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Why underestimating life expectancy in retirement is a costly mistake

One of the biggest challenges associated with financial planing in retirement is accurately forecasting life expectancy.

Using a reasonable estimate for life expectancy is important when calculating how much you need saved in pensions, ISAs and other savings and investments, in addition to the State Pension, to fund the lifestyle you want to live.

If you underestimate your life expectancy, you risk failing to save enough for retirement or spending your savings too quickly and running out of money in later life.

Overestimate your life expectancy, and there is a genuine risk of saving too much, working longer than you had to or spending too little in your golden years and failing to live the life you want.

It’s the equivalent of setting off on an adventurous road trip without knowing if you have enough fuel to get to your destination. Except there are no petrol stations, there is no can of fuel in the boot and nobody can give you a lift.

According to some new research, we have a habit of underestimating our life expectancy. As a result, we could face an average £80,000 shortfall in our retirement savings.

Here’s how we arrived at these numbers:

The research from insurer Scottish Widows found that one in five people are using the age to which their grandparents lived as a yardstick for their life expectancy.

Referring to the lifespan of a previous generation is an flawed methodology when longevity improvements mean we can expect to live, on average, 11 years longer today.

The typical life expectancy of UK adults saving for retirement is 87 years old.

However, the average adult is planning with a life expectancy of just 82, after retiring at 65.

These expectations mean a typical retirement is 30% longer than expected, at 22 rather than 17 years long. Those five extra years of retirement on average require an additional £80,000 in savings.

Despite this likely shortfall, the research also found that one in 10 over-50s don’t know how they will fund their retirement income, and nearly a third say they fear running out of money in retirement.

And the out-of-date assumptions about life expectancy could put retirement plans at risk. Only 9% of over-50s said they were planning to buy a retirement income product that provides a secure income for life, such as an annuity.

Failure to secure an income in retirement could be the result of a lack of knowledge. The research found that 13% of over-50s didn’t know which retirement income products guaranteed an income for life.

Emma Watkins, Annuities Director at Scottish Widows, said:

“Life expectancy has grown substantially in the last 60 years and now one in 10 people will live to be 100. As the concept of the three-stage life is becoming out of date, people facing into retirement are also facing a trade-off between saving more, working longer or having a clearer plan.

“Pension Freedoms opened the door to new opportunities and flexibility for savers, but advice on the best way to put in place a stable, predictable income for life would give some comfort to those facing a retirement that could last more than 20 years.”

As part of our Financial Planning process, we make a series of reasonable assumptions about the future. These assumptions include life expectancy, with our lifetime cash flow forecasts projecting through to age 100 unless there is a very good reason to alter from this course.

We review these assumptions with clients throughout the Financial Plan, as they change over time. By keeping assumptions under regular review, we keep your Financial Plan on track, even when external factors change.

This Financial Planning process enables our clients to be confident that they can live the life they want to live without fear of running out of money.

Jon DoyleWhy underestimating life expectancy in retirement is a costly mistake