Since 1980, the average life expectancy at birth for men and women has increased by 7.2 years, or 9.85%. Whilst living longer is positive in many ways, we do have to think about how we can afford to spend an ever-increasing amount of time in retirement. Individuals underestimate how long they are going to live, and end up spending their last years reliant on the state for money.
The maximum weekly payment for the New State Pension, which applies to anyone who retires after April 2016, is £164.35 per week. This equates to just over £8,500 per year. Imagine this being your only source of income during retirement – it’s an undesirable situation that, unfortunately, many Brits will likely face if they do not start preparing now.
The graph below shows the change in average life expectancy at birth for men and women over time. It is based on data from the Office for National Statistics.
It is clear from the graph that even in the last few decades, average life expectancy has increased significantly, which is putting a lot of pressure on our pension pots.
In addition to a rising life expectancy, studies by the Institute for Fiscal Studies have found that individuals tend to underestimate how long they will live. On average, those in their 50s and 60s underestimated their chances of survival to age 75 by around 20 percentage points, and to 85 by around 5-10 percentage points.
This may have several implications on preparation for retirement:
If individuals underestimate how long they will live, then they are much less likely to save enough during their working years, and they will probably spend more than they should during the first few years of retirement too.
Tom Selby, senior analyst at AJ Bell, said “If large numbers of people massively underestimate life expectancy and spend too long in retirement as a result, they risk running out of money early and potentially falling back on the state.”
The danger of running out of money is exacerbated as retirees are increasingly choosing to take income drawdown rather than buying an annuity. Individuals who believe they will not live as long are more likely to see an annuity, which is based on average life expectancy, as a bad deal, therefore taking income drawdown instead. Drawing money from your pension pot as and when it is needed, without effective planning, could leave many pensioners faced with financial difficulty during the later years of their retirement.
Income drawdown can also make you vulnerable to unnecessary levels of investment risk (as your pension pot remains invested), paying too much tax on your withdrawals, or being scammed. On the other hand, an annuity will guarantee you with an income that will last for as long as you live.
So what can we do about it? Well, a rising life expectancy and therefore a longer retirement for the average person means that you will need to save more money during your working years. The best way to do this is to start saving little and often from an early age, rather than trying to catch up later on. Here are 8 reasons why you should start saving into a pension now, even if you are only 18.
Automatic enrolment means that most employees automatically have a certain percentage of their salary put aside into a pension, before they receive their pay check. However, the default amount is not enough for most people to build up a sufficient pension pot by the time they retire. You may want to consider increasing the amount to be well-prepared for a longer retirement.
For those nearing retirement, it may be worth consulting a financial adviser and planning out what you are going to do when you do retire. Consider the different options such as an annuity, or taking income drawdown, and decide which is best for you. This can be a tricky task. You do not want to underestimate how long you are going to live as you may run out of money and end up reliant on the state pension. On the other hand, overestimating how long you will leave may cause you to be more frugal than you actually have to be, lowering your potential standard of living.
Whatever your situation, it is clear that a rising life expectancy and our inability to accurately estimate how long we will spend during retirement, is causing problems for our pension pots. As a result, we have to be much more careful about how we spend our money in those years, as well as start preparing even earlier than before.