"Longevity Risk," and "Financial Market Risk" Are Key Risks to Retirement Income

The study showed that there are two key risks that could cause depletion of retirement saving before retirees have fulfilled retirement objectives.   These are:

• Longevity Risk: the risk that a retiree, or spouse or partner, will outlive their retirement assets and
• Financial Market Risk: the risk that unexpected, sustained market declines will damage a retiree’s ability to produce the income required to meet his or her retirement needs in his investment portfolio.

The study, conducted by Ibbotson Associates, Inc., analyzed risk factors faced by all current and future retirees and applied them to typical retirement scenarios in order to determine which are most threatening to savings.   The study used Monte Carlo simulations, with variations on inflation, interest rates, and market returns, to produce a range of possibilities in investment outcomes.

Longevity Risk

Traditionally, when planning for retirement, 85 years has been used as the assumed life expectancy.   However, that age is no longer a reliable figure, since for those individuals who live to age 65, more than half, 53%, of single females and 41% of single males will still be alive at age 85.   For married couples, 72% will have at least one spouse alive at age 85.   Therefore, if these retirees had based retirement savings around a life expectancy of 85, other than pensions and Social Security income, their retirement resources would be extinguished, showing the effects of the Longevity Risk. 

Financial Market Risk

Another mistake often made in retirement planning is the assumption that market variations will balance out over time to provide retirement savings with a consistent rate of return.   However, this is not always so, capital market fluctuation can result in the reduction and/or depletion of the value of one’s retirement assets, especially if retirees are withdrawing from accounts during a pro longed market downturn.  Such increased fluctuations, combined with constant withdrawals can leave retirees without retirement income far sooner than expected.  

In order to reduce the effects of these risks, the survey recommended the retirees, both current and future, focus on strategies that will guarantee a set income, so there is a decreased risk from a volatile market.   Additionally, the study suggested diversifying investments, focusing on those which will provide payouts over a longer lifespan.