Tuesday, March 31, 2015

Spending More or Less Than Your Spending Budget

This website is all about helping retirees develop a reasonable spending budget in retirement.   Notwithstanding, we understand that there may be many years in retirement where your actual spending may not match your budgeted spending.  This is ok as long as you realize that over-spending now can result in a smaller real dollar spending budgets in the future and vice versa.  We have addressed this concept in many of our previous posts including “You Can Spend it Now or You (or Your Heirs) Can Spend it Later” and “Budgeting Around ‘Lumpy’ Expenses.”

We are revisiting this concept today primarily as a result of a post that appeared in the Huff Post Financial Education blog entitled, “Baby Boomer’s Retirement Strategy:  Binge Spending Or Nothing At All.” In this post, the author refers to a recent study by Hearts and Wallets which showed that “28 percent of older Americans took no retirement income from their personal assets...Another one-quarter took 8 percent or more…”  The author interviewed Laura Varas, a partner and co-founder of Hearts and Wallets, who hypothesized that a significant portion of older Americans may be fasting and binging with their retirement assets on purpose rather than spending these assets in a systematic manner.   The term used in the article for over-spending is spending in “chunks,” and Varas concludes that "Knowing how to spend safely in chunks is something they [retirees] want."

As we said in our post on budgeting around lumpy expenses, there are several ways to use the Actuarial Approach to deal with unusual and unplanned expenses.  One of the suggested approaches is to carve out some of your current assets in anticipation that this portion of your assets will be dedicated to the lumpy expense expected in the future (thereby reducing your current spending budget).  Another approach is to simply treat over-spending the same as unfavorable investment experience or changes in assumptions and apply the smoothing algorithm recommended in this website. 

While the Actuarial Approach can help retirees deal with spending in “chunks”, it is important to note that the over-arching rule for spending in retirement is you can spend it now or you (or your heirs) can spend it later.  This rule also applies to retirees who use the Actuarial Approach.  If you are using our recommended smoothing algorithm to smooth investment experience, changes in assumptions or deviations from spending and the smoothed budget amount is consistently below the actuarial value produced by the spreadsheet, you may be borrowing from future budgets.  If you are spending more than your spending budget in a year, you may be borrowing from future budgets.  If you follow the recommended longevity assumption of planning on living until age 95 or your life expectancy if greater and you live past age 89, you will have borrowed from real dollar budgets after age 90.  Unfortunately, there are no guarantees when you choose to self-insure some or all of your retirement income, not even if you use the Actuarial Approach.