What is 'Life Expectancy'
Life expectancy in social science is the statistical age until which a person can be expected to live.
BREAKING DOWN 'Life Expectancy'
Life expectancy is a statistical measure used for a variety of purposes in the financial world. Life expectancy is generally recorded as a person's expected lifespan from birth (age 0) and can be represented as either an expected mean or as the true average age of individuals born in that year (which can only be calculated after all people born that year have passed away).
Human life expectancy has been rapidly increasing over the past two hundred years, particularly in developing countries. Today, the average life expectancy in the United States is 78.8 years. However, this is often a poor measure of an individual's life expectancy – if an individual makes it past infancy, for example, their life expectancy has already increased substantially. Similarly, more educated individuals tend to live longer.
Life Expectancy Calculation
Life expectancy is calculated by national statistical agencies in most countries and is used for many financial purposes, most importantly for insurance premiums. Insurance companies use life expectancy tables provided by the IRS to determine your premiums for life insurance. Insurance companies are trying to minimize their liability risk, and life expectancy is the primary factor in determining an individual's risk factor. Insurance companies consider age, lifestyle choices and family medical history when determining premium rates for individual life insurance policies.
Your life expectancy is also a major factor when arranging annuity payments with an insurance company. In an annuity contract, the insurance company agrees to pay you an agreed-upon amount of money for an established period of time or until your death. It's important to take life expectancy into account when negotiating annuity contracts: if you agree to a certain time-period for the insurance payouts, it is tantamount to an estimation of how long you expect yourself to survive. You can also elect to use a single-life annuity payment plan, in which annuity payments will cease after your death.
Life expectancy is also important for retirement planning. Retiring workers arrange their retirement plans based on a prediction of how long they expect themselves to live. While most individuals or couples employ a planner to assist them in their retirement planning, personal, rather than statistical, life expectancy is a major factor in the character of a retirement plan. When couples are planning for retirement (or for annuity payments) they often use a joint life expectancy, in which they take the life expectancy of their partner (who may become the beneficiary of a retirement fund or annuity plan) into account as well.
Most retirement plans, including the Traditional & Roth, SEP and SIMPLE IRA plans also use life expectancy to determine the implementation of required minimum distributions (RMD) for a plan participant. Most retirement plans require a participant to begin distributing at least the RMD by the time the reach the age of 70.5 (an age that itself has been determined using the IRS life expectancy tables). Some qualified plans may allow RMD distribution to begin at a later date.