Longevity risk is the risk of outliving our money in retirement. Take the case of an individual who retires at age 55 and expects to live until 85. At age 55, he has a corpus worth 30 times his annual expenses. If his real return (post-tax portfolio return – inflation rate) post-retirement is zero, his retirement corpus will last for exactly 30 years. Now, let’s say the individual lives until 90 instead of 85. The individual’s retirement corpus would have been consumed fully at age 85. This means that the individual would run out of money 5 years before they die. This is known as longevity risk.
About the author: Akshay holds an MBA in Finance from Great Eastern Management School, Bangalore. His website is akshaynayakria.com. His articles on personal finance and investing can be accessed here: akshaynayakria.com/blog. Akshay is a member of Fee-only India, an informal association of flat fee-only financial advisors. Launched in Sep 2017, it helps connect investors with SEBI-registered investment advisors without conflict of interest. Dr M Pattabiraman is a founder-patron of fee-only India.
Sources of Longevity Risk
Longevity risk has several sources. Today, the average retirement age has reduced from 60 to 55, maybe even 50. This means that the post-retirement period would be that much longer. India has no government-guaranteed system like Social Security to provide for retirement. We also cannot blindly expect our children to take care of us during our retirement in today’s times.
In today’s world, job security is no longer a given. The COVID-19 pandemic and global economic uncertainty have been significant sources of job disruption. Most jobs today are also susceptible to disruption owing to technology. Being forced into retirement earlier than expected is hence a real possibility. We may therefore be dependent on our portfolios for a lot longer. This ultimately increases longevity risk. Our financial plans must therefore have a clear plan to manage these sources of longevity risk.
Estimating Life Expectancy Realistically
Managing longevity risk begins with estimating our life expectancy. Most of us work with low estimates for life expectancy. But according to research data from the United Nations, India’s average life expectancy in 2023 is 70.42 years. This is up from 70.19 years in 2022 and 69.96 years in 2021.
There is a clear, steady rising trend in India’s life expectancy. Also, the figure of 70.42 years is an average. We must remember that many of India’s population live in villages and towns. They are likely to lack access to good quality healthcare. Child mortality in these regions may also be high. These factors are likely to bring the average life expectancy figure down. Those of us who have access to a reasonable standard of healthcare can expect to live until the age of 85 or even more. It would therefore be best to assume a life expectancy of 90 for retirement planning.
Generating Adequate Inflation-Protected Income In Retirement
It is vitally important to provide adequate inflation-protected income after retirement. Pension schemes can create an income floor post-retirement. They can therefore form a considerable part of the debt portion of the corpus. The amount received as a pension should ideally equal annual expenses in the first year of retirement. Other options for the debt portion include PPF, a bond or FD ladder, liquid funds and other debt mutual funds.
Equity Allocation Post Retirement
A portfolio must have an optimal allocation to equity post-retirement. It must not be too low to facilitate sufficient portfolio growth over the post-retirement period. It must also not be too high. Otherwise, a sequence of poor returns may compromise the longevity of the retirement corpus. The equity allocation in a retirement portfolio must be a function of a few factors.
The first among these is the degree of dependence on the portfolio post-retirement. The individual’s net worth at retirement also significantly impacts the equity allocation post-retirement. The length of the post-retirement period must also be taken into consideration.
In most cases, the individual would be wholly or heavily dependent on their portfolios post-retirement. Therefore, the room to take on risk in the retirement portfolio would be quite less. As a result, no more than 30% of the retirement corpus should be allocated to equity post-retirement.
There may be a few cases where a higher equity allocation may be warranted. One such situation could be where the retiree has a high net worth multiple times the required retirement corpus. The disproportionately high net worth may mean that the individual would be able to take more risk in the portfolio post-retirement. They can therefore afford to maintain a retirement portfolio with a higher equity allocation.
Another situation could be where the individual has enough to retire early, say in their early to mid-40s. The post-retirement period would be around 40-45 years in such cases. This would be slightly longer than the post-retirement period in the case of normal retirement at the age of, say, 55 onwards.
Therefore, the equity allocation post-retirement may need to be slightly higher during the initial 10 to 15 years post-retirement. This would facilitate portfolio growth over the more extended post-retirement period. In later years, the equity allocation may be gradually reduced as required.
Strategies For Portfolio Management In Retirement
Retirement Bucket Strategy
The Retirement Bucket Strategy is an ideal strategy for managing a corpus post-retirement. It segregates a retirement corpus into various buckets. Each bucket would contain money for different phases of post-retirement life. The money required for the initial years post-retirement can be put into debt. The money required for later years can be in a mix of debt and equity. The money required for the last few retirement years can be put entirely into equity. This would help the corpus grow and last longer post-retirement. Adopting the retirement bucket strategy requires managing the money in various buckets post-retirement. Money has to be shifted between various buckets based on market conditions and the individual’s needs.
Annuity Laddering Strategy
Those who wish to avoid active management of the corpus post-retirement may opt for an annuity laddering strategy. The strategy involves buying an annuity at various points in retirement. The annuity rates would increase with the age at which the annuity is purchased. The income floor would therefore become higher as the individual progresses through retirement. Take LIC Jeevan Akshay VII, for instance. The annuity rates for policies purchased at various ages starting from 55 are in the table below. The rates given below are for immediate annuities purchased for life.
| Age At Purchase | Annuity Rate |
| 55 | 7.65% |
| 60 | 8.33% |
| 65 | 9.25% |
| 70 | 10.70% |
| 75 | 13.23% |
| 80 | 17.23% |
So the annuity rates offered increase with the age of the individual. Assuming a retirement age of 55 with a 40-year post-retirement period, annuities can be purchased once every ten years. It would allow the creation of multiple pension streams that increase progressively through retirement. This would provide for our spending needs on an inflation-adjusted basis post-retirement.
