Portfolio Ideas. Take care of ‘longevity risk’

The Aegon Retirement Readiness Survey 2016 states that Indians expect to live for an average of 22 years into retirement. The survey also opines that individuals could possibly live longer.

If you are expecting to retire in the near future, this may be a cause for concern! What if you live longer on your post-retirement lifestyle ?

The risk that you will outlive your investments is called longevity risk. You may have assumed life expectancy of 75 and accordingly accumulated wealth in your retirement portfolio during your working life. But if you live till 80 or beyond, you may not have enough money to sustain your lifestyle .

In addition, because you live longer, your portfolio may experience higher-than-expected inflation. When you created your retirement portfolio, you may have assumed an inflation of, say, 4 per cent during your retired life. What if actual inflation is higher? What about healthcare inflation, which is typically higher than general inflation?

To meet higher costs due to living longer, you may have to consume some portion of your investment capital to supplement your retirement income. That will leave less capital on which you will earn income for the following year and so on, which increases longevity risk.

Of course, on renewal, the interest rate on your monthly income bank deposits will increase when inflation increases. But this will only marginally ease the pressure on your living expenses; for interest rate does not typically increase in lockstep with price increases that affect your retired life. There is another issue. Because you do not know how long you will actually live, it is difficult to balance current consumption and savings. Should you live a comfortable lifestyle today not worrying about longevity risk? Or should you cut your current consumption because you expect to live longer?

We believe you should have a comfortable current lifestyle and also comfortably meet your living expenses in old age.

The product discussed here is meant to take care of your longevity risk relating to living expenses. To meet rising healthcare expenses if you live longer, you can monetise your mortgage-free house and avail reverse mortgage line of credit.

That said, you should urge insurance companies to offer old-age deferred annuity. At present, insurance companies offer immediate annuity with return of purchase price; you pay lumpsum money today and, in return, receive a fixed monthly sum starting next month till you live. But immediate annuity can drain your retirement account because it is expensive.

A deferred annuity is one where you pay lumpsum money today without return of purchase price. In return, you will receive a fixed sum every month, but only if you live past 75. And the monthly cash flow you will receive in old age will be decided today.

The advantage is that the purchase price of this annuity will be substantially lower than immediate annuity. So, you will have enough money to enjoy your preferred lifestyle till you reach your life expectancy of 75.

In addition, we urge you to motivate the insurance company to create an inflation basket containing typical costs relating to post-retirement living. This way, the inflation basket will move up as the price levels of these individual expenses increase.

And if insurance companies offer inflation-indexed deferred annuity, your longevity risk will be substantially moderated. So, you will suffer less financial anxiety of living longer.

The writer is founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in