Individuals aren't saving enough for retirement due to a gap between survival expectations and official projections, a report from the Institute for Fiscal Studies (IFS) has warned.
The research, which is based on data from the English Longitudinal Study of Ageing and from the Office for National Statistics (ONS) 2014-based life tables for England and Wales, showed those in their 50s and 60s underestimate their chances of survival to age 75 by around 20 percentage points, and to 85 by around 5 to 10 percentage points.
Conversely, older people in their 70s and 80s are, on average, overly optimistic about the likelihood of living to age 90 and beyond.
This 'survival pessimism' may mean that "individuals save less during working life, and spend more in the earlier years of retirement, than they would, given their actual survival chances," the IFS stated.
The risk of this faster-than-optimal spending down of wealth, combined with optimism about survival at the very oldest ages, means that if individuals survive through their 80s and into their 90s, they may not only have relatively low levels of wealth, but may then be reluctant to spend this, with negative consequences for their living standards, the IFS added.
The research also concluded that survival pessimism is a potential driver of the unpopularity of annuities.
An annuity priced according to average survival chances should represent a fair deal (or better) for around half of individuals, the IFS said.
But given individuals own survival expectations, around two-thirds of individuals in their 60s would perceive an annuity priced according to average survival chances as offering a less than fair deal, it added.
Since the introduction of pension freedoms in 2015, the number of people buying an annuity has dropped from 90 per cent to 12 per cent, according to data from Hargreaves Lansdown.
The report also showed that a deferral of the state pension, a choice analogous to annuity purchase, is rarely taken up despite being offered at a favourable rate.
A spokesman for the IFS said: "While individuals are roughly twice as likely to defer the state pension if it represents a 'fair deal' given their survival expectations, the overall level of deferral is sufficiently low that we cannot make strong statements about this relationship."
According to Bob Scott, senior partner at pensions consultancy LCP, "the conventional wisdom is that half of savers to defined contribution pension schemes – specifically those who will live longer than average - should view annuities as a rip-off and the other half should view them as good value".
He said: "In fact, the proportion of those expecting to live beyond their statistical life expectancy is considerably less than 50 per cent, which means even more people will perceive annuities as poor value.
"This research highlights that saving via a DC pension to provide retirement income is inherently an inefficient process.
"Many people simply aren't able to build up an adequate sum by the time of their retirement, often due to affordability, tax restrictions or poor investment choices.
"That is one reason why many people favour collective provision over individual savings. With that, members have the opportunity to benefit from pooling of experience, notably around longevity issues, which can tend to lead to better outcomes on average."
For Tom Selby, senior analyst at AJ Bell, the combination of underestimating life expectancy, overestimating investment returns and overspending could create a perfect storm for future retirees.
He said: "Automatic enrolment should help ensure people don’t massively undersave for retirement.
"It is now critical policymakers focus attention on engaging savers approaching retirement to ensure they are better informed about their options and the potential risks."
maria.espadinha@ft.com
