Tuesday, June 19, 2018

Wake Up Millennials: What the Latest Social Security Trustees Report is Telling You

On June 5th, the Social Security Trustees released their annual Trustees Report summarizing the financial status of the system.   In the press release announcing the new report, the Acting Press Officer of the Social Security Administration noted that the expected year of depletion of the system’s trust fund assets (under best estimate assumptions) remained at 2034, the same projected year of depletion as in the previous year’s report.   So, another year goes by and most of us simply shrug at this news and go about our business.

We believe it is a mistake for Millennials (or members of other generations) to simply ignore this report and its implications in their financial planning.  Like it or not, Social Security is too important for most Americans to simply ignore when it comes to possible (or likely) future benefit reductions.  In this post, we will discuss what you can glean from one figure in this year’s report and what the current implications of this figure are in terms of your financial planning.

The full Trustees Report contains 261 pages, mostly filled with lots of numbers that would bore even an actuary.  There is one figure, however, on page 13, that fairly succinctly summarizes the system’s long-term financing problem.  This figure (Figure II.D.2—OASDI Income, Cost, and Expenditures as Percentages of Taxable Payroll [under Intermediate Assumptions]) is shown below. 

(click to enlarge)

In addition to showing the expected year of depletion of assets (2034), this figure shows the expected future system cost for scheduled benefits and expected future non-interest income measured as a percentage of System taxable payroll.  Note that there is nothing particularly new about this 2018 picture compared with the same figure presented in many years of past Trustees Reports.

So, what does this Figure tell us?

  • Based on best estimate assumptions, we have approximately a 4% of taxable payroll long-term funding shortfall (gap) in our nation’s retirement plan.  This is not an insignificant shortfall and is larger than the so-called “75-year actuarial balance” measure. 
  • If Congress takes no action to close this gap prior to 2034, system benefits will effectively be reduced by 21%, across-the-board at that time. 
  • To put the program back in long-term balance prior to 2034 will require something like a 22% across-the-board decrease in benefits or a 28% increase in the payroll tax or some combination of changes that accomplish the necessary closing of the gap between expected future cost and expected future income.  
  • If system benefits are not reduced by the same percentage for some or all individuals already in retirement or for some or all individuals who are close to retirement at the time of enactment of system reform changes, benefits for “non-grandfathered” workers will need to be reduced by even larger percentages than the 21%- 22% reductions discussed above. 
What is the Unspoken Message to Millennials Hidden in Plain Sight in the Trustees Report?

Answer:  You should increase your current savings rate. 

In the past, Congress has closed funding gaps in Social Security through a combination of tax increases and benefits reductions.  We expect that the next round of Social Security reform will once again involve a combination of tax increases, benefit reductions and some level of “grandfathering” of workers who are already retired or who are close to retirement.   Until reform is enacted, however, we strongly encourage Millennials to plan on something in the neighborhood of a 25% reduction in their future Social Security benefit and adjust their current savings rate accordingly.  Our Actuarial Budget Calculator workbooks can be used to estimate the additional annual savings that may be required to make up for this anticipated benefit reduction. As discussed in our post of December 15, 2016, we estimated that Congressmen Sam Johnson’s proposal to “permanently save Social Security” would have required Millennials to save an additional 4% of pay (subject to Social Security taxes), on average. 

Of course, future Social Security reform may be accomplished by increasing the tax rate for Millennials (and other workers) or may rely on increased income from other sources.   We don’t know what will be enacted.   However, we believe prudent action is to plan on future benefit reductions and increase current savings accordingly.  You can always decrease your savings rate in the future if reform solutions involve increasing your Social Security taxes and do not involve the benefit reductions you assumed.

We encourage you to be pro-active in this matter.  The sooner you start increasing your savings rate to replace likely future Social Security benefit decreases, the less you will need to save when actual reform provisions are enacted (or system trust fund assets are depleted).

Saturday, June 9, 2018

Expressing Projected Accumulated Savings as Lifetime Retirement Income—Good News for Defined Contribution Plan Sponsors

We are pleased to announce the release of a new workbook—The Actuarial Lifetime Retirement Income Estimator (ALRIE).  Like our other workbooks, this Excel workbook may be downloaded at no charge from the “Spreadsheets” section of our website.   This workbook is a pared-down version of our Actuarial Budget Calculator (ABC) workbooks and is focused on developing an estimate of the amount of real dollar monthly lifetime retirement income (in today's dollars) that may be generated from an individual’s (or couple’s) current and projected accumulated savings.  Unlike the ABC workbooks, it is not intended to help individuals or couples develop a sustainable annual spending budget, but it does employ the same basic actuarial and financial economic principles in its calculations.

We believe ALRIE is a more robust tool for retirement plan providers (including defined contribution (DC) plan sponsors, DC plan administrators and brokerages) who want to give plan participants a better idea of how much lifetime retirement income their account balances may provide.

This post will discuss:

  • The general inspiration for release of ALRIE, and 
  • Why we believe ALRIE is more robust than other approaches we have seen
Inspiration for ALRIE

The general inspiration for release of our new workbook comes from two sources:

  1. The September 19, 2017 article by Carla Fried in the UCLA Anderson Review entitled, “Save-Save-Save, But Then What?  Financial Structure and Spending in Retirement,” and 
  2. The 2018 Voter Guide on Lifetime Income & Retirement Risk issues recently released by the American Academy of Actuaries
In the UCLA Anderson Review article, Ms. Fried discusses current research by noted behavior scholars who are “delivering research to help drive the creation of systemic nudges directed at helping retirees navigate the decumulation stage of their DIY retirement odyssey.”  Ms. Fried notes, “The research suggests retirement plan sponsors and brokerages that are the keepers of the $15 trillion sitting in defined-contribution and IRA plans would do investors a solid if they accentuated the annuity value, not the net worth lump sum.”  She goes on to quote the research authors who say, “to help people reason better about spending in retirement, retirement plan providers should provide people with their projected monthly income at retirement based on their current saving behavior instead of the current practice of providing only account balances.” 

