re that woman, you have essentially a one in two chance of living to 90 and a one in four chance you’ll make it to 95. Those are pretty good odds in any bookie’s book.

Understand this: you have a good chance of living for 30 or even 35 years in retirement. Knowing this means you can plan more effectively for how much you need to save, how much longer you need to work, and how carefully you'll need to manage retirement income to ensure your money outlives you, not the other way around.

Save Some Money

Back in 2007, the Canadian Institute of Actuaries found that the cohort they were studying, those expected to retire in 2030, were not saving at levels anywhere near necessary to meet future living expenses.

They found that individuals earning the Average Industrial Wage (about $40,000 in 2007) had to ramp up their own savings by as much as 14 to 20 per cent of annual earnings to cover even basic non-discretionary expenses in retirement. A couple with a combined income of $40,000 would need to save 30 per cent more. These targets are correspondingly higher if the goal is to have sufficient income to allow for discretionary spending. Although some are on track, a worrying two-thirds of Canadian households are still not saving enough to cover non-discretionary expenses, never mind the luxuries in life, like eating in a restaurant occasionally.

Unfortunately, the Canadian Pension Plan (CPP) and Old Age Security (OAS) will not fill that average standard of living. Not even a workplace pension will fill that gap. And saving through a registered retirement savings plan (RRSP), though an important tax assisted program, is also unlikely to bridge the shortfall. The truth is we will need a combination of all those resources.

Despite this reality, not enough households are getting the message. The public system is not designed to do it all. OAS and C/QPP are geared to replace only about 40 per cent of gross income (at the Average Industrial Wage). We as individuals must build upon this modest income through some combination of the following: workplace pension plans, RRSPs, home ownership and personal savings.

Home ownership and workplace pension plans have the greatest potential to fill this gap. However, to be a viable retirement savings tool, home equity must be sufficient and accessible by the time we retire. Similarly, having a workplace pension plan isn’t necessarily enough—much depends on the plan design and plan type.

So, how have we done in the 10 years since the study to correct course? Not very well, based on the most recent Statistics Canada report. The planned enhancement to CPP by 2019 was designed to address what the feds saw as a crisis in the making. But no one really believes CPP alone will solve the problem. Households still need to take on personal savings strategies plans to fill the holes.

Yet employers, and an alarming number of employees, still don’t fully get or understand the risks of doing nothing. It’s hard to conclude otherwise because where employers do offer some form of retirement savings plan (37.5 per cent) a significant number of their employees decline to participate even when the employer matches their contributions. Have you ever said no to a raise?

Still, there is some good news. Membership and participation in other types of programs like RRSPs is growing. But the bad news here is that the inherent flexibility in those programs can be a member’s worst enemy. We’ve already demonstrated a reluctance to save when offered a choice, and adding flexibility can put years of saving into reverse. Or, perhaps it’s more true that we have an inability to save enough in areas where housing and childcare costs are wildly disproportionate to incomes.

Admittedly, there are many situations where any choice in income allocation is illusory. But wherever possible, do yourselves a favour when you’re offered free matching money and take it. Because life can be long. And who doesn’t want to prosper?

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