Live Long and Prosper

Not too long ago, we came across a story about a retired certified financial planner known for his keen sense of humor. He was speaking at a CFP convention in the United States, and the auditorium was full of fellow planners. The distinguished group was gathered to glean insights into the future of retirement-a topic near and dear to them.

During the presentation, a roar of laughter rose above the crowd as the retired planner began describing a world where life expectancy for the average male and female was 140 years.

"Yes, I can imagine a future life in which I am an active tennis player at 120, taking care of my ailing 140 year-old parents… and coming home to my 100 year-old children who never left," remarked the speaker. You can almost imagine the audience's rueful laughter following such a statement. After all, most folks in North America are fortunate today to live past 85.

As the laughter subsided, the retired financial planner went on to note that few people have grasped the kind of future most of us are facing. He pointed out that retirement is no longer "a brief miserable period of being too sick to work, and too well to die".

Skeptical? Maybe you shouldn't be. While few scientists today are predicting immortality anytime soon, there are plenty of reasons to suggest that the nature of retirement-and how we plan for retirement-will be changing significantly in coming years. In this month's essay, we examine some of the issues related to longer life expectancies and retirement planning.

Life Expectancy: Past and Future

Life expectancy assumptions are a key ingredient of any credible financial plan, because the biggest financial concern of retirees is the fear of outliving their money. As a result, planners are mindful of the life expectancy tables churned out annually by demographers.

According to the U.S. Census Bureau, life expectancy at birth for an average U.S. male today is 74 years. An average U.S. female born today can expect to live 79 years. This is a meaningful increase in life expectancy during the past several decades. Life expectancy at birth for males has risen from 61 years in 1940 to 74 today. The increase for females over the same period has been similar.

As Chart 1 shows, life expectancy at birth for both males and females is projected to continue rising as far as the eye can see. Over the next decade, life expectancy at birth for males and females is projected to rise to 75.2 and 80.4 years, respectively. By 2030, demographers predict life expectancy for males and females to increase further to 76.8 and 81.7 years, respectively.

The gently rising slopes of these life expectancy projections for both males and females imply that demographers are assuming a constant rate of increase in life expectancy in the 21st century. Given these projections, it's not too difficult to see why financial planners might skeptically view statements from a retired CFP about 120 year-old tennis players taking care of their 140 year-old parents!

Before we dismiss our immortality-seeking financial planner as a stark raving lunatic, it's useful to examine trends in life expectancy-not at birth but at age 65. Projections for this demographic segment are extremely useful for financial planning purposes. Chart 2 shows that life expectancy at age 65 for males and females has risen since 1940. For males aged 65, life expectancy today is 15.8 years, while for females it is 19.2 years.

According to demographers, life expectancy for this cohort is projected to continue rising in the next century. For example, by 2020, life expectancy for males aged 65 is projected to rise to 16.7 years-nearly a 6 per cent increase from today. For financial planners, this implies that the average male client at retirement age can be expected to live almost 82 years. Female clients can be expected to celebrate their 84th birthday. But this is not the whole story.

The Acceleration of Longevity

Interestingly, there has been an acceleration of longevity for the 65 and over demographic segment during the past century. As Table 1 shows, during the early part of the 20th century, life expectancy for those aged 65 rose by only 0.1% per year. Today, it is rising by 0.6% per year. For 85 year-olds, the acceleration has been more dramatic. Life expectancy for this group is rising by 1.0% today, up from just 0.1% in the period 1900-1930. The elderly (i.e., 85-plus) are enjoying the largest rise in life expectancy among the 65 and over cohort.

The acceleration of longevity among the elderly helps explain why the fastest growing demographic segment today in North America is 85 years old and over. As Chart 3 shows, the 85 and over cohort is expected to soar in the years ahead. In 1990, this segment was 3.5 million strong. Over the next decade this group is projected to double in size and is expect to continue rising far into the future.

Get Ready for the Biotechnology Revolution

It is clear from the data that there have been significant changes in life expectancy in the past several decades-particularly for the 65-year and over demographic segment. That said, current projections for life expectancy do not support the case for 120 year-old tennis players anytime soon.

Historically speaking, demographic forecasts have ranked among the most accurate of all the projections economists make. However, there are good reasons to suspect that past demographic trends will not be useful in forecasting future trends. Coming advances in medicine and healthcare could significantly extend life expectancy beyond what may seem reasonable today. As we discussed in last month's World Report (see: Biotechnology: The Mother of All Technology Revolutions?), advances in the life sciences during the first half of the 21st century promise to eradicate many life-threatening diseases.

William Haseltine, CEO of Human Genome Sciences, notes that "death is a series of preventable diseases". By identifying the genetic roots of illnesses like cancer and heart disease-made possible by scientists' knowledge of the human genome-dramatic gains in life expectancy may lie ahead. According to a recent article in The New York Times, some experts now predict that it will be possible for a child born today to live to 150, or much longer.

If such predictions are even half right, current life expectancy projections are not even worth the paper on which they're printed. Moreover, comments from our immortality-seeking financial planner appear much more credible.

So what's a financial planner to do? We suggest adopting a more conservative view of life expectancy than demographers. In other words, assume that clients will live longer and healthier lives than current projections suggest.

For example, for clients aged 65 and over, it's probably not unreasonable to assume that longevity for this cohort increases at 1.5 per cent per year. That implies that an individual with a 20-year life expectancy at retirement can expect to live another 26 to 30 years. The bottom line is that folks entering retirement today should figure they will live about 50 per cent longer than current projections suggest.

Rethinking Retirement Planning

In the brave new world of biotechnology, old rules of thumb about financial planning may have to be revisited. Longer life expectancies mean that pre-retirement savers will need higher savings targets for retirement and will have to be more careful about the rate at which they draw down their assets after retirement.

Longer investment horizons also imply that both retirees and pre-retirement savers may wish to consider higher allocations to equities.

One casualty of the biotechnology revolution may be the old rule of thumb that says investors' allocation to equities should equal 100 minus their age. Some financial planners we know are already using numbers like 110 minus their client's age to adjust for the likelihood of longer investment horizons.

Rising life expectancy is also likely to change people's thinking about how they transfer assets to children. Since receiving an inheritance at age 70 or 75 (or 120!) is likely to be less meaningful than receiving it earlier, more wealthy individuals may consider establishing a pattern of lifetime giving, providing regular (or irregular) gifts to children, grandchildren, and even great-grandchildren.

In our view, it's better to be safe and assume clients will live significantly longer lives in the future. If the biotechnology revolution lives up to its promise, a conservative life expectancy assumption will minimize the risk of clients outliving their nest eggs.

The eminent philosopher Yogi Berra once noted that predictions are hard, especially about the future. We're not sure what lies in store for the 21st century but chances are, when it comes to life expectancy projections, the past may not be a good predictor of the future.

Our advice: Live long and prosper.