It’s that time of year again to sit down to determine your spending budget for the upcoming year. Click here to read a short explanation of the Actuarial Approach.
The rest of this post will illustrate the Actuarial Approach for Richard Retiree, the hypothetical retiree we last looked in our post of December 27, 2013 when we developed a spending budget for him for 2014. Richard retired on December 31, 2012 at age 65. His spending budget for 2014 from accumulated savings and his annuity totalled $45,766 ($30,766 plus $15,000). To this amount, he added his Social Security benefit of $20,000 (new information) to get a total spending budget for 2014 of $65,766. His accumulated savings (not counting home equity of about $200,000) as of the beginning of 2014 was $884,909 with about half of this amount to be invested in equities and about half in fixed income securities.
In addition to receiving $20,000 of Social Security benefits and $15,000 of annuity payments during 2014, Richard’s accumulated savings earned $61,944. He spent $60,000 during 2014 ($5,766 less than his budget), so his total accumulated savings at the end of 2014 are $921,853 ($884,909 + $20,000 +$15,000 + $61,944 - $60,000). He is now age 67.
Richard’s Social Security benefit for 2015 will increase by 1.7% to $20,340. He decides to apply the same percentage increase to his 2014 spending budget to determine his preliminary 2015 spending budget from accumulated savings and annuity. This amount is $46,544 (1.017 X 45,766). He then goes to the Excluding Social Security V 2.0 spreadsheet in this website and enters his beginning of 2015 accumulated asset amount of $921,853 and the number of years until age 95 (28). All other input items are unchanged from the 2014 calculation. The resulting spendable amount based on this calculation is $52,790. 90% of this amount is $47,511. If Richard wanted to follow the recommended smoothing algorithm, his budget for 2015 would be the sum of this 90% corridor amount of $47,511 plus his new Social Security amount for 2015 of $20,340, or $67,851.
But Richard has been reading articles that have convinced him that he should be more conservative in his retirement budgeting, so he decides that he will segregate $100,000 of his accumulated savings into an “Emergency Use” fund that he will not consider as assets for normal spending purposes. Therefore, he reruns the spreadsheet with assets of $821,853 and the preliminary spending amount for 2015 (the 2014 amount increased by inflation is now within 10% of the revised spreadsheet amount of $48,215. Therefore, Richard decides to stay with $46,544 as his spending budget attributable to accumulated savings and annuity, to which he adds his Social Security benefit of $20,340 to obtain a total spending budget for 2015 of $66,884.
Richard is also concerned about investing 50% of his accumulated savings in equities. While investment in equities during the last two years has resulted in significant gains to him, he worries that he might not be able to cover his essential expenses if the markets suffer significant losses. He has determined that his essential expenses total about $55,000 per year (or about $34,660 from accumulated savings and annuity income). Using the Excluding Social Security V2.0, he determines that he will need accumulated savings of about $550,000 to meet his essential expenses. Therefore, he decides that he will change his asset investment mix of the $821,853 of accumulated savings not earmarked for emergency purposes to 33% equities and 67% fixed income securities. He understands that he also has his home equity in reserve in addition to his emergency fund if he should need to pay for long-term care or other healthcare emergencies. He is comfortable with a budget for 2015 that is almost 11% higher than the amount he actually spent for 2014.