Wednesday, January 16, 2019

Expand Your Spending Categories in 2019 for Better Personal Retirement Budgeting & Planning

To help you develop a more robust spending budget and facilitate your retirement planning, we encourage you, in this post, to consider allocating your spending in retirement to a minimum of the following four categories:
  • Essential Recurring 
  • Non-Essential Recurring 
  • Essential Non-Recurring 
  • Non-Essential Non-Recurring

Thus, we are asking you to consider the following expanded Basic Actuarial Equation in your budget calculations:  

We will discuss why we ask you to do this below and illustrate the benefits of doing so with an example.  We will also be discussing the present value measurements we believe you should be looking at to help you determine whether you are spending too much or too little in retirement and to help you refine your investment strategy.

Why These Four Categories?

Recurring vs Non-Recurring In prior posts, we have encouraged you to distinguish between recurring and non-recurring expenses when developing your annual spending budget.  Recurring expenses are those that you expect to incur every year, while non-recurring expenses are expenses that you don’t expect to incur every year, and include items such as expected long-term care costs, other unexpected expenses, amount desired to be left to heirs, new car costs, home improvement costs, mortgage payments that are expected to be paid off during retirement, etc.  The reason we encourage you to distinguish between the two is that if you don’t expect to incur a certain cost every year, it doesn’t make much sense to build that cost into your recurring expense budget.  Therefore, if you want to maximize your recurring spending budget, you should develop a separate non-recurring spending budget.

Essential vs Non-Essential Because returns on U.S. equities were down somewhat last year, some individuals are wondering whether they should reduce their spending this year.  We are not necessarily suggesting that you should (or shouldn’t), but if you do (this year or in the future), you are probably going to first look at reducing spending that you classify as “non-essential” (or “discretionary”) vs. expenses that you classify as “essential” (or “non-discretionary”).  Since most retirees are more comfortable with reducing non-essential expenses rather than essential expenses if and when the need to cut back should occur, it is important for planning purposes to have an idea of how much of your spending budget is comprised of non-essential expenses.  Also, quantification of how much of your current spending is comprised of essential expenses may affect your investment strategy.  In the example below, we show how you can use our spreadsheets to determine the percentage of your essential spending that is supported by your non-risky assets.

It may make sense for you to allocate your expected future expenses to more than these four categories.  For example, if you believe that your future medical costs will increase at a rate greater than the rate of increase expected for your other recurring expenses, you may wish to separately account for those expenses as well. 

How to Determine Whether You are Spending Too Much or Too Little

Well.  In addition to being what this website is all about, this little paragraph is where we are going to disagree with most of the personal financial “experts” that you follow on the internet.  Our opinion will come as no surprise to our readers, however, since we encourage you to focus on the portion of your total assets you can spend each year (using a sustainable spending plan), and not the portion of your accumulated savings you can withdraw (using a sustainable withdrawal plan).  Therefore, when determining whether you are spending too much or too little, we believe you should be looking at

  • the proposed total spending budget for the current year divided by the present value of your total assets (the left-hand side of the equation above), and 
  • not the proposed amount to be withdrawn from your accumulated savings divided by your accumulated savings.

For this example, we are going back to 2018 to set up the 2019 budget calculation for our couple, Bill and Betty.  If you want, you can duplicate the results for 2018 using our Actuarial Budget Calculator (ABC) workbook for Retired Couples.  Feel free to jump to the results below if the calculation details are not of interest to you.

Data: Bill and Betty retired at the beginning of 2018.  At that time, Bill was 66 and Betty was 60.

Assets:  When he retired, Bill started receiving his Social Security benefit of $18,000 per annum and purchased a deferred annuity (QLAC) that will pay him $25,000 per annum commencing on his 85th birthday.  Betty estimates her Social Security benefit payable at age 70 (when she plans to commence) will be $26,000 per annum and she plans on commencing her company pension of $12,000 per annum at age 65.   After purchase of Bill’s QLAC, our couple had accumulated savings as of the beginning of 2018 of $750,000.  50% of this amount was invested in equities and 50% in fixed income securities.  They also owned a home with net equity of about $250,000.

Non-Recurring Spending Liabilities:

Mortgage Bill and Betty still have a mortgage on their house with annual payments of $20,000 per annum.  At the beginning of 2018, there were four years of mortgage payments due.  Using the PV calculator spreadsheet and the default assumption discount rate of 4% (from the ABC), they determine the present value of these payments as of January 1, 2018 to be $75,502. 

Extra Healthcare Cost Since Betty is not currently eligible for Medicare, they must purchase health insurance for her.  They estimate the extra cost for Betty’s health insurance for 2018 compared to what their cost would be if she were covered by Medicare to be about $4,800, and they calculate the extra present value of such costs until she is eligible for Medicare at age 65 to be $23,543 (assuming 3% annual cost increases). 

Betty and Bill assume that the equity in their home will be sufficient to cover the expected cost of their long-term care, so they enter “0” in C(28) PV Long-term care costs.

