Saturday, March 3, 2018

Developing a Sustainable Spending Plan (SSP) vs. Using a Systematic Withdrawal Plan (SWP)

We still see quite a bit of literature in the popular press encouraging retirees to use specific Systematic Withdrawal Plans (SWPs) to determine withdrawals from their accumulated savings.  For example, the recent article, “No Pension? You Can ‘Pensionize’ Your Savings” discusses the “Spend Safely in Retirement” strategy developed by Steve Vernon, Joe Tomlinson and Dr. Wade Pfau in collaboration with the Society of Actuaries.  The SWP advocated in their report is the IRS Required Minimum Distribution approach we discussed in our post of December 21, 2017.  In addition, we are aware that many researchers and financial advisors still advocate the use of SWPs, and some even confusingly refer to these “withdrawal plans” as “spending plans.”  Therefore, we will once again
  • attempt to draw the distinction between spending plans (and in particular Sustainable Spending Plans (SSPs)) and SWPs, and 
  • Indicate why we believe SSPs are superior to SWPs

SWPs provide a retiree with an algorithm for withdrawing funds from their investment portfolio.  Sometimes this is also referred to as “tapping” one’s savings.   Common examples are the 4% Rule and the IRS RMD approach.  SWPs can be very simple or very complicated (with floor and ceiling adjustments, etc.) but all involve systematic withdrawals from accumulated savings.  It is generally assumed that the amount withdrawn for the particular year under the SWP plus income from other sources (IFOS) for that year will be spent by the retiree (or couple). 

A SWP isn’t coordinated with the amount or timing of income the retiree (or retired couple) may have from other sources (IFOS).  Assuming a retiree’s IFOS is reasonably constant from year to year, it is possible that adding the SWP withdrawal to the IFOS for the year may be consistent with the individual’s spending goals.  However, even assuming that this is the case, the SWP only focuses on recurring spending needs and does not consider non-recurring spending needs the retiree may have, such as unexpected expenses, long-term care costs or specific bequest motives.  As noted in the Society of Actuaries’ recent report, Shocks and the Unexpected: An Important Factor in Retirement, “Successful provision for the unexpected is critical to success in financial management during retirement.”  So, any SWP will be deficient in this regard.


A Sustainable Spending Plan develops a spending budget that is consistent with the individual’s (or couple’s) spending goals.  Typically, these goals will include:

  • Maximizing current levels of spending without jeopardizing ability to meet future anticipated expense needs 
  • Not spending too much and not spending too little 
  • Avoiding year to year spending volatility 
  • Having spending flexibility 
  • Leaving approximately desired amounts to heirs at death
The reader will note that none of the above goals necessarily involves how much should be withdrawn from savings (or how systematic such withdrawals should be).  The focus of the SSP is on spending, not withdrawals from savings.  For example, if one member of the couple’s Social Security benefit is expected to commence at a later date than the other member, it may be very reasonable (and consistent with the couple’s spending goals) for the couple’s withdrawals from savings to be larger before the second commencement than after.  In fact, in situations where IFOS doesn’t commence at the same time or expenses are non-recurring in nature, an SSP will work much better than an SWP in meeting typical spending goals.

The Actuarial Approach advocated in this website will help you develop a SSP, not an SWP.  Under the Actuarial Approach:

  • All of your assets are considered, not just your accumulated savings 
  • All of your spending liabilities are considered, not just your recurring spending 
  • Since the amount withdrawn from savings is equal to the sustainable spending amount minus IFOS, it will automatically mitigate potential spending volatility associated with amount and timing differences that may be inherent in IFOS 
  • You can maximize current spending without jeopardizing your ability to meet expected future expenses.  For example, you can increase current real dollar spending by
o  treating travel expenses or home mortgage expense as a non-recurring expense, or
o  planning on future expenses that decrease in real dollars
  • Spending is flexible and is automatically adjusted, as a result of annual valuations, to be consistent with your goals (even if those goals change), and 
  • Periodic scenario testing will enable you to better plan for deviations from assumed future experience

Depending on personal situations and goals, SWPs may be OK for some individuals and couples, and may be just fine as a distribution option in a defined contribution plan or IRA, but generally you (or your financial advisor) can do better.  The Actuarial Approach will help you develop a much more robust spending budget (SSP) than can be obtained by simply adding an SWP amount to IFOS.  Will it take a little more work and number crunching?  Yes.  But, we believe it will be worth your while, and that is why we refer to our website as, “The spending budget website for intelligent retirees and pre-retirees (and their financial advisors) who aren't afraid to do a little number crunching to get the right answer.”

Wednesday, February 28, 2018

Save More for Retirement? Nah, I’ll Just Work Longer

This post is a follow-up to our post of December 11, 2017 titled, When Can I Afford to Retire and When Should I Commence my Social Security Benefits (which was a follow-up to our posts of November 14, 2016 and April 28, 2014 touting the clear financial benefits of working longer).  In that post we included an example and concluded that:

“John’s calculations [using our Actuarial Budget Calculators] will show that if he retires and defers commencement of his Social Security benefit, he can expect his real dollar spending budget to increase by about 1% for each year of deferral (or slightly less if John is not in “excellent” health), whereas it increases by about 8% for each year that he continues to work.  Therefore, while we agree that the deferral of Social Security commencement strategy is probably “better than a poke in the eye with a sharp stick”, your decision of when to stop working is generally going to be a more significant driver of the amount of your spending budget in retirement than your decision of when to commence your Social Security benefit.’

