Monday, November 24, 2014

Measuring Personal Retirement Plan Liabilities

I'm pleased to see that several retirement pundits are extolling the virtues of measuring personal retirement plan liabilities and comparing those liabilities with accumulated assets to help individuals plan for retirement.   This approach is comparable to what actuaries do for pension plans and is the basis for the Actuarial Approach advocated in this website.

In his November 22 article, "Is Your Retirement Fully Funded," Robert Powell says:

"If you want to get a sense how best to generate income in retirement, consider doing what corporate pension plans do. Determine the “funded status” of your personal retirement plan."

In his guest article in The Retirement Café, Michael Lonier says:

"The household balance sheet, not portfolio theory, is the foundation of personal financial management, anywhere in the lifecycle. A solid understanding of the household balance sheet provides the basis for a reasonable and practical way to solve the puzzle of how to best use household resources to fund retirement or reach other goals."

Finally, as discussed in our post of November 16, a recent survey 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 (which coincidentally is the basis for the approach recommended in this website).

The Actuarial Approach for determining a spending budget in retirement matches current personal assets with the retiree's liabilities, where such liabilities are defined as the present value of level real dollar spending over the retiree's expected lifetime.  The spreadsheet tools included in this website not only determine liabilities based on these constraints, but can be used to determine liabilities under other constraints.  For example, if a retiree determined that she could spend $75,000 per year, but wanted to know the liability associated with her "essential" level of spending of $50,000 per year, she could use a trial and error process to determine what level of accumulated savings produced a spending budget of $50,000 per annum.  That amount would be her liability for essential expenses.  Similarly, as discussed in our previous post, individuals close to retirement can use the spreadsheet tools (and the trial and error process) to determine what level of accumulated savings (or liability) will produce their desired level of retirement income.