Life Expectancy: It's More Than Just A Number

What Is Life Expectancy?

Life expectancy is a statistical estimate of the average number of years a person is expected to live , based on actuarial data. There are many uses for life expectancy in the financial industry, including for life insurance, pension planning, and U.S. Social Security benefits. In most countries, the calculations for actuarial ages are derived from a national statistical agency based on large amounts of data.

Understanding Life Expectancy

Life expectancy is the single most influential factor that insurance companies use to determine life insurance premiums. Using actuarial tables provided by sources such as the Internal Revenue Service, these companies use actuarial age as they try to minimize their liability risk.

There are several factors that affect your life expectancy (also known as your actuarial age). The two single most important considerations are when you were born and your gender. Additional factors that can influence your life expectancy include:

• Your race
• Personal health
• Family medical history
• Whether you smoke cigarettes or make other risky lifestyle choices

You can view the federal government's data on U.S. life expectancy on the National Center for Health Statistics website and in the Social Security Administration's Actuarial Period Life Table.

It's important to note that life expectancy changes over time. That's because as you age, actuaries use complex formulas that factor out people who are younger than you but have already died. As you continue to age past mid-life, you outlive an increasing number of people who are younger than you, so your life expectancy actually increases. In other words, the older you get (past a certain age), the older you are likely to get.

Overall, human life expectancy has been rapidly increasing during the past two hundred years, particularly in developing countries. However, that rate did decline in the early 2020s during the COVID-19 pandemic. In 2021, the average life expectancy in the United States was 76.1 years.

Life Expectancy and Life Insurance

Life expectancy is the primary risk factor in determining whether someone buying life insurance will pass away, so their beneficiaries will make a death benefit claim. Insurance companies consider age, lifestyle choices, personal and family medical history, and several other factors when determining premium rates for individual life insurance policies.

There is a direct correlation between your life expectancy and how much you'll be charged for a life insurance policy. The younger you are when you purchase a life insurance policy, the longer you are likely to live. That means there is a lower risk to the life insurance company because you are less likely to die in the near term, which would require a payout of the full benefit of your policy before you have paid much into the policy.

Conversely, the longer you wait to purchase life insurance, the lower your life expectancy, which translates into a higher risk for the life insurance company. Companies compensate for that risk by charging a higher premium.

The principle of life expectancy suggests that you should purchase a life insurance policy for yourself and your spouse sooner rather than later. You will save on premium costs. If you buy a permanent policy that builds cash value, buying while younger also gives your policy more time to build savings.

Retirement and Annuity Planning

Life expectancy is critical for retirement planning. Many aging workers arrange their retirement plans' asset allocations based on a prediction of how long they expect to live. Personal, rather than statistical, life expectancy is a primary factor in creating a retirement plan.

When couples are planning for retirement, they often use a joint life expectancy. This approach takes the life expectancy of their partner (who may become the beneficiary of a retirement fund or pension plan) into account as well as their own. The IRS provides tables to help you calculate joint life expectancy.

Most retirement plans, including traditional, Roth, SEP, and SIMPLE IRA plans, also use life expectancy to determine the implementation of required minimum distributions
(RMDs) for the plan. Most retirement plans expect participants to begin taking at least the RMD by the time they reach the age of 72 (or age 73, starting in 2023). Retirement plans base distributions on IRS life expectancy tables. Some qualified plans may allow RMD distributions to begin at a later date.

Your life expectancy is also a significant factor when arranging annuity payments with an insurance company. In an annuity contract, the insurance company agrees to pay a certain amount of money for a fixed period or until the policyholder's death.

It's important to take life expectancy into account when negotiating annuity contracts. If you agree to receive payouts for a specific period, you are essentially estimating how long you expect to live. If you outlive this period, you stop receiving money from the annuity. You may also elect to use a single-life annuity payment plan in which annuity payments will continue as long as you're alive. If you're married, you could use a joint-life annuity that lasts as long as you or your spouse is alive.

The Bottom Line

Life expectancy indicates how much longer the average person of your age will live. Your estimated life expectancy plays an important role in a number of financial decisions, from how much money you should save for retirement to when you should buy insurance and how much you will pay for your coverage. Keep life expectancy in mind as you make these major financial decisions.