Savers misjudge lifespans, as experts call for comms overhaul

Compared to a few decades ago, life expectancy has significantly increased in the UK.

The main risk is people withdraw too much, too soon from their retirement savings and face serious financial hardship in later years as a result

Tom Selby, AJ Bell

Recently published research by thinktank the Institute for Fiscal Studies has found that people from a range of ages and birth cohorts are underestimating their life expectancy.

Survival pessimism means savers are insufficiently prepared

Those in their 50s underestimate their chances of survival to age 75 by around 20 percentage points and to 85 by around 10 percentage points.

The IFS report, written by research economist David Sturrock and international research fellow Cormac O’Dea, said survival pessimism is a potential driver of the unpopularity of annuities.

It found around 65 per cent of individuals could perceive an annuity priced according to average survival chances as offering an unfairly low income.

Twice as many pots are now moving into drawdown as annuities, according to the Financial Conduct Authority, whereas, before the pension freedoms, over 90 per cent of pots were used to buy annuities.

The IFS report notes that uncovering the drivers of decision-making in this area is important as individuals make decisions in the era of pension freedoms. Underestimating life expectancy could mean they are more at risk of being insufficiently prepared for retirement.

“The divergence between subjective and objective survival expectations due to survival pessimism may have important implications for behaviour and policy,” the report states. “Policymakers should continue to closely monitor developments in annuities markets and the adequacy of both savings and incomes through the course of retirement.”

Tom Selby, senior analyst at AJ Bell, said: “The main risk is people withdraw too much, too soon from their retirement savings and face serious financial hardship in later years as a result. This could in turn see more people falling back on the state, potentially increasing the strain on government coffers.”

While some savers underestimate how long they will live, certain cohorts expect that they will live longer than is likely. According to the report, individuals in their late 70s and 80s are, on average, “mildly optimistic” about surviving to ages 90, 95 and beyond.

The research highlighted that this optimism increases at older ages, and is larger for men than for women, among those born in the 1920s and 1930s.

The experience in Australia, which has a similar system to the UK, “suggests reckless conservatism – where people are unnecessarily frugal in retirement for fear of running out of money”, notes Selby. This mindset could be just as dangerous, he adds.

Poor annuity deals also part of the problem

Selby noted that, if individuals underestimate how long they are going to live, “it logically follows that they might also underestimate the value of longevity insurance provided by annuities”.

However, he said he would argue that insurers who failed to offer good annuity deals were also part of the problem in the UK, and that rock-bottom gilt yields have not helped in recent years either.

Hugh Nolan, director at consultancy Spence & Partners, is not surprised by the findings that people underestimate life expectancy. “We definitely see that happening in practice,” he said.

The report found that individuals' stated beliefs about their probability of survival are correlated with known risk factors, such as smoking or the age their parents died.

Nolan said when people base their life expectancy on the age their parents died, for example, this “obviously makes no allowance for the improvements in longevity we’ve seen over the last 20, 30, 40 years”.

Educate and engage

Nolan said better data and simple graphics illustrating how long people are likely to live on average might give savers an improved understanding of their longevity.

The industry should focus on “educating people... and the easiest way to do that is through benefit statements”, he said.

Selby said policymakers should be placing greater focus on boosting engagement, “particularly as more people build decent pension pots through auto-enrolment”.

He added that promoting the value of regulated advice is also crucial, and said providers' retirement communications with customers were "ripe for review".

Erik Pickett, an actuary at consultancy Hymans Robertson's Club Vita, agreed that there is a "need to make sure that savers are able to obtain the financial support they need as they get closer to retirement. Making the wrong decision to leave the labour market too early or to overspend their savings could lead to years of regret”.