Retirement in the age of longevity

Did you know that the person who is going to live to the age of 200 is said to have already been born? We live in unprecedented times where the pace of technological development in medical science has made it possible for people to live longer.

The progress of medical innovation can guarantee better odds of living longer and healthier lives. Current research shows that babies born in 2017 could live to 100 years. Assuming that you retire at the age of 60 and live to the age of 100, would you be able to afford to live comfortably based on your current accumulated retirement benefits?

MARKET TRENDS

Over the past decade, an increasing number of employers are registering Defined Contribution (DC) schemes as opposed to Defined Benefit (DB) schemes. The uncertainty in the cost of promising a defined benefit to employees in retirement has become a heavy burden to bear. Managing the cost of retirement has been shifted to members who now bear the investment and other risks associated with DC schemes.

A DC scheme requires the employer and the employee to remit a defined amount of contribution to the scheme each month. These contributions are credited to each member’s account which forms part of the scheme’s assets which are invested by the Trustees to generate income. Based on the income earned each year, the Trustees will declare interest which is credited to the member’s account.

Over the working life of the employee, their member account grows with new contributions each month and potentially with interest declared annually. When the member eventually retires, the size of the member account at retirement will be dependent on the level of contributions (the amount contributed and the length of the contribution period) and the net investment returns.

The amount of retirement income that a member gets is dependent on the annuity factors used by insurance companies to convert a lump sum member account into a monthly pension.

THE CHALLENGE

The retirement concept needs to change because the average 60-year-old can expect to live another 20 to 40 years. The present standard of retiring between the ages of 60 and 70 is not going to be sustainable when people live to the age of 100 or more. Members could spend more time in retirement than they did working.

The challenge at hand is how to create sustainable retirement income if members are expected to draw benefits for over 20 years.

WHAT CAN YOU DO?

To support a reasonable level of income in retirement, you simply need to contribute more to your member account.

Contributing 10 percent of your monthly salary? Increase it to 15 percent. Thanks to the power of compound interest, the additional contributions over a couple of years will have an impact on the size of your member account at retirement.

Got a raise? Channel the extra funds to your member account. Research has shown that people have a strong tendency to spend more if they have more, in what is called lifestyle inflation. A raise should be an opportunity to increase your contributions.

Struggling to contribute more? Automate. Good intentions are not enough because life gets busy and it is hard to maintain focus. Automatic deductions to your retirement benefit scheme would go a long way in ensuring greater retirement benefits.

Changing employment? Preserve your benefits. Most members are tempted to withdraw their benefits when they leave the service of their employers. Remember that the current regulations are more penal to members who access their benefits before retirement age.

Not ready to retire yet? Delay your retirement. With the consent of your employer, you can contribute more by working for a few more years.

Don’t know how much you will need? Aim for an income replacement ratio of at least 75 percent. An income replacement ratio is a measure of your post retirement income and your pre-retirement income. You can use this metric to calculate your ratio and determine how much more you need to contribute.

WHAT CAN TRUSTEES DO?

Remember that investment income has a significant impact on the size of each member’s retirement account. Trustees can consider venturing into non-traditional asset classes such as infrastructure, private equity, real estate investment trusts, property and derivatives to maximise investment returns that support higher retirement benefits. These classes provide high risk high return portfolios, increased long term returns due to diversification, less correlation to other asset classes such as equities and inflation hedging therefore improving investment returns.

WHAT SHOULD ANNUITY PROVIDERS DO?

What happens when investment returns fall short of expectations and people are living longer than expected? Annuity providers need to formulate strategies for managing increased longevity due to the financial implications of increased longevity. They could factor in future changes in mortality and life expectancy in determining annuity rates, consider investing in longevity bonds to hedge longevity risk, or reinsure longevity risk among other risk management policies.

WAKE-UP CALL

The possibility of increased lifespan is a call for action. As members look at their member accounts, they are realising that the retirement income may not be sustainable and hence the need to contribute more. Trustees need to make investment decisions that support higher retirement benefits. Finally, current annuity providers must be able to deal with the financial implications of increased longevity.

The writer is Actuarial analyst at Zamara.