How To Avoid Longevity Risk in Retirement (pt 1)

When it comes to planning for a financially comfortable retirement, what do you think is the biggest threat to your success?

Straight away I would guess you’re probably thinking about stock market risk/what would happen if your pension or investment portfolio was to suddenly drop overnight? 

And to an extent you’re right to worry about market risk…

But. There’s no denying that when you’re accumulating wealth you can afford to ride out the highs and lows of the stock market. But it’s a very different matter when you’re drawing down your wealth. Perhaps you no longer have the long-term investment horizon to weather the short-term market storms.

For some people their financial LifeMap (your robust, stress-tested financial roadmap) will evidence that they’re in a fortunate position such that they’ll never need to draw upon their wealth. 

It may be the case that their pensions are instead considered a ‘multi-generation’ product that are instead invested for the long-term to be passed on to children or grandchildren in a tax-efficient way.

For most people however, once you reach ‘retirement’ – whatever that means to you – the pressure is on you to make your wealth last. And therein lies the dilemma: how can you squeeze as much as possible from your invested wealth to enjoy life to its fullest, but not run out of money in the longer term?

I explained in a previous blog that navigating this conundrum in retirement is exceptionally difficult when there are so many unknowns to plan around (how long will you live, how will markets perform, what will inflation look like, will successive governments change the goalposts?!).

Most retirees don’t really care about market risks or inflation risks (that’s for your financial adviser to worry about.. right?). 

Instead, the main concern for many is navigating the increased risks of longevity. 

So the good news first of all is we’re all living longer. 

But with this bonus comes the added stress that our hard-earned wealth has to potentially last us for longer too.

Say you opt to ‘retire’ at 60. We should hope and plan for you living another 30+ years. That’s a long time to keep making your wealth last. 

This is why I encourage my clients who are in, or nearing, retirement to consider this life stage as the birth of a new investment horizon. Taking your foot of the gas and removing all market risk completely from your portfolio is worrisome and will surely only lead to a sub-par retirement.

Okay so the question then is ➡️ how much risk do you need to take to enjoy the quality of retirement you aspire to and what impact does longevity risk have?

Fear not, I’ll explain. 

The case of Mike & Helen 

To help illustrate this example and bring it to life, let’s consider Mike and Helen.

Together they have a retirement portfolio of £500,000. 

The average pension pot for those 55-64 years old is £107,300 so clearly they’ve been doing something right so far.

To bring market risks and longevity risks to life, as a firm we subscribe to a fantastic tool called Timeline which allows us to stress test over 100 years of market performance. It’s pretty much the best tool out there save for having a crystal ball. 

Let’s assume the following first of all:

  • Both Mike and Helen are due to receive their full State Pensions at state pension age;
  • They don’t plan to gift any money to their 3 children;
  • They aren’t concerned about planning for potential care costs and hope these won’t materialise in the future;
  • They are happy in their family home and don’t want to ever move as they like where they live and have family and friends around them;
  • They pay professional fees of 1.5%, which includes all fees paid to us as their advisers, their platform fees and investment fees. This is what our typical clients would expect to pay, below the standard average 1.9% ongoing fee charged by other financial advisers);
  • Their investment portfolio is originally invested solely in cash so they aren’t taking any investment risk whatsoever;
  • They hope to spend around £40,000 per year to enjoy a rewarding and enjoyable retirement.

So how does retirement look for Mike & Helen? 

Our standard scenario tests how Mike and Helen’s retirement would look if they felt they were no longer able to withstand investment risk and effectively sold to cash.

It probably won’t surprise you to learn that in such a case their financial plan is unsustainable. 

When we tested this strategy against 109 years of rigorous data, their financial assets only outlasted them in 8% of scenarios. 

Given they haven’t looked into any ‘worst case scenarios’ such as care costs materialising or early death for either one of them, I’m sure you would agree this is not an encouraging place to start. 

We can look at this another way: Mike and Helen’s income needs of £40,000 per year are completely unsustainable. 

By looking at how their portfolios would have performed historically in different time periods we can see that in most cases they would need to target a level of income far below the £40,000 target. 

In a worst case scenario (shown in red below) they could actually only afford to withdraw £20,600 per year; a far cry from their desired target of £40,000. In some historic scenarios they could have afforded it, but ‘some’ isn’t good enough. 

By taking all ‘investment risk’ off the table and locking in the value of their portfolio at £500,000 and selling to cash we can see that in the worst case scenario (red line) their retirement pots fizzle out in as little as 6 years time. Or 9 years if we look at the median outcome, shown in blue below. 

This all makes for pretty depressing reading. What are Mike and Helen doing wrong and how can they improve their chances of living a comfortable retirement in line with their wishes? 

In next week’s blog I’ll explain how finding a balance of taking sensible risks in retirement can improve chances of success. Selling to cash might feel like a risk free strategy, but the terminator of wealth that is inflation doesn’t suddenly disappear in retirement. 

If anything it’s never been more important that you understand the risks it brings to your financial plan.  


Disclaimer – the above is intended as guidance and should not be relied upon as financial advice. Please seek regulated financial advice.

Benjamin Mitchell

Benjamin Mitchell

I’m a chartered financial planner that can help you plan for tomorrow and also live for today.

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