Defined benefit pensions are becoming ever rarer, with the exception of the state pension. Most people are going to need to derive some of their retirement income from drawing down from accumulated savings. This means there are two questions we each need to ask ourselves. Firstly, how long will my savings last? Secondly, how long will I live? If we underestimate our lifespan, then we may withdraw too much too soon, and run out of money before we die. If we overestimate it, we may withdraw too little, and miss out on having more discretionary spending in our retirement.

At any given age, it’s possible to estimate our average life expectancy. There are numerous online calculators to help with this. But using average life expectancy as the target number of years for drawing down our savings is not good enough. Life expectancy is the average over a large group of people. This means that half the people will live longer than the average. The other half will live shorter. For the moment, let’s ignore other uncertainties. Even if we could guarantee to draw down our savings exactly over our average life expectancy, we would still have a 50% chance of running out of money.

## Inflate Our Life Expectancy?

To overcome this, some planning approaches suggest picking a more pessimistic life expectancy. For example we could add 10 years to our average life expectancy. This is clearly safer than just using the average life expectancy, but it’s arbitrary. How can we be sure that planning on this basis will be sound? The problem is that life expectancy is not the only uncertainty. Investment returns are also both uncertain and volatile.

### Example 1: Single Person

Let’s take an example. A 65 year old single man retires with a £500,000 retirement fund. He doesn’t mind if he leaves no legacy. Let’s assume for this example that his average life expectancy is 20 years. He decides to plan based on living another 30 years. In conjunction with a financial advisor, he devises a drawdown plan for withdrawing £20,000 in year one, and uplifting the amount by the rate of inflation in each subsequent year. Let’s say that his financial advisor calculates that this level of drawdown will last for 30 years with 90% probability, with a 10% probability of running out of money.

How reassured should the man be? Does this mean that his drawdown plan has only a 10% chance of failure? Unfortunately, the answer is no! The calculation has failed to take into account the small, but significant, possibility that the man will live longer than 30 years. The actual probability of failure will be significantly more than 10%.

That’s not quite the end of the story. The actual probability of the 65 year old man surviving a full 30 years is quite small. So it’s very likely that he’ll live a shorter lifespan, and so maybe he was under-spending!

### Example 2: Couple

For a couple, the risks are compounded! Suppose that the husband and the wife each have a 10% probability of surviving 30 years. Then the probability that at least one of them will survive 30 years is 19%, and the actual probability of failure will be significantly more than 19%.

## Recognise That Life Expectancy Is Uncertain

The truth is, it isn’t possible to plan to make one’s savings last exactly till the end of our lifetime. Planning for a fixed number of years is not the best way. Life expectancy is an uncertain variable in retirement planning calculations. It should be treated as such, just like the volatility of investment returns. If my financial advisor tells me that my plan has a 10% failure rate, then I want to know that he has taken the variability of life expectancy into account.

For this reason, our own retirement calculator treats life expectancy as variable, not fixed. It uses mortality tables published by the UK government.