Focus on Your Spending Budget and Your Funded Status, Not on Withdrawals from Your Accumulated Savings

It seems that every other article we read these days in the retirement media involves someone’s thoughts about how best to withdraw funds from accumulated savings to supplement income from other sources such as Social Security, pensions and annuities in retirement. The most common withdrawal strategy for this purpose, of course, is “the 4% Rule”, but there are literally thousands of alternative withdrawal strategies (and more being developed every day). Advocates of these strategies stress that “converting” accumulated savings to “retirement income” is essential to ensuring that one’s annual retirement income (“I”) exceeds one’s annual expenses (“E”), or (“I > E”). In fact, several authors have proclaimed this “common-sense equation” to be, “The most important rule of personal finance — spend less than you earn.”

Why is the Actuarial Profession Reluctant to Advance Actuarial Solutions to the Decumulation Problem?

As a retired actuary who advocates the use of basic actuarial principles and processes to help retirees and near retirees make better financial decisions, I frequently wonder why my profession is so reluctant to advance actuarial solutions to the problem of decumulation in retirement. In this post, I will discuss:

• Mission and vision statements of the two major actuarial bodies in the U.S. (and how advancing an actuarial approach can be considered entirely consistent with these statements)
• Fundamental concepts of actuarial science that the actuarial bodies appear to ignore when providing planning advice to retired households (and an example), and
• Possible reasons why the actuarial profession in the U.S. is reluctant to advance actuarial solutions

Using the AFP to Develop a More Aggressive Financial Plan in Retirement

In our last post, we indicated that there are several levers in the AFP that more conservative users can employ to reflect their lower tolerance for potential future spending reductions, including:

• Using more conservative (than default) assumptions about the future to determine their household Funded Status,
• Building up a larger Funded Status over time, or
• Classifying more expenses as “essential.”

In this post, we will flip the coin and look at levers available for those with a higher tolerance for potential future spending reductions, or for those with insufficient assets to cover their spending liabilities using the default assumptions (and therefore, have little choice but to assume more risk).

We include an example. 

Improving Retirement Planning by Employing Basic Actuarial and Financial Economic Principles

In our post of July 23, 2020 entitled, “How to Fix Advisor Retirement Planning Models,” we summarized some of the problems with commonly used Monte Carlo approaches used by financial advisors to develop plans for retirees and near retirees. These problems were identified by three retirement thought-leaders (Michael Kitces, Michael Finke and David Blanchett) in a panel discussion at the Engage 2020 virtual conference. 

Check These Five Boxes to See if You Are Financially Ready to Retire

The Actuarial Financial Planner (AFP) is a useful tool to facilitate household decision-making in or near retirement. In this post we will discuss how the AFP (and possibly the Actuarial Budget Calculator for Single Retirees) can be used to determine if you are financially ready to retire. We include an example below to illustrate the process.

Ongoing vs. One-Time Financial Planning in Retirement

The Actuarial Financial Planner (AFP) advocated in this website is a relatively simple, deterministic actuarial model (i.e., it uses deterministic assumptions about the future to determine results).  By comparison, many financial advisors use more complicated Monte Carlo models which involve the use of one or more stochastic assumptions.  In this post, we will once again discuss why we believe the AFP is the more appropriate model for the purpose of ongoing (as opposed to one-time) financial planning in retirement.

This post is a follow-up to our post of December 25, 2022.  We start by providing background on deterministic vs. stochastic models and then discuss one of the main purposes of financial planning--periodically rebalancing household assets and spending liabilities to keep spending on track during retirement.  We conclude that the AFP better accomplishes this purpose than Monte Carlo models commonly used today.

Managing Risks in Retirement

Actuaries use models, dynamic processes and periodic risk assessments to measure and manage risks for financial systems. The same basic actuarial principles and processes used by actuaries for other financial systems can be applied to the problem of how much a retired household can afford to spend in retirement.

In his January 3, 2023 Advisor Perspectives article, fellow Fellow of the Society of Actuaries and friend, Pete Neuwirth, describes risks faced by retired households during “decumulation.” He concludes his article by saying:

“The fundamental nature of decumulation is different from accumulating sufficient assets to provide for a sustainable retirement. While the extensive body of investment and asset-allocation theory developed over the last 50 years is applicable, decumulation is more of a risk management problem where actuarial science should be brought to bear.

At its core, decumulation is an asset-liability and cashflow matching problem governed by random variables from unruly and difficult to determine probability distributions. It will take researchers in both the investment and actuarial professions to make progress.”

I agree. 

Updated Implied Discount Rates for Single Premium Life Annuities as of January, 9, 2023

In prior posts, we discussed possible assumptions used by life insurance company actuaries in pricing single premium immediate life annuities (SPIAs). In those posts, we provided implied discount rates consistent with quotes obtained from ImmediateAnnuities.com based on two different mortality assumptions (one based on life expectancy (50% probability of survival) and the other based on a 25% probability of survival, which is the basis we recommend in our website for planning purposes).

In this post, we will examine the implied interest rate assumptions built into quotes from ImmediateAnnuities.com as of January 9, 2023 and compare the quotes and the implied interest rates with the results of the similar exercise we performed as of November 25, 2022. You may wish to revisit our prior posts for more general discussion of annuity pricing assumptions.

The key takeaway from this post is that implied interest rates (rates of return) on SPIAs have decreased over the past several months. We have no idea, however, if they are going to decrease even more in future months (or even increase).

Automatic Funded Status Adjustments to Your Spending Budget

The Actuarial Approach advocated in this website is a dynamic spending approach that anticipates periodic determinations (or valuations) of the retired household funded status and, if necessary, adjustments in the household spending plan to maintain a desired funded status level. Contrast our recommended approach with static approaches (like the 4% Rule or static Monte Carlo models) that anticipate a one-and-done determination of future household spending with presumably a relatively high probability of success. 

In our last post, we provided an example of the actuarial approach for a couple (Bill and Betty), whose Actuarial Financial Planner (AFP) funded status decreased from 112% as of January 1, 2022 to 99% as of January 1, 2023. In that post, we left it up to Bill and Betty (and their personal tolerance for risk) to determine actions they might want to consider in light of this decrease. In this post, we propose an alternative automatic approach for Bill and Betty (and other households) to use to adjust their spending budget if their AFP funded status either becomes too low or too high now or in the future.

Retirees, it’s Time to Update Your Financial Plan

At the beginning of each new calendar year, we encourage our retired readers to perform an actuarial valuation of their household assets and spending liabilities to see whether changes should be made in the spending and investment components of their financial plans, especially if they haven’t done so recently. This year, we will use an example and the Actuarial Financial Planner (AFP) to illustrate the five easy steps we recommend for performing this annual actuarial valuation. 

2022 was a tough year for retirees. In addition to poorer-than-assumed investment return experience, we also experienced higher-than-assumed rates of price inflation. The combined effect on most retiree’s household balance sheets was to significantly reduce the size of household assets and Rainy-Day Funds (the balancing item between household assets and household spending liabilities). Going forward for 2023, retired households will need to decide what actions, if any, should they plan on to address these reductions.