The American Academy of Actuaries 2018 Voter Guide covering Lifetime Income & Retirement Risk asks the question, “What can be done to…better prepare current and future retirees to secure and manage their lifetime income needs?  They indicate that “solutions require participation from all stakeholders:  policymakers, actuaries, employers financial planning advisors and financial product and service providers.  We agree (especially the part about participation by actuaries—or at least two of us anyway). 

The Academy noted several possible approaches for educating individuals and increasing their financial literacy.  The two that struck a chord with us were:

  1. “Improve information provided to workers to raise their understanding about how to prepare for retirement, and focus on the concept of lifetime income by expressing benefits in terms of monthly lifetime income in periodic retirement plan statement,” and 
  2. “Expand existing initiatives of the U.S. Department of Labor and other public entities that currently disseminate objective retirement information.”
Sufficiently inspired by these two sources, we humbly concluded that we could apply the same basic actuarial and financial economics principles that we apply in our Actuarial Budget Calculators to help defined contribution plan participants determine approximately how much lifetime retirement income their current and projected account balances may generate.

Why do we Believe ALRIE is More Robust Than Other Approaches?
We have certainly not seen all the approaches that plan sponsors and others have used to express account balances as equivalent lifetime retirement income.  We have seen the DOL website approach, and we were not particularly impressed. 

Here are some of ALRIE’s features that we don’t normally see in other lifetime retirement income calculators:

  • It shows estimated real dollar (inflation-adjusted) monthly lifetime retirement income in today’s dollars. 
  • It provides default (recommended) assumptions that may be overridden 
  • It uses lifetime planning periods from the Actuaries Longevity Illustrator 
  • It is more closely tied to current inflation-adjusted annuity purchase rates (the market value cost of retirement income) 
  • It can handle pre-retirees, retirees, couples and single individuals 
  • It uses actual ages for both members of a couple and permits input of desired percentage reduction in income upon first expected death within the couple 
  • It has more functionality for determining future non-investment additions to accumulated savings 
  • It calculates an implied “withdrawal rate” from projected accumulated savings in first year of retirement (or current year if already retired).

As suggested by Ms. Fried in her UCLA Review article, plan sponsors and plan providers can do investors (plan participants) a ‘solid’ by accentuating the annuity value and not the net worth lump sum value of participant accounts.  We believe ALRIE is a robust tool that can be used for this purpose.  You can download a protected version of ALRIE from our website, or if you contact us, we can make an unprotected version of ALRIE available to you at no charge.

To the American Academy of Actuaries and its Lifetime Income Task Force:   If you are truly serious about the profession’s mission to serve the public and about having actuaries participate in the two items discussed above intended to increase the public’s financial literacy, we ask, in the spirit of cooperation, that you kick the tires on ALRIE and take one (or a combination) of the following actions:

  • Endorse it 
  • Suggest changes to us for ways to improve it  
  • Develop a better alternative to it with or without our input 
  • Make it (or an improved version) available on your website just as you do with the Actuaries Longevity Illustrator

Wednesday, May 16, 2018

Actuarial Budget Benchmark (ABB)—A Much More Robust Spending Algorithm

In our post of May 1, we talked about how the ABB differs from Monte Carlo models, and we sort of promised that we weren’t going to talk about this subject again for a while.  Subsequent to our post, our friend Dirk Cotton over at The Retirement Cafe also discussed this subject in his post of May 14, 2018.  Dirk did a very good job of explaining the different uses of these models (better than we did), so if you are still interested in this subject, we encourage you to read Dirk’s post.  We also recommend that you read it just because Dirk said some nice things about the ABB.  Because of our promise, however, we are going to keep this post very brief.  l

If you do read his post, you will note that Dirk refers to the ABB (and other Structured Withdrawal Plans) as “Spending Rules.”  Unlike Dirk (and others), we draw a distinction between withdrawal rules and spending algorithms.  The ABB is not a Structured Withdrawal Plan (SWP) designed to determine annual withdrawals from an investment portfolio after retirement, but rather is a variable spending algorithm that is used to develop a total annual recurring spending budget from all sources of income (either before or after retirement and either as a stand-alone spending budget calculator or as a spending algorithm in a Monte Carlo model).  As such, it is much more robust than a SWP.  Unlike SWPs, the ABB:

  • Considers all sources of assets and all spending liabilities (both recurring and non-recurring)
  • Considers expenses that may not last a lifetime
  • Considers sources of income that may not last a lifetime or may start or stop at different times
  • Can be used both before and after retirement
  • May be smoothed from year to year
  • Can be used in combination with other approaches
Under the ABB, withdrawals from accumulated savings for a particular year are equal to the calculated total annual recurring spending budget for the year minus income from other sources for the year.  This will also be true for a spending algorithm in a good Monte Carlo model but will generally not be the case when using a SWP.   Thus, the ABB coordinates income from all sources to develop a true spending budget rather than simply developing a way to “tap one’s savings” in retirement.