By Cheryl Krueger and Anna M. Rappaport
The Society of Actuaries Committee on Post-Retirement Needs and Risks (CPRNR) has been focusing on post-retirement risks and how they might be addressed for nearly fifteen years. One of the most important planning decisions for individuals is how long of a future time period they will plan for. Key to this issue are life spans and their variability. Traditionally, financial planning is based on planning to a certain age or range of ages.
In the spring of 2011, Anna received a request to work with NAPFA University, the continuing education program of the National Association of Personal Financial Planners (NAPFA), an organization of fee-only planners, to bring information about mortality to them in a way that would help them be effective in working with their clients. A small working group was established, and Cheryl took the lead in putting together a joint presentation, which she and Rick Miller presented to several professional audiences. The sessions at the NAPFA annual meeting in May 2012, titled "Understanding Longevity: What to Tell Your Clients," were recorded and will soon be available for purchase at NAPFA's online store.
Note about the collaboration: The CPRNR has been collaborating with different groups to bring a multi-disciplinary focus to its work and to offer its findings to others to whom it may be useful. The collaboration with NAPFA is important because financial planners are individuals who help people solve a broad range of financial problems. This is one of several efforts to work with the planning community. Cheryl and Rick Miller spoke at NAPFA University in November 2011, and again at the NAPFA National Conference in May 2012. Anna spoke at the Financial Planning Association Retreat in 2010 and at the Wisconsin Financial Planning Association in 2011, bringing SOA research to planners. There is also an ongoing joint project with the Financial Planning Association (FPA) and the International Foundation for Retirement Education (InFRE ) on addressing the needs of the middle market.
Planning for the next collaborative presentation is expected to start in summer 2012.
The working group’s discussion leading up to the presentation focused on identifying the key facts about mortality, how a planner could discuss these facts with clients, what kinds of information to give to clients, and what related practices might prove most informative and valuable. The working group focused on understanding how the perspectives of actuaries and planners may differ and how best to explain the issues. At about the time the presentation was being finalized, the SOA received a call from the FPA. The FPA had just finished its periodic survey and had added a new question: what ages were financial planners planning to in their retirement projections? The FPA’s survey results on this question were also reflected in the presentation to NAPFA and in a subsequent article published in the Journal of Financial Planning.
In this article, we review some of the key information presented as part of the NAPFA University presentation and in the December 2011 Journal of Financial Planning article, “Mortality Assumptions: Are Planners Getting It Right?”
First of all, it might be helpful to understand how most financial planners reflect longevity in their projections. Projections are developed that show funding of the clients’ major goals, typically including a retirement goal. Assumptions are developed to reflect interest or asset earnings rates, taxes, inflation, future pension and Social Security income, goal amounts, etc. Since the financial plan is typically for an individual or couple, an “end date” is selected to determine whether the goal is expected to be fully funded or requires additional funding or other adjustment. The “end date” reflects the longevity assumption the financial planner is making for that individual or couple. In this article, we use the term “planning age” to identify the age at death assumed in the financial projections for the client—the “end date.”
Our presentation to financial planners started with some key takeaways:
- People are likely to live longer than they think
- Longevity is variable—averages can mislead
- Substantially all couples eventually will become singles
- Longevity is positively related to education and income
- Longevity is increasing
- Longevity is expensive, and
- Longevity is an insurable risk.
With respect to overall longevity, the maximum life span for humans is currently assumed to be 120 years. It was interesting to note that some financial planners did use age 120 as their planning age, and this was the oldest “end date” noted in the survey. We also know that few individuals live beyond age 100, that the average life expectancy at age 65 is into the mid-to-late 80s, and for many couples one spouse will live into his (or more usually, her) 90s. However, if you ask most people in their 50s how long they think they’ll live, they’ll estimate something around their life expectancy, or to age 85 or so.
Life expectancy is simply one statistic; approximately half of a group is expected to live fewer than or more than this number of years. For example, Table 1 shows how many of a group of 1,000 60-year old females are expected to die within each of the five-year groupings shown.
Table 1 - Deaths by Age Bracket, 60-year old females
While the life expectancy age for this group is age 87.4, over 20 percent of this group is expected to die between the ages of 90 and 94, and over 26 percent are expected to die at age 95 or later. As you can see, life expectancy provides guidance for setting a planning age; but is unlikely to be an appropriate single planning age.
And so, in the case of life expectancy, we noted that the “plan-to-age” approach risks understating lifespan unless the “plan-to” age is 100 or older.
