The silent retirement risk we all ignore - and how to manage it

The best laid retirement plans are designed to withstand inflation shocks, market crashes and health scares. But even some of the most carefully crafted strategies fail to take in one key risk: the risk you’ll live longer than you expect.

It is a fatal flaw of human psychology that we seem to consistently underestimate our lifespans.

In our new report, The longevity revolution: Preparing for a new reality, in partnership with the National Innovation Centre for Ageing (NICA), Fidelity found that around two in five people aged 50+ are underpreparing for retirement by 10 years or more when measured against the average life expectancy in their location. This shortfall leaves many at risk of running out of money later in life.

• Get our updates on markets, ISA funds, pension saving and much more

Our global study, which surveyed 11,800 people aged 50+, showed that most people are budgeting for 20-year retirements, when they may well need 30 years or more of funding.

In the UK, we found, people expect to live for another 19 years after retiring on average. We also expect our savings to last for 19 years after retiring.

However, a woman at current state pension age (66) is actually expected to live another 22 years, according to the Office for National Statistics (ONS).¹ She also has a one in four chance of living to 94 and one in 10 chance of living to 98. If her savings do last just 19 years, that means she has a high chance of outliving them by nine years and a one in 10 shot of living another 13 years after her retirement pot runs dry.

Underestimating our lifespan can seriously impact our ability to eke out our savings over a retirement.

The dangers of underestimating life expectancy

Let’s look at an example. Sarah is 50 years old and employed full-time on a £45,000 salary (the average for someone her age).² She has a pension pot worth around £100,000, which is also typical for someone her age.³

We assume Sarah puts 5% of her salary into her pension each month and her employer contributes 3% until she retires at age 65. She will then reach state pension age two years later at 67.

The cost of a ‘moderate retirement’ is estimated to be around £32,000 a year, according to trade body Pensions UK.⁴ If Sarah wanted to spend £32,000 a year in retirement, we calculate that she would likely deplete her savings and pensions by 2053 when she is 78 years old.⁵

Our research showed that UK adults expect to live for another 19 years after retirement - so Sarah might assume she only needs to cost her retirement to age 85.

Under this assumption, she could spend around £29,000 a year from now until age 85 and avoid running the pot dry - barring any significant market shocks or large, unexpected costs, like care home fees.⁶

However, average life expectancy for a woman of Sarah’s age is actually 87, with a one in four chance of reaching age 95 and a one in 10 chance of reaching 99.

So, by underestimating her lifespan, Sarah could be seriously overestimating how much she could spend without running out of money. The good news is that, once you do come to terms with the realities of life expectancy, there are ways to plan for it.

Reducing expenditure

The first option is to reduce your spending to ensure your money lasts longer.

Our modelling suggests that Sarah would need to bring down her yearly spending in retirement from £29,000 to around £26,000 from today (age 50) to ensure her savings and pensions, along with the state pension, could last her to age 100. As above, this assumes no other spending is required, she doesn’t need to pay for long-term care, and there are no major stock market tumbles over the 50-year period until she reaches 100.

Working for longer

Another option is to work for longer. This may be the last thing many people want to hear, but working for longer means you have more years to build up your pension, more years to benefit from investment growth and fewer years of having to draw down on your retirement pot.

What’s more, working longer does not have to mean doing a job you hate. You could retrain, set up your own business or find work that is more flexible.

In our study, 70% of pre-retirees globally expect to do some kind of work after retirement. The most common reason they gave for keeping working is because it keeps you mentally and/or physically active - highlighting the additional benefits of working in later life beyond financial planning.

If Sarah worked until age 68, rather than retiring at 65, we calculate that she could spend £29,000 per year and not run out of money before age 100.

While working longer can be beneficial, it’s not always feasible for everyone. Health, caregiving duties, or job availability can be limiting factors.

• Read: How to ensure your savings beat inflation in 3 charts

Insuring against longevity

Another option would be to use some or all your pension pot to buy a lifetime annuity. These guarantee to pay you a set income for life, no matter how long you live. This means the insurer is taking on the risk that you will live longer than expected, rather than yourself.

Annuities have been out of favour for a long time as rates on offer were low. However, recently annuity rates have been spiking - making them a much more attractive option for retirees.

By age 65, we estimate that Sarah would have amassed a pension pot worth £225,248.⁷ Based on her age and gender, if she wanted to take out an annuity, she would be able to use her pension to purchase a policy paying around £17,065 per year pre-tax.⁸

This is a fixed policy, where the amount paid each year does not go up with inflation, and it does not come with any guaranteed payouts if Sarah dies early. She should also receive a full state pension from age 67.

Income in retirement is a very complex area of financial planning. The government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

If you’re unsure of anything, it would be worth speaking to a qualified financial adviser. If you have over £100k invested (this includes your pension) our financial advisory service can help. The initial conversation with a Fidelity adviser is free and there’s no obligation, it’s simply a chat to see if financial advice might be right for you. 

For more information on the pros and cons of annuities, read our article here: The benefits of a blended approach to annuities and drawdown

Property as a second pension

Some retirees may be planning to use their property wealth to supplement their retirement income, either by releasing equity in their property or by downsizing. However, it’s important to remember that property is not always easy to sell and this strategy depends on finding suitable alternative accommodation to move into. What’s more, with equity release, compound interest can eat into the value of your estate.

The importance of having a plan

There is no right or wrong answer when it comes to making your money last: the important thing is to have a plan.

Our research showed that people who have done some level of financial planning feel much more prepared for all aspects of retirement, including the social, physical and emotional side.

Among all pre-retirees who had done some retirement planning:

• 83% felt physically and emotionally prepared for retirement
• 79% felt socially prepared
• 78% felt financially prepared

For those who had not done any planning, the preparedness figures dropped significantly:

• Only 65% felt ready physically prepared for retirement
• 68% felt emotionally prepared
• 65% felt socially prepared
• Just 55% felt financially prepared

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Eligibility to invest in a SIPP and tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.