One important thing to remember about life expectancy is that it’s the average expected age of death for people in a certain group. While most realize it’s an average, many don’t stop to think about what that means.Bet_Noire/iStockPhoto / Getty Images
When talking to clients about financial planning projections, the most common assumption they question is the plan’s timeline: “Why are you projecting it to age 90, 95 or 100?”
This question can become a protest when their financial plans show an inability to maintain their desired retirement lifestyle for the plan’s duration. When that happens, many push back with the basic mathematical solution of shortening the plan duration so they can increase spending throughout retirement. More often than not, the big pushback comes in the form of a question: “Why would you project to that advanced age when life expectancy is only 80?”
This question demonstrates a misunderstanding of life expectancy – and its implications for clients and their financial plans.
An average, not a terminal date
The first and most important thing to remember about life expectancy is the root of the last word: expect. Life expectancy is the age at which we expect the average person within a group to live. Put simply, it’s the average expected age of death for people in that group. While most realize it’s an average, many don’t stop to think about what that means.
While the remaining life expectancy of a Canadian at age 50 is 34.01 (to age 84), according to Statistics Canada, there is a 50/50 chance that the average 50-year-old will die before or after that age. What’s more eye-opening to many is just what the distribution of their life expectancy looks like. For example, that same 50-year-old Canadian expected to live to 84 has an approximately 25 per cent chance of dying before 75, a 25 per cent chance of living beyond 91, and a greater than 10 per cent chance of living past 95.
The uncertain nature of one’s actual date of death creates uncertainty and a possibility of outliving one’s money, otherwise known as longevity risk.
A moving target
The second fact about mortality is that it’s not static, for two reasons.
The macro reason is life expectancy has been increasing over time due to medical advances and changes in lifestyle. The average remaining life expectancy of a 50-year-old Canadian in 1950 was approximately 25 years versus the current 34. We have also seen reductions in life expectancy due to COVID-19 and the increased use of opioids in Canada. The key point is life expectancy changes based on the world and society we live in, and it’s not something we can look at today and ignore for 20 years when planning for the future.
In addition, on a personal level, if you’re alive today and live to see your next birthday, congratulations – your life expectancy just increased. For example, a 50-year-old today has a remaining life expectancy of 34.01 years, but a 51-year-old has a remaining life expectancy of 33.1, increasing their expected age at death from 84 years and 1 month to 84 years and 11 months. This effect is more pronounced the older one gets. For example, the remaining life expectancy of an 84-year-old is 7.69 years, bringing the expected date of death to approximately 91 years and 8 months.
Anyone who doesn’t die is part of the survivor group. At the start of the period, the people who died were bringing the expected average down for everyone else because they were expected to die. Once they’re no longer counted as part of the group, they stop bringing down the average.
The simple takeaway is that every year you live, you are expected, on average, to live longer than you were the year before.
Other factors
To complicate matters, there’s more than one set of mortality tables to help us estimate life expectancy and distribution. The population can be segmented into multiple groups, each with mortality calculations based on factors that impact mortality. These include obvious categories such as gender and smoking, but there are also less obvious ones like where someone lives, financial status and even if one is entitled to a pension.
Research shows that people with pensions in Canada live approximately six years longer than the general population. Therefore, the general population’s life expectancy significantly underestimates that of a healthy, affluent, non-smoking female with a pension. At the same time, the unhealthy, chain-smoking, financially struggling male with poor health may be grossly overestimated.
In the end, how should financial planners incorporate mortality when developing plans?
FP Canada recognizes the risk and recommends the following in its projection assumption guidelines:
- Utilizing the Canadian Pensioners Mortality Tables. That’s the table used to project the life expectancy of pensioners in Canada, who, as stated above, have longer life expectancies.
- Projecting a timeline in which the client has a 25 per cent chance of living to said age, not life expectancy, which has a 50 per cent chance of living to that age.
- Adjusting the period based on the client’s circumstances, such as poor health or a history of family longevity.
- Testing the plan by looking at the outcome should the client live five years more or less than the tables project.
Given that the planning time horizon is one of the most critical inputs for financial planners’ projections, getting it wrong can be costly. We can curtail spending unnecessarily and create unneeded financial stress when we grossly overestimate the timeline. Conversely, we could lead the client down a path on which they’ll face running out of money without correcting the course before it’s too late.
Jason Pereira is a senior partner and financial planner at Woodgate Financial Inc. in Toronto.