The new risk to our retirement savings

If you're a 65-year-old woman, on average you're expected to live until you're 89. But the variation is high - on average one in 10 women aged 65 will live past 100 years and one in 10 won't make it to 77.

If you're in the group that will live past 100 years, you need to find an additional $39,000 a year for more than a decade to fund yourself (based on the AFSA comfortable standard for singles aged around 85). So, how do you manage this "risk" of living a long life?

Professor Moshe Milevsky points out that when the probability of something happening is low, but the cost high, we normally buy insurance. Take a house fire - you probably don't have a spare $600,000 to cover the unlikely event that your house burns down. Instead you manage your risk in the form of home and contents insurance. But how do you manage the risk of outliving your average life expectancy? There are the obvious options: save more, spend less or hope that the age pension is a sufficient supplement. But what about insurance policies you can buy?Frankly, the options are pretty limited.

The first option is a standard annuity. Basically, you pay a lump sum up front and in exchange receive a periodic income stream for a set number of years or for life (even if you live longer than you expect). Annuities can prove tax effective (particularly through super) and they can help protect against inflation. So how do they work? Well, it depends on the specifics of the product and issuer, but generally speaking, if you're a 65-year-old woman, you might pay $100,000 and receive about $3500 a year (adjusted for inflation) for the rest of your life. Note, in an environment of declining rates, the income you receive for an annuity has gone down; not too long ago, you would have received closer to $4500 a year.

Then there is a deferred annuity. This is similar to a standard annuity, but the start date is deferred. If you're a 65-year-old woman and pay $100,000 upfront, but elect to defer the first payment until age 85, you might receive more than $23,000 a year. Clearly the 20 years (between ages 65 and 85) that a life company has to invest your $100,000 (while not making any payments to you), and the chance that the company may not have to pay you for long (or at all - if you don't make it to 85) results in a much higher annual payment. In theory, a deferred annuity makes retirement planning much simpler - you now have certainty (for a price) that your retirement savings need only last until you're 85. Challenger has led the charge for issuing annuity products in Australia in recent times.

The final option involves pooling your "longevity" risk with others - morbidly known as a "mortality credit". Basically, all participants in the pool contribute a lump sum and receive some income in exchange. The catch is when people in the pool start dying. The survivors receive their portion of income plus they split the income of the people who have died. So the longer you survive - the more you receive. There are a few obvious barriers - the initial psychological barrier (basically hoping you live and others die) and finding a wide pool of people to participate. This concept has been around for centuries and could provide a viable alternative to annuities in managing longevity risk - Mercer has developed a variation of this concept called LifetimePlus.

The uncertainty around how long you will live makes retirement planning complicated. And the levers to manage this risk are limited. The Financial System Inquiry acknowledged that "the retirement phase of superannuation is underdeveloped and does not meet the risk management needs of many retirees". But that assessment was almost three years ago and the product options remain scarce.

As a white collar, non-smoking female, I'm worried that I will live well past 100. And while I'm trying to tuck away as much as possible, it would be nice to know there is a well-developed range of products to manage the risk of living longer than I expect. After all, a long and happy life is what we are all seeking, right?

Annika Bradley is a financial services consultant and commentator who is passionate about financial literacy and adequate retirement incomes for Australians. The information in this article should not be considered financial advice. Readers should consider their own personal circumstances and seek professional advice before making any financial decisions.

This story The new risk to our retirement savings first appeared on The Sydney Morning Herald.