Unless you are very wealthy, you probably carry insurance for things like auto accidents, house fire, and medical claims – even if you’re fortunate enough to never have filed a claim. Most people value the security and protection that insurance provides in an uncertain world and consider the cost a necessary living expense.
Yet, when it comes to retirement planning a much different attitude seems to emerge. For example, when faced with a decision as to whether to take a fixed monthly pension guaranteed for life or a lump-sum cash payment to manage themselves, a majority opt for the lump-sum. According to Institutional Investor, when employees retire or change jobs, only about five percent select a guaranteed annuity option.
Similarly, reverse mortgages were founded largely on the notion of providing a lifetime income stream for “house rich-cash poor” seniors. Yet the most popular payment option under HUD’s Home Equity Conversion Mortgage (HECM) program isn’t the federally-guaranteed “tenure” (fixed for life) option, but rather the line of credit under which borrowers can draw funds according to any schedule they choose.
To be sure, there are good arguments against choosing fixed payments:
- inflation erodes fixed payments
- credit lines and lump sums provide greater flexibility to deal with the unexpected
- the cost of annuities and other fixed payment options is too high.
- if the credit line/lump-sum is left untouched, it will grow over time
But when it comes to the most important consideration of all – how long you expect to live – most of us aren’t very astute. According to the Society of Actuaries:
A large majority of both retirees and pre-retirees underestimate life expectancies. 61 percent of pre-retirees underestimate and 67 percent of retirees underestimate life spans. One consequence is that they believe they are accurately planning for life expectancy, but in fact are underestimating. While four in 10 think theyï¿½re estimating accurately, the reality is that over 50% of them are actually predicting theyï¿½ll live shorter than average lifespan, while only three in 10 believe they may live longer than average.
In , conducted in May 2003 by the Met Life Mature Market Institute, it was found that most people misunderstood life expectancy statistics and incorrectly thought inflation would be the greatest financial risk faced in retirement:
People are living a significant number of years past the typical retirement age of 65, thus increasing the time horizon over which their savings must last. Just 4 in 10 (37%) respondents believe that an individual who reaches age 65 has a 50% chance to live beyond life expectancy of age 85. They clearly do not understand the concept of life expectancy being an average, with half the population living beyond that age and half never reaching that age. Less than 2 in 10 (16%) of respondents believe there is a 25% chance that one or both members of a 65 year old couple can live to age 97. Lastly, 8 in 10 incorrectly answered that one or both of these members had a 10% chance or no chance to live to age 97. Only 14% of respondents knew that there are 82,000 centenarians in the U.S.– people living to age 100.
Not only do respondents underestimate longevity, they do not view it as a financial risk. That is, just 2 of 10 (23%) respondents understand that longevity is the greatest financial risk facing retirees. Inflation is a very significant financial risk, selected by 41% of respondents, but it is important to note that longevity risk is exacerbated by inflation risk.
Is flexibility truly that important? Is it worth the extra risk, work and anxiety, or would retirees be better served putting such matters on auto-pilot and focusing instead on managing expenses to stay within a budget? There are no right or wrong answers, but reading the comments from the Society of Actuaries and the Met Life study should give anyone weighing this decision reason to pause.