Is it Too Early to Start Thinking About Reducing Your Discretionary Spending?

The S&P 500 closed just under 4,000 today and is down approximately 16% year to date. The default assumption for returns on risky investments in our Actuarial Financial Planner (AFP) workbooks is 6%, so to date, we are looking at actuarial losses in the neighborhood of 20% on Upside Portfolio assets invested in equities for 2022. Of course, the equity markets may bounce back tomorrow, next week or next month, and these losses may be completely eliminated by year end. 

Lump Sum Option vs. Life Annuity from a Pension Plan

As indicated in our post of February 18, 2015, we generally recommend that individuals elect to receive a lifetime income form of payment from a pension plan when offered a choice between a lump-sum and a life annuity. Yes, we have heard from readers who believe we are wrong, and they tell us that they have done quite well, thank you, investing their lump sum distribution in the current bull market. We received similar comments from individuals who disagreed with our recommendation relative to borrowing and investing proceeds in a low-interest rate environment in our post of February 18, 2015. What can we say? Sometimes people take risks and are rewarded for doing so.

Calm Your Financial Fears with the Actuarial Financial Planner (AFP)

Actuarial science offers proven approaches and processes for assessing and mitigating financial risks. The Actuarial Financial Planner (AFP) advocated in this website utilizes basic actuarial and financial economics principles to help retirees:

• Quantify household spending liabilities
• Develop a sustainable spending budget process
• Develop a liability-driven investment (LDI) process for allocating household assets between risky and non-risky investments, and
• Establish a strong foundation for retirement planning.

And while we can’t guarantee that you will never have to reduce your future spending budget in retirement if you use the AFP annually and fully fund your Floor Portfolio with non-risky assets, we believe that you will be able to sleep better at night knowing your essential spending in retirement is relatively safe. 

After some background discussion, we will discuss four ways the AFP can help you mitigate financial risks in retirement.

Planning For Non-Recurring Expenses in Retirement

As we have said many times in this blog, if you want a reasonable spending budget in retirement (or if you want a better idea of whether you can afford to retire) it is important to estimate your expected non-recurring expenses in retirement separately from your expected recurring expenses. For example, see our post of February, 7, 2019, “If You Aren’t Separately Budgeting for Non-Recurring Expenses, You Probably Don’t Have a Robust Retirement Spending Budget.” 

Actuarial Financial Planner Consistent with General Personal Retirement Planning Guidance Issued by the American Academy of Actuaries

As professional number-crunchers, actuaries generally use and develop models designed to produce useful information to help clients and others make financial decisions. These models typically consist of:

• Input (data and assumptions),
• Calculations that transform the inputs into outputs, and
• Results that translate outputs into useful financial information

The Actuarial Financial Planner available in this website is a simple model that we designed to help retirees and near retirees make better financial decisions. It is a deterministic model (with no random variable assumption inputs) much like the actuarial models generally used by actuaries to determine pension plan contribution and expense requirements or Social Security’s funded status. 

Discount Rate Assumptions Used to Price Life Annuities

Thanks to our friend, Will Selden, for asking what discount rates are currently being used by insurance companies to price life annuities in his March 28, 2022 blog post SWAG on Annuity Discount Rate. Based on his analysis, Will notes that current annuity pricing appears to be based on higher interest rate assumptions than in the past few years. This is not terribly surprising as interest rates in general have increased since the Federal Reserve signaled that it would raise the Federal Funds interest rate and would probably continue to do so into 2023. For example, the 10-year constant maturity Treasury rate has increased by almost 70 basis points during the month of March. All things being equal, higher assumed interest rates translate to higher monthly life annuity benefit amounts per dollar of premium. 

Thinking About Retiring Early?

The primary purpose of this website is to help the retirees and near retirees who happen to stumble across this blog site make better financial decisions. We attempt to do this by providing relatively simple tools (spreadsheets) and processes which utilize basic actuarial and financial economics principles. These tools and processes, which are available for free, can be used by DIYers or by financial advisors to quantify the effects of various options available to retired or near-retired households with respect to their spending and investing. The authors of this blog are retired actuaries. Neither of us receives any direct or indirect compensation from visits to this website or from any activity associated with this blog.

Planning on Temporary Higher Levels of Inflation

This is a follow-up to our post of January 30, 2022 on stress-testing your retirement plan for rising interest rates/inflation. In this post, we will provide you with a work-around for the Actuarial Financial Planner for Retirees (AFP) default inflation assumption if you believe that today’s increased rates of inflation relative to interest rates will be temporary and will revert back to “more normal rates” in the future. 

Will Kitces.com Guarantee the 4% Rule?

In this post, we will discuss a recent Kitces.com post defending the 4% Rule, and we will compare this widely-used rule of thumb with the Actuarial Financial Planner (AFP) approach for a hypothetical single retiree. We believe the example illustrates that many retirees can better meet their spending goals and better manage their investment risk by using the AFP approach rather than the 4% Rule.

Planning on Future Decreases in Discretionary Spending? OK With Us.

In this post we will revisit the planning implications of research that finds that household spending may decrease in real dollars as retired households age. This week we became aware of research in the U.K. that, like several other research reports we have discussed, shows that spending in retirement does decrease in real dollars, on average. Unlike other research, however, this research measured the sources of spending decreases in retirement and concluded:

• Much of the decline in consumption is explained by falls in spending on “non-essential items” such as recreation, eating out and holidays.
• Spending on essential items remains relatively flat during retirement, which means essential items account for an increasing proportion of the overall household budget. Indeed, by age 80+, over 50% of expenditure is on essential goods and services.
• There does not appear to be a post-retirement spending boom on leisure and holidays. In fact, from age 50 onwards, spending on most non-essential items begins a slow decline.

We believe the conclusions of this research are consistent with the thoughts we expressed on the planning implications of possible spending decreases in retirement in our post of December 11, 2021 where we said,