Morningstar - Q4 2020 - 61

Estimating the End (of Retirement)
How advisors can personalize the
expected length of clients' retirement.
RETIREMENT

David Blanchett

The length of retirement is one of the most
important assumptions in a financial plan. Care
must be taken to ensure the estimate is
reasonable, because errors in forecasts can have
a significant impact on estimates of how much
someone must save for retirement and how much
he or she can spend during it. I recently
released research exploring this topic.1 Here is
a summary of the key findings:
Life Expectancy and Mortality Rates
Life expectancy is defined as the average
number of years a person can expect to survive at
a given age. The life expectancy of the average
newborn male (age 0) born in the United
States is 76 years, according to the Social Security
Administration 2016 Period Life Table. Life
expectancy tends to decline with age, but the
average expected age of survival increases
with age, because the person has already survived
to the respective age. For example, the life
expectancy of a 65-year-old male is 18 years, which
implies the average 65-year-old will live to age 83,
which is seven years longer than a newborn.

Life expectancies are estimated using mortality
tables. A mortality table includes the probability of
survival for a certain population for each
age. Mortality rates can vary significantly across
different cohorts of individuals, based on
different attributes or behaviors; therefore, it's
important to understand the respective
population and how well it fits a given individual.

For example, the Social Security Administration
2016 Period Life Table is based on the
population of individuals eligible for Social Security
benefits, which is effectively the entire U.S.
population. Therefore, it reflects aggregate U.S.
mortality rates and would be suitable to describe
life expectancies for the "average" American.
It may not accurately reflect the expected
mortality rates for an individual for whom more
information is available (for example, whether
he or she smokes).
Client-specific factors need to be considered when
estimating the retirement period given the impact
of various behaviors and attributes on mortality
rates (and life expectancies). Gender is one of the
most well-known factors that affects mortality
rates. Virtually all mortality tables have different
mortality rates for men and women, where women
almost always have longer life expectancies
than men. For example, a newborn female in the
U.S. has a life expectancy that is approximately
five years longer than a newborn male, based
on the Social Security Administration 2016 Period
Life Table, and a 65-year-old has a life expectancy
that is approximately 2.5 years longer.
Smoking is a behavior that has a well-known
negative impact on life expectancy. The Centers
for Disease Control and Prevention notes that
mortality rates are 3 times higher for male
and female smokers and that life expectancy for
smokers is at least 10 years shorter than for
nonsmokers. Therefore, the assumed retirement
period should generally be shorter for someone
who smokes than for someone who doesn't,
holding everything else constant.

Other variables, such as income, have a positive
relation to life expectancy-households with
higher incomes have longer life expectancies
than households with lower incomes, an effect
that has been widening. For example, Chetty
(2016) notes that 40-year-old males in the top 1%
of the income distribution had an expected
age of death of 87.3, which is 14.6 years longer
than the bottom 1%. The difference had increased
by 2.34 years from 2001 to 2014. Income is
especially relevant for financial planners,
because households that use them tend to have
significantly higher incomes.2
Many other factors that influence mortality,
such as family history, marital status, exercise,
education, location, and so on, also warrant
consideration when estimating the retirement
period for a client.
Estimating the Length of Retirement
The Internet provides a wide variety of free tools,
of varying levels of complexity, to estimate
the potential length of retirement. Most provide
a single life expectancy estimate based on a
person's current age. There are two important
reasons these estimates might need to be
adjusted when forecasting how long retirement
might last in a financial plan.

An example of an online tool, available for free,
that provides insight into the probability
distribution of survival for both an individual and
a couple is the Longevity Illustrator made
available by the American Academy of Actuaries
and the Society of Actuaries.3 The tool incorporates
attributes such as age at retirement, years
to retirement, gender, smoker status, and health
when estimating mortality rates. The tool also
determines the length of retirement, assuming the
individual has a 100% probability of surviving
to retirement.
Household attributes can have a significant
impact on survival probabilities and corresponding
retirement period estimates. This effect is

1 "Estimating 'the End' of Retirement," which can be found at https://www.morningstar.com/lp/end-of-retirement.
2 Based on data observed in the 2016 Survey of Consumer Finances.
3 https://www.longevityillustrator.org/.

morningstar.com/lp/magazine

https://www.morningstar.com/lp/end-of-retirement https://www.longevityillustrator.org/ http://www.morningstar.com/lp/magazine

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