Monday, November 30, 2015

5 Ways to Increase Your Near-Term Retirement Spending Budget

In our post of August 31, 2014, Managing Your Spending in Retirement—it’s Not Rocket Science, we set forth a simple four-step process for managing spending:

Step 1:  Develop a reasonable spending budget

Step 2:  Determine your spending needs/living expenses for the upcoming year

Step 3:  Compare results of Steps 1 and 2 and make necessary adjustments to bring them into balance (i.e., reducing expenses, increasing the budget or some combination of these two actions), and

Step 4:  Rinse and repeat at least once a year.

For purposes of this post, we will assume that you have crunched your numbers, the result of Step 2 is larger than the result of Step 1 and you would prefer to increase your near-term spending budget rather than decrease your current living expenses.  We will look at some of your options.  Remember, however, that since you can either spend more in the near-term or you (or your heirs) can spend more later, you may not be all that comfortable increasing your risk of possible real dollar spending reductions as you get older under some of the more aggressive approaches below.  You can use the spending spreadsheets in this website to quantify the possible effects on your current spending budget of adopting these approaches.

  1. Find part-time work or other sources of income.  Perhaps the best way to increase your current spending budget is to go out and find additional sources of income.   This can involve a part-time job such as becoming an Uber driver or additional income from renting out one of your rooms through an organization like Airbnb.  If you are lucky, it may involve an inheritance from one of your relatives or friends.  It can also involve reverse mortgages or funds you expect to receive in the future from the sale of your home or from other assets. 
  2. Defer commencement of Social Security and/or purchase immediate or deferred annuities.  As discussed in previous posts, implementing these approaches (which involve mortality pooling credits) can enable you to increase your near-term spending budgets because some or all of the future expenses you previously needed plan for will be covered by these lifetime guarantees.
  3. Use more aggressive assumptions.  The recommended assumptions for determining a spending budget for 2015 under the Actuarial Approach were:  4.5% investment return, 2.5% inflation and an expected age at death of 95 (or life expectancy if greater).   The rationale for selecting these assumptions was discussed in more detail in our post of February 14, 2015, but suffice to say that many investment advisers would find a 4.5% annual rate of investment return (2% real) to be relatively conservative for most investment portfolios.  Also, until you reach your late 80s, the recommended expected lifetime assumption is longer than life expectancy, which could also be perceived as a conservative assumption.  I stand by my recommended assumptions (for the reasons noted in the February 14 post), but if you are willing to increase your risk of future real dollar spending decreases, you can develop your budget by running the spreadsheets in this website with higher assumed real rates of investment return and/or lower expected payment periods.
  4. Use more aggressive assumptions only for non-essential expenses.  This is a variant of item 3  for individuals who aren’t comfortable taking the risk of being too aggressive for all expenses, particularly essential expenses, but are more comfortable assuming an increased risk of declining future real dollar non-essential expense budgets.  Some experts believe that such expenses generally decline with age.
  5. Increase your budget by X%.  This final option is equivalent to making a conscious decision that you are going to spend what you want as long as it is within x% of your calculated budget.  Clearly if you do this on a consistent basis, you are more likely to experience decreases in future real dollar spending budgets, but this may not be a significant issue for you.  

Of course it is also important to remember that in addition to increasing the risk of declining real dollar spending later in retirement as a result of too much spending early in retirement, spending budgets can also go up or down temporarily as a result of investment performance.  If you want to stress test your spending budget for variations in investment performance, you can model future experience with the 5-year projection tab in the “Excluding Social Security V 3.0” spreadsheet. 

Tuesday, November 24, 2015

Retirement Researcher Endorses Qualified Longevity Annuity Contracts

In his recent article in Advisors Perspectives, Why Advisors Should Use Deferred Income Annuities, Dr. Michael Finke touts the benefits of including Qualified Longevity Annuity Contracts (QLACs) in a retirement portfolio.  Dr. Finke is a Professor and Director, Retirement Planning and Living at Texas Tech University. 

I agree with the points made by Dr. Finke, as his article is very similar to my post on the pluses and minuses of QLACs on July 12, 2015.  Readers who want to dive deeper into QLACs can also revisit my posts of May 28, 2015, April 26, 2015, February 25, 2015, July 31, 2014 and July 26, 2014 for further discussion. 

As I have indicated many times in this blog, The Actuarial Approach is probably one of the only strategic withdrawal approaches that easily and properly coordinates withdrawals from investments with benefits payable from a QLAC. 

Year end is coming soon.  Next month I will be re-visiting my recommended assumptions for developing 2016 spending budgets. 

Let me take this opportunity to wish all my readers a happy and safe Thanksgiving.

Wednesday, November 18, 2015

Actuary Discovers Chinks in Monte Carlo Modeling Armor

In his recent article in Advisor Perspectives, fellow actuary Joe Tomlinson raises serious credibility concerns about Monte Carlo simulations that use historical data to calculate the expected equity premium for stocks when such simulations are used to determine how much wealth to spend down during retirement.    Mr. Tomlinson points out that out limited statistical evidence regarding equity premiums produces levels of uncertainty that are unacceptable to most clients. 

As I have indicated in prior posts (see for example my posts of July 15 of last year and January 24th and 25th of this year), I am not a buyer of the supposed superiority of Monte Carlo modeling as a tool for developing reasonable spending budgets for retirees.  These Monte Carlo models are also frequently used to develop static withdrawal strategies (see my last post for discussion of the superiority of dynamic over static approaches).  Mr. Tomlinson article confirms some of my major concerns about using Monte Carlo simulations and static approaches.

While the simple spreadsheets provided in this website can accommodate higher equity premium investment return assumptions, I recommend (at least for determining essential expense budgets) that retirees use an investment return assumption that is approximately equivalent to interest rates baked into single premium immediate life annuities at the time of determination.  For example, an immediate monthly life annuity of $582 ( yesterday from Income for a 65-year old male with a life expectancy of 274 months under the Society of Actuaries’ 2012 Individual Annuitant Mortality Table with 1% mortality projection translates into approximately a 4.5% annual interest rate.  As I have previously indicated, including riskier assets in your portfolio (such as equities) can increase your expected rate of return, but it will also generally increase variability and therefore may not increase your annual spending budget over the long-run. 

The Actuarial Approach is a dynamic approach that involves periodic (usually annually) remeasurement of the retiree’s assets and liabilities and possible periodic adjustments to the spending budget, not a one-and-done static approach developed using Monte Carlo modelling.  I caution you to question the data used in Monte Carlo simulations producing a spending budget for you that significantly differs from the budget you (or your financial advisor) develop using the Actuarial Approach.  

Budget Pun of the Day (My first and probably my last one):  You’ll feel Stuck with your debt if you don’t properly Budge it.