Death and taxes are inevitable, as the saying goes. So too, increasingly, is individual responsibility for retirement. As Governments and employers retreat from the field on the grounds of cost so the responsibility for retirement saving and spending passes to individuals. Whether we like it or not, do-it-yourself is the new mantra. Longevity risk, investment risk, inflation risk – it’s the duty of individuals to manage these on their own account. We are all actuaries, now.
It is a morbid and uncomfortable subject, but our eventual demise, and especially the timing of it, matters greatly when planning for our later life. We need to think about how long we will live in retirement (clue: it is a lot longer than it used to be) and how we fund it. Burying our heads in the sand is no use. Part of being effective actuaries will be recognising the three levers at our disposable: savings, retirement date and standard of living.
Typically, we have until now outsourced the uncertainty surrounding when we will die to actuaries themselves. They use mathematical models, statistical techniques, and time estimates of life expectancies. They are able to project longevity, investment and inflation risks, on average. The overall liabilities can be predicted, the assets necessary to meet those liabilities calculated, and the appropriate mix of investment returns sought by the life insurance company.
Our task as individuals, with responsibility for our own retirement, is infinitely harder. By definition the pooling which defines actuarial science is absent. We are either dead or alive – there is no average. Since we can’t model our longevity, how can we overlay a required rate of investment return or a sustainable income withdrawal rate? Judging how long an individual life will last is art not science. No wonder being your own actuary can lead to under spending as well as over spending. The fear of living longer than we bargained for contributes to the phenomenon of retirement under consumption.
But if being your own actuary is by definition an uphill struggle – at least in this case the actuary knows his subject well. Retirement is by definition individual – there are so many variables in play whether in terms of health, dependents, tax, bequests, and the like. Doing it for ourselves (or, ideally, with the help of a financial adviser) opens up the possibility to better tailor our retirement savings pot to our own lifetime spending needs and goals. As long as we know what we want from life, that is.
With greater freedom comes greater responsibility
Systems without compulsory insurance based retirement provision are not new: in the US, Australia, New Zealand and Hong Kong, for example, longevity insurance i.e. annuities have never been popular. Citizens have always had the right to do it themselves.
But with rights come responsibilities.
As we, individually, take on greater responsibility for making our retirement income last our lifetime we need to gain a better understanding of our life expectancy and investment risk, as well as inflation, compounding and sequence of returns risk.
A greater overall appreciation of how long we are living is required. World Health Organisation statistics put average global life expectancy at 71.4 as of 2015; in 1960 the figure was 52.4 years. It is also a moving target. As medical advances continue apace, your life expectancy is likely to rise further from the at-birth time series estimate: i.e. you will live longer than the life expectancy figure assigned to you at birth suggests. Assuming the same growth rate that has applied steadily in the past two hundred years, people born today have a 50% chance of living to 104.
These figures are mind-blowing, and should force a complete rethink of retirement.
Working through the sums
Living the 100 year life means rethinking how much we save, when we retire and how much we spend in retirement. It also means recognising the need to grow your savings in retirement as well as draw an income from them. This means taking on investment risk. Not least to protect your income against inflation.
Inflation is a silent assassin. It is not something most people think about on a daily basis, but is essentially the time decay of money – gradually eroding the purchasing power of your money. Worse still, as we all live longer, we give it more time for its insidious effect to take hold. See below.
But time can work in your favour, too. The power of compound returns is the eighth wonder of world, as Einstein once said. It demonstrates that time, literally, is money. Someone who saves from the ages 21-30 and then stops, ends up with more money at retirement than someone who saves for 40 years, but only started saving at 30 (Source: CLSA, assumes 7% per annum growth). By a similar token, sharp and unfortunate drops just before or after you start to draw an income from investments can be nigh on impossible to recover from – even when the average return is reasonable over the course of retirement investing – this is known as sequence of returns risk.
Over to you, then
Being your own actuary sure ain’t easy. But it isn’t impossible either. Save more, work longer, spend less. Invest shrewdly with both eyes on the risks of longevity, investment and inflation.
In certain countries, we can already see a hybrid model evolving where essential income needs are met via the state pension and other assets with discretionary income from drawing down on still-invested pots of money. This is both practical and sensible. So too is the increasing prevalence of older workers in the labour market and rising state pension ages. In this way Governments can prescribe and proscribe individual behaviours; nudge and coerce. We are not totally on our own. But in the end the responsibility for retirement is ours, increasingly. It is time to unleash that inner actuary.