The financial planners were interested in the sources of mortality assumptions. Many are familiar with the general population tables from the CDC, and are aware of the life expectancy calculator on the Social Security Administration’s website. Most have also heard of annuity tables such as the Annuity 2000 table and the GAM table. We noted that the general population tables are based on populations that are likely less healthy than the typical higher-net-worth financial planning client. We referred planners to the SOA’s website to find copies of all of these tables.
One of the key points of our discussion was the variability of longevity. As mentioned, a single planning age is typically chosen for financial planning projections. However, as we see from the following table, the probability that an individual now age 65 will die at the planning age is less than 5 percent for all future ages. And while death within two or three years of the chosen planning age may not significantly impact the outcome of the plan, death outside of that range might mean the client dies leaving a life insurance need for irreplaceable income (e.g., pension or Social Security), or outlives their nest egg.
We suggest that the “plan-to-age” approach is overly simplistic, and can be enhanced through contingency planning for both shorter and longer lifespans.
In the case of “early death” planning, financial planners should discuss with their clients the expected level of living expenses on the death of each partner. Also, the planner and clients should understand the impact of a single death if the surviving partner lives a long time afterward. This is especially important when a significant portion of income will be lost on the death of one of the partners, for example, Social Security, single-life pensions, or leaving much of the couple’s wealth to non-spousal heirs.
Also important to planners is the quality of life of older clients. It is interesting to note the findings in the following table, showing that while women live longer than men, they also tend to spend more of their life expectancy in various stages of disability. This finding has an impact on how we plan for couples or single women, with or without strong family support.
We also presented data on how longevity is increasing with time in two different contexts. One, people are living longer, so while family history is important, the age of death for a client’s parents should take into consideration that a 65-year-old now lives longer than a 65-year-old thirty years ago. Workers need to consider saving more to spread resources over a longer future lifespan. Secondly, as clients age, their life expectancy increases as survivorship is reflected. From Table 4 we see that a female, age 65, has a life expectancy to age 85, while an 85-year-old now has a life expectancy of age 93. And while financial plans are meant to be adjusted with time, it is difficult for most 85-year-olds to find additional income to support an extending life expectancy.
Possible solutions for the dynamic longevity problem include purchasing or retaining life insurance to protect the living standard of a surviving spouse, planning to reduce inflation-adjusted expenses as needed, and considering immediate and longevity annuity solutions to insure against the tail end of the longevity curve. In all cases, it is important to review Social Security and occupational pension strategies (looking at survival of both partners or only one), and considering the longer portfolio horizon implied by longer lifespans.
We summarize longevity considerations that are needed for each financial plan:
- What is the life expectancy assumption for the client’s financial plan?
- How does the planning horizon impact other plan assumptions and recommendations?
- How do we reflect differences in lifespans between spouses/partners?
As part of the presentation, we presented case studies. These demonstrated the relative portfolio amounts needed to fund various lifespans, and also showed the use of an immediate annuity as a solution to reduce the risk posed by longevity.
How did the planners react to the presentation?
Besides going through the data and its implications, we also referenced the Life Expectancy Calculator on SOA.org, and went through one of the life expectancy surveys on livingto100.com. The audience was a bit amused with some of the personal questions included in the Living to 100 calculator! One planner noted that he has used the website as a tool with some of his clients.
Because of the volume of material and to allow time for discussion, the presentation was made over two sessions at the December 2011 and May 2012 NAPFA meetings. After the first session, we received many positive comments and it looked like most of the people who'd attended in the morning also came to our 4 p.m. follow-up session. We got lots of interaction and questions (Rick is a spectacular presenter and excels at engaging his audiences). Several people complimented us and were very enthusiastic that the topic was being discussed. One planner came to tell Cheryl his daughter is interested in being an actuary.
After the afternoon session ended, NAPFA University Chancellor Bob Maloney came up and thanked us and asked us to pass on his gratitude to all on the working group for helping with this effort. The working group consisted of Anna Rappaport, Steve Siegel, Cheryl Krueger, Rick Miller (NAPFA), Joe Tomlinson, and Andrew Peterson.
Cheryl Krueger, CFP®, FSA, is a financial planner who specializes in retirement planning for middle-market boomers. She owns Growing Fortunes Financial Partners, LLC, and is a member of the SOA, NAPFA, and the Garrett Planning Network.
Anna M. Rappaport, FSA, is an internationally known expert on retirement strategy and frequent author and speaker. She chairs the SOA Committee on Post Retirement Needs and Risks.