Life Expectancy and Retirement Planning: What You Need to Know
Life expectancy is one of the most important factors to consider when planning for retirement. It determines how long your savings must last and informs decisions about pensions, such as when to start receiving Canada Pension Plan (CPP) and Old Age Security (OAS). In this article, we'll explore some of the key factors to consider and provide tips for estimating your own life expectancy as part of your retirement planning process.
Understanding life expectancy for retirement planning
Life expectancy is the average number of years a person is expected to live. It can be calculated for an entire population, such as all Canadians, or a subset of that population, such as Canadians who are members of a pension plan.
To get an accurate estimate of life expectancy, it is important to use data that takes into account your own characteristics. This is because various factors, such as educational attainment, income and wealth, smoking, diet, exercise, and heredity, can all impact your lifespan. By considering these factors in your life expectancy estimate, you can make more informed decisions about your retirement planning.
In addition to individual life expectancies, couples should plan for their joint life expectancy — the chance that one or both will still be alive at a given age. The combined life expectancy for a couple is higher than that of a single individual, so it is wise to plan for a longer retirement period.
Life expectancy guidelines for CFP Professionals
Every year, FP Canada releases guidelines for assumptions that Certified Financial Planner® (CFP) professionals should use in their financial projections. These guidelines include a mortality table, which estimates the likelihood of survival at various ages.
A condensed mortality table based on FP Canada’s 2022 guidelines.
A look at the first row of the table shows us that:
a male age 55 has a 10% chance of living to 98, a 25% chance of living to age 94 and a 50% chance of living to age 89.
a female age 55 has a 10% chance of living to 100, a 25% chance of living to age 96 and a 50% chance of living to age 91.
a male/female couple, both age 55, would have a 10% chance of one of them living to age 101, a 25% chance of one of them living to age 98, and a 50% chance of one of them living to age 94.
The high life expectancies listed in the table may be surprising to some people. This is because the mortality table used by the guidelines is based on the 2014 Canadian Pensioners’ Mortality Table, which uses longevity data from members of pension plans. This group of people generally have higher income and education levels, which are associated with longer life expectancies. Additionally, the table takes into account anticipated advances in medical science, which are expected to lead to further increases in lifespan.
This mortality table was chosen by FP Canada because it reflects the tendency for those who engage in financial planning to be more affluent than the average Canadian.
Using a life expectancy calculator
In addition to mortality tables, life expectancy calculators can be useful tools for understanding our potential lifespan. They provide a more detailed estimate based on our own characteristics and behaviours and can help illustrate the importance of health behaviours to increase lifespan.
One such life expectancy calculator is from Project Big Life. It was created by Dr. Doug Manuel, a senior scientist at The Ottawa Hospital and professor at The University of Ottawa. The calculator will ask you questions about your personal circumstances and provide a personalised life expectancy estimate, as well as estimates of the probability of living to different ages.
Some may discover that the calculator's estimated life expectancy is shorter than the guidelines set by FP Canada, particularly for individuals with certain health conditions or who are long-term smokers. It may be reasonable to plan for a shorter retirement in these cases. However, retirement also presents the chance to focus on health and wellness, potentially improving overall health outlook through increased participation in healthy activities.
Life expectancy and retirement planning
Once you have an estimate of how long you may live, you can choose an age to base your retirement plan on according to how much risk you’re comfortable with.
When preparing for retirement, it is recommended to plan for an age that is longer than the average life expectancy, because there is a 50% chance that you will live longer than average. The FP Canada guidelines recommend that people plan for a retirement period where there is less than a 25% chance of living longer. More cautious individuals can plan for a longer retirement where there is only a 10% chance of living longer.
Pension income and life expectancy
The impact of planning for a longer or shorter retirement period can vary greatly. Planning for an additional 10 years, for instance, could make a significant difference in your retirement planning, or it may not matter much at all.
If you have a pension that provides a steady stream of income for as long as you live, you may be less concerned about running out of investments because you will continue to receive income. On the other hand, if you have less overall pension income, you may face a more difficult situation if your investments run out.
For example, Sharon is a member of a defined-benefit pension plan with the option to withdraw the lump sum (commuted value) of her pension at retirement. She also has a modest amount of savings. If she chooses the monthly pension option and defers her CPP and OAS benefits until age 70 to take advantage of the increase in benefits, her income in retirement will remain fairly consistent no matter how long she lives.
If on the other hand, she were to take the lump sum option as well as start CPP and OAS at the earliest ages, her total income in old age from pensions would be much lower. In this case, living longer than expected would result in substantially reduced income in her later years.
By choosing how to receive her workplace pension and when to begin her government benefits, Sharon has a lot of control over her level of pension income. Choosing an appropriate amount of pension income is one of the most powerful ways she has to manage risk in retirement.
What if you run out of money?
Unless we plan on living for an extremely long time (the current record is age 122), then we will have to accept some risk of our nest egg running out. This is known as longevity risk.
To assess the impact of potentially running out of investments in retirement, compare your expected pension income to your essential retirement expenses. Here’s how:
1. Calculate your essential retirement expenses
How much income will you need to cover your essential expenses in retirement? What is considered essential will be personal to everyone, but for this worst-case scenario, think about what you would need for a satisfactory, albeit, no-frills retirement budget.
2. Add up all sources of lifetime pension income
Next, add up your expected annual pensions income from CPP, OAS, and workplace pensions you may have.
3. Adjust for inflation if necessary
Once you’ve calculated your total pension income, we can start to think about inflation. The reduction in purchasing power due to inflation over long timeframes can be large, so don’t skip this step.
Your CPP and OAS benefits will increase along with inflation, but your workplace pension may not have any cost-of-living adjustments, or they may only be partial increases. An online calculator can be used to measure the impact of inflation.
For example, with a long-term inflation rate of 2.5%, an annual pension of $20,000 with no cost-of-living increase would only be worth the equivalent of about $12,000 after 20 years.
If you also expect to receive a combined total of $20,000 from CPP and OAS, your total pension income after 20 years would be $32,000.
4. Compare essentials budget against inflation-adjusted pension income
Once you’ve calculated your future pension income and adjusted it for inflation, you can compare that amount to your essential retirement budget. If the pension income is greater than your spending needs, then you’ll know that you’ll at least be able to remain comfortable in retirement. If your spending needs are greater than your projected income, then more caution is needed when estimating life expectancy to avoid running out.
Planning for a long retirement
Determining appropriate estimates of lifespan is a crucial aspect of my work in retirement planning, as it helps clients make informed decisions about their financial future. By using the tools and steps outlined above, we can ensure that Canadians have the resources they need to maintain their desired lifestyle throughout retirement.
