It is the “ticking time bomb” of financial planning. New retirees in the UK risk seriously misjudging their retirement planning because they underestimate how long they are likely to live after stopping work, a professional services firm has warned.
Barnett Waddingham issued the alert based on new analysis of data on people in defined benefit pension schemes, a group that lives slightly longer than average. The study found that at age 65 women on such schemes underestimated their life expectancy — which is 89 — by seven years. Men underestimated their figure — 86 — by four years.
Jack Carmichael, an actuary at Barnett Waddingham, calls the figures a “wake-up call” for anyone nearing retirement, particularly women, since they are most at risk.
Other wealth advisers agree.
“It’s not just a pensions issue,” Carmichael says. “It’s a fundamental financial challenge that demands immediate attention, and is a ticking time bomb for society’s approach to older people’s financial planning.”
The miscalculation may prompt pension savers to put aside too little provision for their future pensions, wealth advisers say. It may also lead them to take on too little investment risk, be unprepared for future care needs or underestimate the attractions of buying annuities.
Matt Conradi, deputy chief executive and head of advisory at Netwealth, acknowledges the problem but says it is “normal and natural” to underestimate life expectancy at retirement.
“People often think of when their parents died,” he says.
Underestimates can be a particular concern for women, who typically have smaller pension pots than men, according to experts. They recommend women take full advantage of their pension saving allowances. Partners with earnings can contribute up to £3,600 gross annually towards the pension of a non-earning spouse.
Malvee Vaja, a financial planner for Rathbones Financial Planning, says women should also make full use of their annual £20,000 allowance to save in tax-free Individual Savings Accounts (Isas).
“We have some clients who have done that and some of the women have £1mn Isas,” Vaja says.
Most couples should plan for the female spouse to live longer — and to outlive her husband. Men not only have shorter average life expectancy than women but are on average three years older than their wives.
According to Oliver Saiman, co-founder of wealth adviser Six Degrees, people particularly tend to underestimate their chances of reaching 90. Barnett Waddingham found only 14 per cent of both sexes expect to reach that age but 28 per cent of men and 40 per cent of women are likely to do so.
“Planning for average life expectancy when one in three women will live beyond 90 is problematic,” Saiman says.
Wealth advisers usually model a couple’s cash flow up to age 93 when giving advice at the point of retirement. One firm even says it models up to 100.
Conradi says: “You should never model for [death in] the early 80s unless you have a health condition.”
Such cash flow plans end with the death of the younger spouse. But they build in a big margin of safety because, according to Vaja, when one partner dies, household expenditure does not necessarily halve.
“When one partner passes on, sometimes expenses are more but they might also be less, if the person is not as mobile,” Vaja says. “You don’t know which it is until you get there.”
One risk for women is that they act as caregivers for their partners then outlive them and have no one except their children — if they are willing — to care for them.
But Conradi says it is still common for retirees to overestimate how long they are likely to spend in residential care and the resources they will need to pay for that.
“Most people spend less than two years in a care home,” he says.
Yet Saiman warns that anyone drawing down money from their pension pot needs to take care not to end up running out of money later in retirement. In particular, he warns that pensioners — used to the idea that they should reduce their risk exposure as time goes on — should consider increasing their risk exposure to ensure the income is sustained.
“Risk may actually need to be greater than they’ve taken previously when building a pension,” Saiman says.
Many contemporary pensioners even in their 70s and 80s are able to shoulder extra risk because they still have some employment income from roles as consultants or non-executive company directors, he adds.
“Their capacity for investment risk is higher than they think it is,” Saiman says.
A failure to grasp their true life expectancy may also prompt couples to underestimate their capacity to make gifts without incurring inheritance tax, advisers say.
Couples avoid making gifts to their children, according to the advisers, because they fear they will not survive for seven years after the gift — the period required to ensure any gift is exempt from inheritance tax. More retirees are considering making such gifts to minimise their liabilities after pensions become subject to the tax in April 2027.
According to several financial planners, meanwhile, skewed ideas about life expectancy can prompt retirees to miscalculate the odds on purchasing an annuity to fund their pension.
Such instruments — which offer a guaranteed income for life, bought with a lump sum from a retirement pot — are in effect a bet with the provider about the buyer’s longevity. The buyer wins if he or she lives longer than the provider expects. A 65-year-old can currently buy a level single life annuity of £7,830 a year with a pension of £100,000.
William Burrows, a financial adviser at Eadon & Co, says that potential buyers often think the annuity’s odds are against them.
“They think they will not live long enough to win their bet,” Burrows says.
Yet Barnett Waddingham’s Carmichael says that, for someone who has exercised and followed advice to eat five portions of fruit or vegetables daily, the odds might be better than they initially think.
“Think about what your lifestyle has been in your 50s and 60s,” Carmichael says. “If you’re a marathon runner and eat your five-a-day then it might be worth the purchase.”
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