Longevity risk: why average life expectancy is the wrong number to plan to

The most common mistake in retirement income planning is using average life expectancy as the planning horizon. It seems intuitive — if the average Australian man dies at around 81 and the average woman at around 85, why plan much further? The problem is what "average" actually means. By definition, half of all retirees live longer than the average. If your retirement plan runs out of money at the average life expectancy, there is roughly a fifty-fifty chance it will run out of money before you do.

What do the Australian life expectancy numbers actually mean for retirement planning?

According to the Australian Bureau of Statistics Australian Life Tables 2020-22 — the most recently published series — a man aged 65 today can expect to live approximately 20 more years, to around 85. A woman aged 65 can expect approximately 23 more years, to around 88. These are the averages. But the distribution around those averages is what actually matters for retirement planning.

A substantial proportion of 65-year-olds will live well into their nineties. For couples, the relevant figure is not either person's individual life expectancy — it is the life expectancy of the longer-lived partner. The probability that at least one member of a couple aged 65 today will still be alive at 90 is meaningfully high. The probability of reaching 95 is lower but not negligible. This is the longevity risk problem: you cannot know in advance which part of the distribution you occupy, but your retirement income plan must be durable enough to cover the longer scenarios.

Why is planning to average life expectancy not enough?

When a retiree plans to the average — structuring their drawdown to exhaust savings around age 85 for a man, or 88 for a woman — they are implicitly accepting a roughly fifty percent chance of running out of money. The asymmetry matters enormously here. If you plan conservatively to age 95 and live to 87, the consequence is that your estate receives the surplus. If you plan to age 85 and live to 94, the consequence is nine years of inadequate retirement income. The first outcome is benign; the second is not recoverable. This asymmetry argues strongly for planning to the upper end of the distribution rather than the middle.

There is an additional complication beyond the baseline uncertainty: life expectancy has been rising consistently for decades. A 65-year-old today is likely to face different mortality probabilities than a 65-year-old in 1990. Projections from Australian and international actuarial bodies consistently suggest that future longevity will exceed what current life tables show. Retirement plans built on today's averages may understate the longevity exposure of today's retirees over the full thirty-year horizon they face.

How does longevity risk work differently for couples?

For couples, the planning challenge is more complex than for singles. Each partner faces their own longevity distribution, and the household income plan must be durable enough to support whichever partner survives the other and for however long. A couple where both partners are 65 today has a substantially higher joint probability of at least one person reaching 90 than either partner individually. This means that couples should plan to the longer life — not to the average of the two, and not to either individual's individual median expectation — and should factor in the income consequences of one partner predeceasing the other.

Early bereavement does not reduce the surviving partner's longevity exposure. A woman whose husband dies at 75 may have twenty or more years ahead of her. The retirement income plan must support that possibility from the outset, not be constructed on the assumption that both partners will die around the same time at average age.

What tools can retirees use to manage longevity risk?

Several practical approaches address longevity risk, and they complement each other.

The most accessible is simply extending the planning horizon. Using age 90 or 95 as the planning boundary — rather than the average — changes the drawdown rate, the required capital, and the risk tolerance appropriate for the portfolio. A plan structured to last thirty years is more conservative than one structured to last twenty, but the asymmetry of the potential outcomes justifies that conservatism.

For self-funded retirees who need guaranteed income regardless of how long they live, lifetime annuities convert a lump sum into income payments that continue for life. They eliminate longevity risk for the converted portion by pooling it across all annuity holders. Deferred lifetime annuities are a variation specifically designed as longevity insurance: purchased at or around retirement, with payments commencing at a later age (say, 80 or 85) and continuing for life. A retiree might use a portion of their capital at 65 — say, $100,000 to $200,000 — to purchase a deferred annuity that kicks in at 85, then draw down their remaining account-based pension over the intervening years knowing a guaranteed income floor awaits. The 2019 regulatory reforms introduced more favourable assets test and income test treatment for qualifying lifetime income streams meeting prescribed criteria, which improved the means-test position for retirees near the Age Pension threshold who hold these products.

The Age Pension itself is the structural longevity insurance in the Australian retirement system. It pays indexed income for life, regardless of how long the recipient lives and regardless of what happens to financial markets. For retirees with modest asset bases, the Age Pension provides an income floor that cannot be outlived, and the means-tested system naturally increases entitlement as personal assets are drawn down. Self-funded retirees who do not qualify for any Age Pension face the most direct longevity exposure, since their personal assets must fund the entire retirement income without a floor. For this group, lifetime income products and conservative drawdown rates are most relevant.

Drawdown strategy also matters significantly for long retirements. Drawing down capital at a rate higher than investment returns can sustain accelerates balance depletion and compresses the time before income becomes inadequate. Conservative initial drawdown rates — understanding that returns can vary and markets experience downturns — tend to produce more sustainable outcomes over thirty-year horizons. Maintaining some equity exposure over the retirement period, rather than shifting entirely to cash and bonds at 65, helps support the growth needed to fund late-life expenditure.

What does managing longevity risk look like in practice?

For retirees considering their income plan, the most useful reframe is from "how long do I expect to live" to "what is my plan for the upper end of the distribution." Concretely: if you are a couple aged 65 today, your plan should address the possibility that one of you is still alive at 95. If you are a single retiree, plan to 90 or 95 rather than to the average. The surplus, if you don't live that long, goes to your estate — that is a far better outcome than running out of income at 87.

For self-funded retirees with substantial balances, the combination of a long planning horizon, conservative early drawdown, and a deferred lifetime annuity for late-life insurance can address the full longevity distribution without excessive conservatism in the early retirement years. For retirees approaching or already receiving the Age Pension, the structural income floor is already in place, and the longevity risk is correspondingly bounded.