Example
Mary is a 65-year old with $500,000 in accumulated savings and she is receiving a Social Security benefit of $2,000 per month. For simplicity purposes, let's assume these are her only two sources of income and her only expected non-recurring expense is $50,000 of unexpected expenses. Using the Actuarial Budget Calculator for Retirees (ABC) and our recommended assumptions (4% discount rate, 2% inflation, 2% desired increases and 31 years LPP), Mary develops an annual recurring real dollar spending budget of $43,135. This amount is equal to the present value of her future spending budgets of $1,014,425 divided by the present value of her future years with desired increases of 23.5177. If all assumptions are realized in the future, Mary expects her spending budget to remain at this level in real dollars throughout her period of retirement.
Mary has determined that her non-travel essential expenses are about $38,000 per year. The spending budget that she has developed in the paragraph above therefore only leaves her with about $5,100 as an annual travel budget. Based on her understanding of the “go-go, slow-go and no-go” stages of retirement, she understands that she may not have the same desire to travel when she becomes older, and she decides to consider “front-loading” her desired travel expenses over a limited period rather than spreading them equally over the remainder of her life.
So, let's assume that Mary decides that she is going to travel until she is 80 (15 years) and she would like to spend $10,000 per year in real dollars for travel each of those 15 years. Since she does not anticipate traveling every year of her retirement, she treats her traveling expenses as a non-recurring expense rather than one that will last until she dies. Using our Present Value Calculator spreadsheet, she determines the present value of her future traveling expenses to be $131,397 and enters this amount in the ABC along with the $50,000 present value she has budgeted for unexpected expenses. This reduces her recurring non-travel budget to $37,547, but her total real-dollar travel and non-travel budgets for this year (and the next 14 years are expected to be $47,547 ($10,000 plus $37,547), or about 10% higher than her initial “non-front-loaded” spending budget. All things being equal, however, she expects her real dollar total spending budget under this “front-loaded” approach for ages after 79 will only be $37,547 in real dollars, or about 13% less than the non-front-loaded budget. Since this amount is a little bit more than her expected non-travel essential expenses, she considers this alternative front-loaded budget shaping approach as a possible way to go. If Mary decided that a travel budget of $10,000 per annum may still not be sufficient to satisfy her desired travel plans, she could look at a higher travel budget and shorter travel period as another alternative.
The graph below illustrates Mary’s choice, again assuming all assumptions made about the future are exactly realized.
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Conclusion
The graph illustrates the general rule of spending in retirement that we refer to frequently in our blog: You can spend it now or you (or your heirs) can spend it later. There is no free lunch. If you want a higher spending budget in retirement, you either need to increase your assets (for example, Mary could take a part-time job) or you can increase the risk that your spending will decrease in the future in real dollars by front-loading your current spending.
It is also important to note that assumptions made about the future will not be exactly realized. For example, as you age, your lifetime planning period plus your age may increase (your expected age at death). All things being equal, an increase in your expected age at death will result in an “actuarial loss” that will decrease your real dollar annual spending budget. Therefore, it is critical to revisit one’s spending budget annually to reflect actual experience, actual spending and any changes in your desired spending goals. Things change. Budgeting your spending should not be a “one and done” process.
