Investing beyond 100: How rising life expectancy will change everything
A century is an important milestone worthy of celebration. We recently commemorated 100 years since the Battle of the Somme. Vogue made headlines in May for featuring a 100-year old model to celebrate the magazine’s centenary year. On your hundredth birthday, you can expect to receive a message from the Queen. But what happens when living 100 years is no longer unusual but normal? Ten years ago, one person was responsible for sending out the Queen’s cards. It now takes seven.
This is just one of the fascinating examples Lynda Gratton and Andrew Scott of London Business School use to illustrate an extraordinary transformation that is taking place across the world. “Just as globalisation and technology changed how people lived and worked,” they argue in their new book, The 100-Year Life, “over the coming years increasing life expectancy will do the same”.
A few statistics give a flavour of what is coming. Since 1840, every year has brought an increase in life expectancy of three months with extraordinary constancy. A child born in the West today has more than a 50 per cent chance of living to 105. Such forecasts could even be a massive underestimate depending on your assumptions about future innovation in medical science – according to some researchers, the first person who will live to 500 or even 1,000 has already been born.
At the heart of their book, Gratton and Scott challenge a notion that has gained ground, particularly among governments worrying about how to fund a massive explosion in pension spending – that increasing longevity is essentially a curse. Yes it could be, they argue, if the way we live our lives remains static, and pension arrangements, working practices, behaviour and cultural attitudes don’t change. But with foresight and planning, a longer life can be what it should be: a gift.
Saving amid uncertainty
Scott and Gratton’s book covers a vast range of subjects – from HR practices to relationships – but for most people the major concern will be money. Even without factoring in another 10 or 20 years of retirement, a great many pension pots will already be too small to ensure a comfortable and enjoyable retirement.
On the one hand, state provision of retirement income as it stands – a pay as you go model, where current taxes pay for pensions as they are distributed – probably isn’t sustainable without massive increases in the retirement age. It was designed for a time when a relatively large number of workers was funding a relatively small number of retirees for a relatively short period of time.
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But part of the problem with individuals taking more responsibility for their own saving is that it’s very hard to estimate your own life expectancy and people tend to be more pessimistic than they should be. A study by the IFS in 2012, for example, found that men aged 50 to 60 underestimate their life expectancy by an average of two years, and women by four. While only 9 per cent of men and 10 per cent of women aged 30 to 60 expect to live to at least 90, the official estimates are that 18 per cent and 29 per cent will do so respectively. Expectations of income are also overly-optimistic. Higher earners expect, on average, to be able to retire on about half their current salary using private pension assets, according to Investec Wealth & Investment. They’re more likely to get about a third.
This is more than understandable, says Steve Webb, former pensions minister and now director of policy at Royal London. “If you think about how long you’re going to live, you’ve got your parents to compare yourself against. Beyond that, it’s your grandparents. But that’s two generations ago.” This is one of the arguments for having strong default savings rates in the auto-enrolment private pension system, he says, a bit of benevolent paternalism that leaves the decision in the individual’s hands but guides them towards making a good one. “You need a system that broadly works for those who don’t engage, so that everyone ends up with a decent pension pot.”
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How much do you need?
Yet there’s no getting around the fact that people are seriously undersaving. “We’re probably all a bit deluded and kidding ourselves that we’re making adequate savings provision,” says Andy Cumming, head of advice at Close Brothers Asset Management.
In their book, Scott and Gratton give the example of a man (Jimmy) born in 1971 with a life expectancy of 85. Assuming he wants to retire at 65 in 2036 on a pension worth 50 per cent of his final salary, he would need to save 17.2 per cent of his income each year, an almost incredible amount given that, between 2000 and 2005, the group with the highest savings rate in the UK (50 to 55-year olds) only put away 5.5 per cent of their income each year. And Jimmy will also, of course, have to save more to pay off his mortgage and other major expenses, while not enjoying the advantages of a final salary pension scheme.
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This all sounds terribly miserable, but Scott and Gratton give reason for hope. The problem with the above modelling is that it assumes that, as we live longer, we simply work for the same period (or perhaps a little longer than our parents) and spend much more time in retirement. And as people live longer even than Jimmy above, required savings rates of 20 per cent, 22.5 per cent, 25 per cent and onwards are clearly overly-ambitious. The current three-stage model of life we have today – childhood, career, retirement – will be stretched to breaking point, with people either forced to save such huge amounts during their career that they enjoy dramatically lower living standards in their prime years or required to work much longer than they might feel capable of.
Far more likely, they say, is that this three-stage model will disappear entirely. Yes, we’ll probably all work much longer, but patterns of employment will change dramatically. Taking time out mid-life to reskill or rest will become the norm, with “retirement” effectively paced throughout your life whenever you want.
What are the implications for investment?
Webb is sceptical that such a shift will be realistic for most people. “I think it’s a bit naïve, a bit idealistic. The vast majority of people are not going to be able to take a couple of years out at 43. If you want to make both that and retirement work, and we already know people aren’t saving enough, the problem is you’re taking time out in your prime earning years and you’ll probably muck up any career progression.”
But even if it doesn’t work out in quite the way Scott and Grattan envisage, there could be implications for how we manage our money.
First, it’ll probably be sensible to take more risk for longer. As you get older, capital preservation and income become more important, so typically investors move out of equities into assets like bonds. “Probably having a higher proportion in equities for longer will be important given the length of the savings journey,” says Cumming, especially since more people will keep their pension invested beyond the state retirement age.
Second, flexibility will be prized. Your pension is currently locked up until you reach 55, and that age is likely to rise substantially over time. But the government is already innovating with the new Lifetime Isa, which will allow savers to withdraw money to put towards a house deposit. Enabling people to save in such a way that they can afford to take time out mid-career may be a focus of future changes to tax-incentivised savings products.
Third, with the government’s pension freedoms as a starting point, we’ll likely see a huge amount of innovation around how we take retirement income. “The annuity itself was never a bad product. It just had a bad reputation,” says Webb. He says a product that combines drawdown (where you take an income from your pension pot, with or without eating into the capital) and the annuity (a guaranteed income for life which subsumes your pension capital) could well emerge, enabling people both to ensure their money grows for long enough and that they aren’t fully exposed to the risk they may live much longer than expected.
In short, the world can adapt to much longer lives. There will be different ways of hedging the risk of things like care costs just as different individuals will take different approaches to saving for time away from work. Although the question of inter-generational fairness will no doubt rear its head over the coming years, however, people in their 20s and 30s, even those in their 40s and 50s, need to come to terms with the fact that the gift of longevity means they will not simply be able to emulate the lives of their parents.
This article appears in City A.M's Money magazine, out on 14 July.