It would reduce dependence on appreciation and income from market-linked assets. There are a couple of significant drawbacks inherent to the annuity laddering strategy. The initial retirement corpus required would be much higher than the bucket strategy. Also, annuity income received is taxable at slab rates applicable to the individual.
Withdrawal Rates And Their Relevance
The rate at which an individual withdraws from their portfolio yearly is an essential determinant of portfolio longevity. Withdrawal rates are usually defined as a fixed percentage of the retirement corpus. Theoretically, a 4% withdrawal rate has been prescribed as a safe withdrawal rate. This rate has been prescribed based on research conducted in America in the 1990s. The research was based on a 50:50 asset allocation between stocks and bonds. It assumes a retirement age of 60. Life expectancy post-retirement is assumed to be 30 years.
But, India’s average retirement age is becoming increasingly closer to 55. Therefore, a corpus lasting 30 years post-retirement may not always be adequate to retire completely. Asset allocations of retiree portfolios may vary from the 50:50 allocation between stocks and bonds assumed by the research study. Also, inflation in America has historically been a lot lower than in India.
Therefore a 4% withdrawal rate is not realistic in the Indian context. Adherence to such rates implies that we withdraw a fixed percentage of our portfolios in our first year of retirement. From there, the annual withdrawal would equal the initial withdrawal rate plus inflation. But in reality, our spending needs may change from year to year.
This points towards the fact that the concept of a safe withdrawal rate is arbitrary. India has a limited capital market history compared to most other countries. Until recently, Indians have primarily avoided taking on capital market risk when planning for retirement. There is no historical data regarding retiree behaviour when handling capital market risk. So there is no reliable way to define a safe withdrawal rate in the Indian context.
One possible way around this may be to define an upper limit to portfolio withdrawals each year post-retirement. This can be done as shown in the illustrative example below.
Available retirement corpus = Rs 5,00,00,000
Current age = 55
Life expectancy = 90
Years in retirement = 90 – 55 = 35
Withdrawal limit for the current year = 5,00,00,000/35 = Rs 14,28,571
This shows that portfolio withdrawals for the year must be capped within Rs 14,28,571. This calculation can be repeated year after year. It would define each year’s upper spending limit and maximum withdrawal amount.
Managing Sequence Risk Post Retirement
Portfolio returns post-retirement have a significant impact on portfolio longevity. A few consecutive years of poor or negative returns post-retirement can severely reduce the longevity of the retirement corpus. This is known as the sequence of returns risk. It is usually seen as the risk of retiring into a bear market.
Portfolio withdrawals for spending needs during a prolonged bear market are usually higher than expected. This severely depletes the retirement corpus. And when markets ultimately recover, there would be little to no money left in the corpus to benefit from the recovery. Therefore the retirement corpus would run out a lot earlier than expected. It is, therefore, essential to provide for this risk.
One way to manage sequence risk would be to keep portfolio withdrawals to a minimum post-retirement. That way, a poor sequence of returns would not affect the individual too severely. But most individuals depend primarily or entirely on their portfolios for their spending needs post-retirement. Therefore, keeping post-retirement withdrawals low may not be viable in most cases.
The most practical way to manage sequence risk is to progressively reduce the retirement portfolio’s equity allocation throughout the accumulation phase. Over the last 15 years of the accumulation phase, the equity allocation can be reduced gradually stepwise. The reduction can be done at 3 to 5-year intervals. Post-retirement, a withdrawal limit can then be defined for each year in retirement. It must be defined based on the retiree’s risk profile; spending needs for that particular year, and prevailing market conditions. This will ensure the corpus is adequate at the time of retirement.
There are multiple ways to manage sequence risk post-retirement. Those employing the bucket strategy can have 15 years’ worth of inflation-adjusted expenses in a very low-risk income bucket. It can contain products such as annuities, FD or bond ladders, money market mutual funds, dividends from listed stocks, etc. This would
significantly reduce sequence risk post-retirement.
Those opting for the annuity laddering strategy can purchase a fresh annuity for every decade in retirement. Each annuity can be purchased for an amount equal to the average inflation-adjusted annual expenses for each 10-year period. This would reduce sequence risk while allowing the retiree to benefit from increasing annuity interest rates in each passing decade.
Both strategies mentioned above can be combined with the income flooring strategy. A portion of the retirement corpus can be used to purchase an annuity at the start of the retirement period. It can be purchased for an amount equal to annual expenses in the first year of retirement. The rest of the corpus can be put into buckets. Withdrawals from the buckets can be made to meet inflation in expenses over the
forthcoming years.
Healthcare Expenses Post Retirement
Significant healthcare expenses are another major source of risk post-retirement. It may force us to dip into our retirement corpus. This would interrupt the effects of compounding on our retirement corpus. We must therefore have adequate health insurance coverage in place all through retirement. Our medical insurance would then cover any healthcare expenses we incur.
Purchasing health insurance in our later years may make us ineligible for coverage. The premium on any coverage we do receive may be exorbitant. It is hence vital to purchase health insurance coverage during our younger years. Our chances of enjoying coverage for a reasonable premium would be higher. From there, we can renew the coverage for as long as we live.
Conclusion
Building a retirement corpus requires us to choose the right products. We must ensure the adequacy of our retirement corpus when stepping into retirement. We must also ensure that the corpus lasts for long enough post-retirement. Longevity risk must therefore be a factor in our retirement plans from day one. It would allow us to build a big enough corpus that lasts long enough.
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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