What is longevity risk? And is your retirement portfolio built to handle it?
Longevity risk is the possibility of living so long after retirement that you go through your savings too soon. A couple of generations ago, longevity risk wasn’t much of an issue for Canadian retirees. Back in 1970, Canadians had an average lifespan of around 72, so their retirement savings only had to last for around seven years, on average.
Today, if you retire at 65, you can expect to live to be almost 86, and that life expectancy increases as you age. On average, then, many Canadian retirees will need their retirement income to last at least 21 years, which is considerably longer than seven.
And while longevity provides Canadian retirees with more time to enjoy their freedom after decades of working, it can also prompt them to ask themselves: how long will my money last in retirement? Longevity risk brings with it some challenges that you need to be aware of and prepare for.
Your retirement savings need to factor in health care costs
One of the common longevity risks is the greater likelihood of experiencing health issues, which can be costly. Your chances of developing dementia or Alzheimer’s increase with age, as do the chances of certain other illnesses. For example, over half of Canadian adults with diabetes are over 65, and in that same age group, 44% have high blood pressure, 30% have high cholesterol and 15% have heart disease.
These are some of the health costs you may have to pay for in retirement, depending on your circumstances and your province:
- Prescription drugs: if you’re over 65, your province may cover a percentage of certain prescription drug costs, if those drugs appear on their drug program list. Otherwise, you may have to pay the full amount.
- Dental treatment is usually only free for low-income retirees.
- Physiotherapy is rarely covered for people under 65 and often not covered for the over-65s.
- Medical equipment: some provinces may cover part of the costs if you’re over 65, while others will only contribute if you have a low income.
- Other health care expenses could include diabetes care, eyeglasses and dentures.
If you get a long-term illness or become disabled, you may need ongoing care, either at home or in a care home. As you can imagine, these costs can soon add up.
For example, in Ontario, If you stay at home, a personal support worker (who can help you to bathe, eat and dress) can cost between $28-35 per hour. A nurse, who can provide more medical care and advice, can cost between $45-60 per hour for a registered practical nurse and $55-80 per hour for a registered nurse.
If you decide to move into a long-term care home, the costs could vary greatly — between $800-6,000 per month — depending on your province, type of room and the amount of provincial government support you might qualify for.
But won’t you spend less in retirement?
A common retirement myth is that you’ll need much less money in retirement than when you were working. A general rule for retirement planning in the past was to have around 70% of your working income as retirement income. That figure is now closer to 80% and even 100% or more if you plan to travel and have a really active retirement.
The amount of retirement income you’ll need will really depend on a whole number of circumstances, including the kind of retirement you want, how much debt you have and your other financial obligations. For example, around 14% of retirees still have a mortgage and 42% are carrying some sort of debt. Having to manage debt payments can have a huge impact on how much income you need in retirement.
Many Canadians in or about to enter retirement are still providing their children with considerable financial support. This might be to help with their children’s education or with a down payment on a home. This could have a huge impact on your retirement savings. Retirees who recently became divorced could also find that their single income and splitting up the family home and belongings have left them with less retirement income.
Longevity risk, having to deal with potential health issues and making your savings stretch further can all make retirement a financially tricky proposition. Thankfully, careful planning can help you to fully enjoy your retirement, no matter how long you live.
A plan to have your retirement money outlast longevity risk
Being realistic about your life expectancy is key; on average, people underestimate their life expectancy by 4.7 years (2.5 years for men and 6.1 years for women). While it can be difficult to estimate exactly how long you’ll live, overestimating is much better than underestimating. And leaving a little more money to your family is better than running out of money too soon.
Your financial advisor should take longevity risk into account when putting together your financial plan, along with several aspects of your retirement plan that will address potential longevity risk, including:
- The best time to start drawing the Canada Pension Plan/Quebec Pension Plan and Old Age Security. Starting them as late as possible would mean that you’ll receive a higher guaranteed annual income, which is indexed to inflation, for the rest of your life.
- Being as tax efficient as possible. Maxing out your Registered Retirement Savings Plan and Tax-Free Savings Account are key goals. Also, your advisor will help plan your taxable retirement income so that it is as consistent as possible from year to year, thereby maintaining as low a tax bracket as possible. They will also help develop a retirement income splitting plan with your spouse or common-law partner, if feasible.
- Starting to save as early as possible, so you have the maximum number of years to benefit from compounding returns, can greatly increase your retirement savings. This way, longevity risk will be much less of an issue.
- Ensuring that your investments in retirement are still working for you. Given that retirement could last 20-plus years, keeping your savings purely in low-interest assets could see them effectively lose buying power. They should be in a mix of assets that can provide steady income, weather market volatility and provide adequate growth, while still taking into account your risk tolerance.
- The best age to retire for longevity. If your savings and other retirement income sources aren’t quite enough to ensure income for the rest of your life, you may need to postpone retirement by a few years. Alternatively, you could choose to reduce your lifestyle expenses to help bridge the income gap.
Start ensuring your retirement plan accounts for longevity risk
Your IG advisor has probably already accounted for longevity risk when putting together your financial plan. The IG Living Plan is a holistic financial plan that incorporates every aspect of your financial life; it’s a living plan that adapts to your circumstances and market changes. Talk to your IG advisor today about your retirement plan. If you don’t have an IG advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.