The financial downside of living too long

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This article was published 11/06/2016 (3783 days ago), so information in it may no longer be current.

Long may you run — and hopefully, your savings will last, too.

In the retirement planning world, ensuring your money will outlive you is a top concern.

While it’s often less so for individuals who have a defined benefit pension plan because they’re guaranteed an income for life, fewer Canadians have access to these workplace plans.

Increasingly, it’s our RRSPs and other savings that fund the bulk of our retirement needs — sometimes over several decades.

“When I’m putting together financial planning for my clients, there’s an end point,” says Doreen Sigurdson, a certified planner with Edmond Financial Group.

“Most people plan to use a good portion of their capital, so you have a conversation along the lines of ‘Should we project to 80, 85 or 90?’”

What if you live longer than expected? Although long life is often thought to be desirable, in retirement planning, it can be problematic. The longer you live, the more money you require, and the less of your savings you can spend early in retirement.

As well, you’re often relying on your investments to produce a necessary return — often an average of three to four per cent (after fees) — for several years to keep growing your capital so you can provide an increasingly higher income that stays in lock-step with inflation.

The financial industry has its share of solutions. The most common of which is an annuity. And yet the majority of investors are reluctant to buy one.

“Everybody wants a guaranteed income for life, but nobody wants it if you call it an annuity,” says Ronald Sanderson, director of policyholder taxation and pensions at Canadian Life and Health Insurance Association.

“It’s a bit of a peculiarity.”

Understandably, it’s difficult to hand over a large sum of cash in exchange for income for life, knowing that lump sum is gone for good. And with interest rates near historical lows — which determine annuity payouts — the income from annuities is less than it once was, making them less attractive.

But investors may overlook annuities to their own disadvantage because more of us are living deep into old age.

In 2006, there were about 180,000 Canadians over age 90, census data show. In 2015, Statistics Canada estimated there were more than 280,000. By 2036, that number is expected to more than double.

While most people figure they’ll spend less as they age because they won’t be travelling, golfing or doing many of the activities they engaged in during early retirement, Sanderson says the costs associated with late retirement can be high because of health care needs.

“When it comes to future long-term health-care costs, the estimate is that government funding only addresses about half of the need,” he says. “The number that comes to mind is about $600 billion for a shortfall just for the baby boomers.”

So through this lens, annuities make sense. And yet that security is relatively expensive to buy — a point made in a recent article published in the Financial Analysts Journal. Author Don Ezra writes that to receive $1 of guaranteed income for life at age 68, you’d have to pay $14.78 up front.

By contrast, in the U.S, a slightly different product has emerged called longevity insurance, which is less costly.

Rather than receiving an income for life, an individual hands over a lump sum or pays a continuing premium, and gets an annuity payment that starts at, for example, age 86. If you die before reaching that age, the policy doesn’t pay out. But if you live, you receive a monthly payment for the rest of your life.

This may sound like a raw deal — and it may be if you don’t have longevity in your genes. Yet, it’s a less costly way to protect against living too long.

Consider this: for that same 68-year-old to get $1 of income starting after age 85, Ezra writes, the cost is $2.53 today — much less than the cost of a life annuity that would start right away.

And while many retirees would rather take their chances with the markets, this product is gaining momentum in the U.S, says Moshe Milevsky, a finance professor at Schulich School of Business at York University — a leading expert on annuities.

“In the U.S., you have 15 insurance companies offering it, and New York Life sold $1 billion worth of policies in one year alone,” he says.

The product itself is not new to the industry.

“While they’ve been promoted lately in the U.S, they’ve been around for more than 300 years,” Milevsky says.

It’s just a sign of the times that longevity insurance now has appeal — particularly for baby boomers and generations to follow.

They want to maintain their standard of living — which is often more lavish than older generations — and fear running out of money by doing so.

In reality, no one ever runs out of money in Canada because of CPP, Old Age Security and the Guaranteed Income Supplement.

“You won’t be thrown out in the street and starving to death,” says Milevsky, author of Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income for Life.

“There’s a myth out there that if you don’t have money, you won’t have an income, but that’s not how our social system works.”

Still, no one wants to run out of savings and live off about $20,000 a year if they can avoid it. And longevity insurance could be a cost-efficient means to protect against that outcome, Sigurdson says.

“It’s kind of a reward for staying healthy and living longer than the average, and would allow you to use up your other assets in earlier retirement,” she says. “Think of it as the reverse of life insurance where the longer you live, the lower your return.”

But longevity insurance isn’t available in Canada — yet.

Sanderson suggests the industry here has not yet offered this product because companies would face challenges achieving the investment returns necessary to provide the income they would potentially have to pay customers who live long enough to receive payments.

“Any type of long-term income guarantee is going to reflect what the current interest rates are,” he says.

“To the extent that you invest in the lead-up period, there’s some volatility involved, and that can make the pricing difficult.”

Sanderson points to public-private infrastructure projects as a potential opportunity for insurers to achieve these returns. Insurers have been lobbying governments to have a seat at the table as infrastructure funding is expected to grow in the coming decade, based on federal government promises.

“We have the capital to invest in those things and then get an income payment from them over time once the projects are completed and the assets are up and running.”

Milevsky doesn’t necessarily buy the idea Canadian insurers have yet to offer this product because of the difficulty achieving steady, long-term returns.

“As it stands now, insurance companies already have to invest their money for the long term.”

Just consider a millennial buying whole life insurance — a span potentially lasting several decades.

Milevsky thinks it’s just a matter of time before longevity insurance is offered in Canada.

“There is a price point for these things where insurance companies can offer this product,” he says.

“The question is, will it be attractive to consumers?”

Milevsky seems to think it will because many pre-retirees won’t have solid workplace pensions.

“That’s why I think this product will really take off, eventually,” Milevsky says. “There’s going to be big growth in this as you’ve seen in the U.S.”

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