Thursday, June 16, 2016

Commission Proposes Comprehensive Changes to Strengthen U.S. Retirement System

This month, the Bipartisan Policy Center’s Commission on Retirement Security and Personal Savings issued a report entitled, “Securing Our Financial Future:  Report of the Commission on Retirement Security and Personal Savings.”  This report includes many policy recommendations designed to strengthen the retirement system in the U.S., and with one exception that I will discuss below, I believe the recommendations are very well thought-out.  If you are interested in possible changes in Social Security and retirement related law in the U.S., I encourage you to read this report.  The report’s recommendations are organized into six major areas:

I. Improve Access to Workplace Retirement Savings Plans
II. Promote Personal Savings for Short-Term Needs and Preserve Retirement Savings for Older Age
III. Facilitate Lifetime-Income Options to Reduce the Risk of Outliving Savings
IV. Facilitate the Use of Home Equity for Retirement Consumption
V. Improve Financial Capability Among All Americans
VI. Strengthen Social Security’s Finances and Modernize the Program

By far the most controversial recommendations to strengthen our retirement system are the ones regarding Social Security.  According to the report, long-term solvency is achieved under their proposal by increasing system revenues by about 53% and by decreasing scheduled net benefits (there are some proposed increases) by 47%.   The Commission notes that their proposed package of changes would not only solve the 75-year actuarial deficit, but it would also result in “sustainable solvency” as that term is defined by the Social Security actuary. 

The only real bone I have to pick with the Commission’s conclusions with respect to Social Security’s long-term solvency is that these conclusions are valid only if the 2015 Trustees assumptions are exactly realized (or are more favorable) and not changed over the next 75 years.  For example, the Commission proudly announces that, “the commission’s package of recommendations would extend Social Security’s ability to pay benefits without abrupt reductions through the end of the 75-year projection period” and “if adopted, the commission’s recommendations would secure the program’s trust funds for 75 years and beyond…”  The commission neglects to point out that these statements are conditioned on the accuracy of the assumptions made for the 75-year period.  And since very few people can accurately predict the future (not even actuaries), it would seem imprudent to assume that assumptions made in 2015 will be accurate for 75 years or longer.  After all, even though the assumptions made in 1983 weren’t horribly inaccurate, they were still wrong to some degree, and we now find ourselves facing the very significant changes recommended by the Commission earlier than predicted in 1983.  No sound “actuarial” process involves making assumptions for 75 years without anticipating making periodic adjustments in future years.  The current approach just isn’t sustainable. 

As I said in my post of May 17, 2016, “There exists no process in current law to automatically adjust the System’s tax rates to maintain a balance between system assets and system liabilities.  Imbalances (in the form of deficits in the annually calculated 75-year actuarial balance) may occur as a result of the previously unrecognized deficits…, or because of changes in assumptions, experience losses or gains, or from other sources.  Unfortunately, the Commission does not address this problem in their recommendations, so instead of achieving their goal of providing predictable Social Security benefits that workers can plan on, workers relying on Social Security could once again in the near future find themselves in a position similar to Charlie Brown trying to kick a football being held by Lucy van Pelt.

As I have said in previous posts on Social Security financing, we just need to look at what Canada did with their Canada Pension Plan for an example of how to use sound actuarial principles to provide “Self-Sustaining Sustainable Solvency.”

Monday, June 13, 2016

Retired Actuary Calls for Actuarial Profession to Encourage Application of Sound Actuarial Principles for Managing Spending in Retirement

The Society of Actuaries has published an article authored by me in its May/June issue of the Pension Section News.  The article is entitled, “Using Sound Actuarial Principles to Better Manage Retirement Finances.” In this article I make a case for why I believe the actuarial profession should take a more active role in helping retirees and near retirees develop reasonable spending budgets.  
The problem of determining how much to spend in retirement is a basic actuarial problem that requires an actuarial solution.  A November, 2014 Survey of financial advisors by Russell Investments concluded that not enough financial advisors were using “math and science to develop spending budgets for their clients and should be periodically comparing the client’s assets with the client’s liability (the present value of the future withdrawals from the accumulated assets) similar to how actuaries measure the funded status of pension plans.”  This was a clear shout-out to the actuarial profession to step up its game and become part of the solution. 

