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Self Managed Super Fund (SMSF) Article
New Life Expectancy Table
By Tony Negline.
This article may be out of date.
21st July 2004
Allocated pensions are popular products for retirees because they are incredibly flexible.
Based on the many discussions I have with financial planners it would seem that many people who have bought allocated pensions are under a very big misunderstanding about how long that product will keep paying income.
Pension payments from an allocated pension will cease as soon as the account balance reaches zero.
How long an allocated pension lasts depends on three factors – how much the underlying investments earn, how much income is paid from the product each year and the costs incurred in running the product.
The basic point is that allocated pensions are not necessarily designed to last for as long as the investor lives – although with good investment experience they may well last as long as is necessary.
One difficult problem for investors planning to retire is that once retired they have a finite sum of money to generate their income needs but don’t know how long that money will last or how long they will need that income because they don’t know how long they will live.
About four weeks ago the Australian Government Actuary (AGA) released the 2000-2002 Australian Life Tables. These tables show a remarkable increase in the period of time we can all expect to live. Improvements in life expectancies for older Australians have been rapid over the last 25 years.
However the Government’s Actuary, Peter Martin, told Wealth that life expectancy data probably understates how long people can expect to live because the new tables assume that we will continue to live and die at the same rate as we were in the 2000 – 2002 period into the future. The government’s life expectancy tables assumes that there will be no future medical advances or lifestyle changes in the future.
The AGA has modelled what life expectancies would be if the previous increases in life expectancies which have occurred over the last 25 years continued at the same rate into the future. If this were to occur then a 65 year old male would have a life expectancy of 20.1 year and a 65 year old female of 23.7 years. This compares to official data of 17.7 years for males and 21.15 for females. (Increases of 14% and 12% respectively.)
The AGA predicts that if we continue to indefinitely experience these longer life expectancies at the same rate as we have done over the last 25 years then children born in 2050 can expect to live for about 100 years.
Out living your money is a major risk for nearly all retirees who have reasonably good health. Financial planners call this longevity risk.
Allocated pensions have less ability to cope with longevity risk than other retirement income stream products. A 65 year old male who started an allocated pension 10 years ago in 1994 was officially expected to live another 14.6 years (the figure in the 1985-87 Australian Life Tables) when the product started. The same life tables expected that if that 65 year old male survived until age 75 then that person could expect to live another 8.78 years (that is until 83.78 years).
That 75 year old man is now expected to live another 10.9 years (an increase of 24% on the 1985-87 life tables). If we assume that life expectancies increase as they have done in the past then we can add a few more years to this increased life expectancy.
Most allocated pension have not been structured to cope with these ever extending income payment periods.
The new Market Linked Income Streams (aka Growth Pensions) cope with this problem but retirees will still need to be careful with this product because even these products do not necessarily cater for continuing improvements in life expectancies.
A retiree living under the false illusion that their allocated pension will provide them with a lifelong retirement income probably needs to go back and see if the product has legs for another 5 years longer than they reasonably expect to live based on the current life tables. If that extra term works out OK, then see if the product survives for an extra 10 years based on current life expectancies.
If the product falls over then perhaps the level of income should be reduced. If a retirement income stream is paying too much income then that excess should be saved for a rainy day.
Retirees who run out of money can always turn to Centrelink for the aged pension or could consider extracting equity from their family home using a reverse mortgage.
As long as it is run prudently a lifetime pension potentially solves the problem of longevity risk built into other pension products. It is therefore strange that the Government has attempted to strike down this type of product in Self Managed Super Funds.
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