In their recent research paper, “The Power of Working Longer,” the authors reach the same conclusion, stating, “Roughly speaking, deferring retirement by one year allows for an 8 percent higher standard of living for a couple and the subsequent survivor.”  And while it is nice to have esteemed academic scholars support the same annuity-based pricing of spending liabilities that we recommend and confirm our calculations, we have some concerns about the authors’ assumptions and methodology, which cause them to conclude that working longer may be a more attractive option for individuals and couples than increasing their savings.  While we agree that working longer is a powerful tool for increasing an individual’s or couple’s spending budget in retirement, we think it is probably a financial planning mistake to believe that you don’t have to save for retirement because you will simply work longer and rely on increased Social Security benefits, especially if you are relatively highly paid. 

Authors’ Assumptions and Calculations for Stylized Household

The authors look at a “stylized household” which consists of a 36-year-old primary earner and his or her same age spouse.  It is not clear from the example whether the spouse has the same earnings or has no earnings.  The following assumptions are made by the authors:

  • Whatever wage is being received by the household (either approximately the economy-wide average wage index by the primary earner and nothing for the spouse or two times that amount assuming they are both paid the same amount), it is assumed to remain constant until the assumed retirement age of 66 
  • Contributions of 6% of annual wage are made to their respective 401(k) plans and these contributions receive a 50% match (assuming here that the spouse actually has earnings) for a total of 9% of wage annual contributions. 
  • The assumed rate of return on accumulated savings in the 401(k) plans is 0%.  This assumption is inconsistent with the assumptions used by the authors to convert accumulated savings to lifetime income and significantly inconsistent with the approximate 6% return assumption used in Social Security law to develop actuarially equivalent adjustment factors for early and deferred retirements. 
  • Social Security benefits for the husband and wife at age 66 are assumed to be 42% of their assumed to be constant wage at age 65.  Note that the authors state that this is an average benefit payable at Social Security’s full normal retirement age, but under current law, age 66 would not be the full normal retirement age for these individuals.  No Social Security spousal or survivor benefits are considered. 
  • Social Security law is assumed to remain unchanged in the future.  This assumption includes continuation of actuarial increases of 8% per annum for each year of deferred commencement (even though increases in wages and real investment returns are assumed to be nil, and no changes in program benefits in light of significant future expected deficits. 
  • Accumulated savings are converted to an annuity at assumed retirement using fairly conservative assumptions and also assuming payment in the form of a joint and survivor annuity with 100% to be paid to the last survivor (even though the effect of survivor benefits in Social Security is to pay in the form of a joint and survivor annuity with 66.67% paid to the surviving spouse.
Using these assumptions, the authors conclude that the 9% of pay rate of savings (6% plus the 3% match) for the next thirty years will generate only about 19.4% of total expected retirement income at expected retirement at age 66 with the remainder (80.6%) coming from Social Security. 

Comparison with Our Calculations

Somewhat surprising to us, given the assumptions made by the authors, the authors’ approximate 80%/20% distribution of expected real retirement income between Social Security and accumulated savings for this stylized couple is not terribly different from the distribution obtained by using the Actuarial Budget Calculator (Pre-Retired Couple) for a 36-year-old couple currently both earning $50,000 per year and contributing 9% of pay.  For our calculations, we assumed:

  • 3% future pay increases, 
  • Economic and longevity assumptions we recommend for determining the Actuarial Budget Benchmark, 
  • a 33 1/3% reduction in desired retirement income upon the first death within the couple. 
  • Social Security benefits from The Social Security Online Quick Estimator (with adjusted future pays to be consistent with our 3% pay increase assumption) of about 47% of final year’s pay (about $55,092 per annum in future dollars). 
  • Consistent with the author’s calculations, we assumed no other non-recurring expenses or other sources of income. 
  • We also ignored the present value of expected spousal benefits from Social Security upon the first death within the couple.

Using these assumptions, we developed projected total real first year retirement (age 66) spending of $74,957 of which $60,829 was expected to come from Social Security and $14,128 from accumulated savings.  Thus, our calculations produced a 77% Social Security/ 23% accumulated savings lifetime income split for the authors’ stylized couple. 

This total first year of retirement projected spending of $74,957 represented 62.07% of projected real dollar spending for the final year of working (age 65).  Since it is less than the 85% rate that we recommend as a benchmark target, and further, since no reserves are contemplated for long-term care, unexpected expenses, rainy-day reserves, etc., we would encourage this stylized couple to consider alternatives such as increasing savings, continuing to work, taking on part-time employment, investing more aggressively, cutting back current expenses and/or not committing to funding education costs, tapping home equity, finding a rich person who will leave them an inheritance, etc.

