Longevity risk is an odd concept because it refers to the “risk” that a person will live longer than expected and outlive their assets. Since most people want to live longer, the real risk is that an investor will not save enough money to cover a lifespan. For example:
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- George estimated that he would live to the age of 78.
- He carefully calculated the amount of money he would need to maintain his standard of living through age 79.
- George saved and invested enough money to meet his retirement goals until age 79.
- With the help of modern medicine, George is still alive at age 83, but he ran out of money.
- He is forced to live his final years with only Social Security and Medicaid to pay his bills, so George’s standard of living decreased tremendously.
Rather than hoping for a shorter life, the best way to deal with longevity risk is to plan for a longer-than-expected life. The Smart401k Education Center article titled Life Expectancy details a strategy to help prevent the problem of outliving your assets. Smart401k members can visit our Retirement Guidance planning tool to get a detailed picture of retirement needs.
Longevity Risk for Pensions and Annuity Companies
Recently, pension plans and insurance companies that issue annuities have begun to face the longevity risk issue: as people live longer than expected, these entities find that they must pay incomes longer than expected. Solid insurance companies and pension plans will have enough assets to cover the unexpected expenses associated with greater longevity. But companies and pension plans that invested poorly are facing the possibility that they might not remain solvent as participants continue to outlive expectations. Prior to purchasing an annuity, an investor should research the issuing company to ensure that it is rated well and is expected to be able to continue to meet its obligations.