The public voice of the actuarial profession is the American Academy of Actuaries.  The stated mission of this profession body is to serve the public and the United States actuarial profession.  “Through its public policy work, [the Academy] seeks to address pressing issues that require or would benefit by the sound application of actuarial principles.”  I suggest in the article that helping retirees and near retirees develop reasonable spending budgets is indeed a pressing issue for our country that would benefit significantly by the sound application of actuarial principles.

Friday, June 3, 2016

Adjust the 4% Rule Enough and You Might End Up with Something as Good as The Actuarial Approach—Part 2

This post is a follow-up to my post of May 9, where I described all the adjustments to the 4% Rule recommended by Charles Schwab to make it work.  And Schwab is not alone in this pursuit.  There is no shortage of experts out there proposing adjustments to the 4% Rule to come up with what they believe is a better safe withdrawal rate approach.   As indicated in my previous post, the Motley Fool suggested that perhaps instead of using the 4% Rule, you might want to use 3% or perhaps you may want to withdraw “more” than the spending called for under the 4% Rule after a good investment year and “less” after a poor investment year.  In my June 24, 2015 post, I looked at Michael Kitces’ proposal to “ratchet up” spending under the 4% Rule by 10% whenever the retiree’s account balance exceeds more than 150% of the initial account balance.  He further proposed that if the account balance continues to remain high thereafter, the retiree can continue to apply further increases every three years.  He indicated that these spending increases can be “ratcheted” up without much concern about subsequent declines.

As readers of this blog know, I’m not a big fan of safe withdrawal rate (SWR) approaches.  My most recent list of the disadvantages of SWR approaches is contained in my post of April 25, 2016.  There are, however, two significant potential advantages of using a SWR when compared with a more dynamic approach such as the Actuarial Approach:  simplicity and stability of withdrawals.  Of course, if you implement all these recommended adjustments, these potential advantages quickly fade away.

Thanks once again to Martin from Maine for providing me with more grist for my blog mill.  This time, he alerted me to yet another individual who believes that the 4% Rule needs to be adjusted to work properly.   Rob Bennett has developed a “new school” of safe withdrawal rate analysis that adjusts the safe withdrawal rate to reflect market valuations at time of retirement.  His website,, includes a safe withdrawal rate calculator that requires four input items:  “(1) the [Shiller] P/E10 (valuation) level that applies at the start of the retirement; (2) the real return being paid on Treasury Inflation-Protected Securities (the non-stock investment class examined by the calculator); (3) the stock-allocation percentage; and (4) the percentage balance that the retiree desires at the end of 30 years.”  For 80% stock allocation percentages, the safe withdrawal rates developed by Mr. Bennett’s calculator vary dramatically depending on the inputted P/E10 level.  Using the default assumptions, for example, the safe withdrawal rate (95% probability of not-running out of assets over 30 years and no desired legacy assets) varies from 9.13% for an initial P/E10 ratio of 8 to 2.02% for an initial P/E10 ratio of 44.

Mr. Bennett’s “new school” differs from the “old school” in that current market expectations are expected to affect future investment experience rather than old school techniques that project future experience based on historical results without regard for current market conditions.  Mr. Bennett’s default results for Scenario 3 (P/E10 of 26, which is approximately the current level) are not much different from results obtained by Blanchett, Finke and Pfau in their article, Retiring in a Low-Return Environment, which used similar concepts to account for current market conditions (Mr. Bennett’s calculator produces somewhat higher safe withdrawal rates). 

If I had to use a SWR approach, I might consider the results of Mr. Bennett’s calculator as another data point to use in my selection process.  Fortunately, I am not required to use a SWR approach, and I will stick with the Actuarial Approach, which I believe to be a much sounder approach.  And, as I have indicated many times in prior posts, the Actuarial Approach produces a spending budget for the year; it does not tell you how much you must spend.  If you are bothered by the potential volatility associated with the Actuarial Approach, you can always smooth the results from year to year (or smooth your actual spending or reduce the expected volatility of your investments).  If you insist on using a SWR approach, you can still use the Actuarial Approach to see how far off track you may have strayed.  But, of course if you do this, you are adding yet another layer of complication to all those adjustments the experts want you to make to the “simple” 4% Rule.