Should You Give Up on Increasing Your Savings?

If you haven’t saved enough to date, we don’t think you should give up in your efforts to save for retirement and assume that you will just keep working and rely on Social Security.  Here are some reasons why we believe you should increase your savings if our ABC tells you that you are falling behind:

  • One very nice aspect of increasing your savings, from our point of view, is that it lowers your current spending budget and gives you a smaller spending target to replace in retirement.  If you are saving 25% of your pay and you spend 15% of your pay on work-related expenses, your replacement spending target in retirement is only going to be 64% of your pay (.75 X .85).  By comparison, if you don’t save, your replacement target will be 85% of your pay. 
  • The years just prior to your desired retirement will, in many cases, be your best opportunity to save.  You may be eligible to make “catch-up” contributions and expenses such as education costs may be reduced, 
  • Given Social Security’s financial condition, there is a non-zero probability that Social Security benefits will be reduced in the future.  These reductions may take many forms, including the possibility that Social Security’s actuarial increase factors for delayed commencement will be reduced to be more consistent with today’s low interest rates.  We call this “Social Security Reduction Risk” 
  • You (or your spouse) may not be able (or want) to continue to work at a job that will pay you the same level of earnings (or more) as you age.   Poor health, the need to take care of a family member, corporate downsizing initiatives/mergers, etc. may reduce employment opportunities.  We call this “Continued Employment Risk” 
  • If you are highly compensated, Social Security represents a smaller percentage of your overall total retirement income, so you need to save more, all things being equal. 


Working longer is a great solution to solving the problem of not having enough income in retirement, if you can make it work.  As the old saying goes, “Nice work if you can get it” (pun intended).  Therefore, unless you:

  • really love your job, 
  • you are quite happy with the idea of working until age 70 or longer, 
  • you believe your boss thinks you are absolutely irreplaceable and/or there is almost no chance you (or your spouse) will lose your jobs (e.g., you are a tenured college professor),
we strongly encourage you to use our calculators annually to help you develop a financial plan that considers and, if possible, reduces your Continued Employment and Social Security Reduction risks.    Sorry folks, but for many individuals, this will require increased savings.

Wednesday, February 21, 2018

Investing and Spending in Retirement is Risky Business

In our February 4, 2018 post, we cautioned our readers to be skeptical of investment or spending strategies that appeared to support higher levels of current spending than those developed under the Actuarial Budget Benchmark (ABB) with little or no perceived increase in risk that future spending would need to be reduced.  Subsequent to writing that post, we came across an excellent article on this subject that we would like to bring to your attention in this post.  The article is “What Investment Risk Is, Illustrated” by Barton Waring and Laurence B. Siegel .  Like most scholarly articles, this one involves making somewhat of an investment in time and effort to wade through, but we believe the effort and expenditure of time is worth it. 

Not surprisingly, what we really liked about this article was that the author’s conclusions are very consistent with the Actuarial Approach and the Actuarial Budget Benchmark advocated in this website.  And while there are minor differences in our recommended approaches, we both advocate:

  • Low investment-risk pricing of future spending liabilities, and
  • Developing a spending plan by periodically solving for the present value of future spending that equals the market value of assets

The authors conclude that, “Maintaining the value identity allows rules like the ARVA to maximize sensible spending at every point in time, but it means that the spend itself will have volatility.”  The “value identity” to which the authors refer is the requirement that “the present value of planned future spending must equal the present (current market) value of the assets.”  The value identity concept is equivalent to our Actuarial Balance Equation, and ARVA is the “annually recalculated virtual annuity” which is similar in concept to our Actuarial Budget Benchmark (ABB) (and initially discussed in our post of March 22, 2015).

Like us, the authors take on the 4% Rule and conclude, “the faults of the 4% rule as a spending rule always add risk relative to a multi-period CAPM [Capital Asset Pricing Model] inspired ARVA rule.” They write, “Why does the 4% rule perform so poorly? The present value of the planned future 4% spending plan at no time bears any relation to the value of the portfolio, grossly violating the equality of the present value of future spending and the asset value — implying both a greater (unintended!) bequest plan than would have been desired if had been known, as well as a tolerance for a significant possibility of spending ruin.”

The most important take-away from the author’s article, in our opinion, is that if you invest in risky assets in the hope you will achieve higher returns, you will be assuming additional risk.  And this is true whether you use the 4% Rule, the ARVA or the Actuarial Budget Benchmark to determine your spending.  In the author’s words, “Here’s the bottom line: If you take more strategic asset allocation policy risk, you might do much better either in single-period asset-only space, or in multi-period spending space. And on average, you can fairly expect to do better. But the thing is, that you might do a lot worse! You pays your money and you takes your chances. If you don’t like the risk of doing worse, reduce the risk by adopting a more conservative strategic asset allocation policy.”

Since most of us do invest in risky assets in the hope we will achieve higher returns, we encourage you to model the impact on your actuarially determined spending budget of significant deviations in investment returns by using our 5-year projection tab.   As discussed in our post of February 4, we also encourage you to consider establishing a Rainy-Day Fund to mitigate potential spending budget fluctuations.