Travel Betty and Bill would like to travel somewhat while they can.  They establish a travel budget of $11,000 per year increasing with inflation until Bill reaches age 80.  They determine the present value of their future travel expenses to be $136,155.

Therefore, they enter a total of $260,200 ($75,502 mortgage + $23,543 extra healthcare cost + $136,155 + $25,000) in C(29) PV Unexpected expenses & other non-recurring expenses of the ABC workbook.

They budget a present value of $25,000 for unexpected expenses and they budget $25,000 in today’s dollars for funeral costs.

So they enter $25,000 in cell C(30) Desired estate at end of LPP-Either Alive in Today's dollars of the ABC workbook.

Assumptions:  Bill and Betty use the default assumptions in the ABC workbook.  They are comfortable with assuming that their future recurring expenses will increase with inflation and they are comfortable assuming that recurring spending will be reduced by 33% upon the first death within the couple.

This what the Input and Results tab looks like for their 2018 calculations:

(click to enlarge)

Results The present value as of January 1, 2018 of Bill and Betty’s total assets were $1,790,337 in cell M(7).  Reducing this amount by the present value of future non-recurring spending of $272,153 leaves $1,518,184 in cell M(14) as the present value of future recurring expense budgets.  Dividing this result by the present value of future years with desired increases in future recurring spending budgets and desired decrease after first death within the couple of 25.6683 (in cell M(18)) produces a 2018 recurring spending budget of $59,146 in M(20).  If all assumptions are realized in the future, this recurring expense budget is expected to remain constant measured in real dollars until the first death within the couple (at which time it is expected to be reduced by 33%).

If we add this recurring spending budget to Bill and Betty’s 2018 non-recurring spending budget of $35,800 ($20,000 mortgage + $4,800 extra healthcare cost + $11,000 travel), we obtain a total spending budget for 2018 of $94,946.  Since Bill’s Social Security benefit is only $18,000, this means that they will need to withdraw about $76,946 from accumulated savings if they spend their actuarially determined spending budget in 2018.

Second Thoughts After reading one of the many articles on the internet strongly suggesting that retirees limit nest egg withdrawals to 4% (or less using the IRS RMD withdrawal plan), Bill wondered whether their 2018 spending budget was too high and required too much to be withdrawn from their accumulated savings.  He noted that 4% of $750,000 was only $30,000 –  much less than the $76,946 withdrawal their budget plan anticipated.  He also noted that when they had met with their financial advisor, he told them that their firm’s Monte Carlo model indicated that there was a 90% probability that they could spend only $70,000 each year.

Betty assured him that their total 2018 spending budget of $94,946 represented only 5.3% of the present value of their total assets ($94,946 / $1,790,337), and their recurring spending budget of $59,146 represented only 3.9% of the present value of their assets dedicated to recurring spending ($1,518,194).  She also pointed out to him that it makes more sense to front-load their spending to match their expected front-loaded non-recurring spending liabilities, and it doesn’t make sense to build those non-recurring expenses into future recurring spending budgets.  Bill agreed, but they both decided to closely monitor their spending in 2018.


Betty and Bill’s 2019 budgeting process began with a review of their 2018 spending and investment results.  Here is a breakdown of Bill and Betty’s actual spending for 2018 into the four categories suggested above:

  • Essential Recurring:  $40,000 
  • Non-Essential Recurring:  $10,000 
  • Essential Non-Recurring:  $25,000 ($20,000 mortgage and $5,000 extra healthcare costs) 
  • Non-Essential Non-Recurring:  $12,000 (travel costs)
So, their total 2018 spending of $87,000 and withdrawal from accumulated savings of $69,000 was $7,946 less than expected based on their 2018 total spending budget. 

But, they lost 3% on their invested assets during 2018, so their beginning of 2019 accumulated savings is only $660,570 [ .97 x ($750,000 – $69,000)], and their accumulated savings is now approximately invested 55% in fixed income ($363,000) and 45% in equities (about $297,570). 

2019 Budget Calculations

Because of the 2.8% cost of living increase, Bill’s 2019 Social Security benefit has been increased to $18,504 and Betty estimates her age 70 Social Security benefit will now be $26,204.  They calculate the present value of their unexpected and other non-recurring expenses as of January 1, 2019 at $234,397.  Updating ages, accumulated savings and relevant deferral periods in their 2019 ABC workbook, they develop a recurring spending budget of $58,974 and a total spending budget (before any smoothing of results) of $95,226 ($58,974 + $20,000 for mortgage + $4,944 for expected extra healthcare + $11,308 for travel).  They expect to withdraw $76,722 ($95,226 – Bill’s Social Security benefits of $18,504) from their savings if they spend exactly this total 2019 spending budget. 

While Bill still remains somewhat concerned about depleting their savings, Betty assures him that they are not on the road to financial ruin by telling him:

  • Even if they spend their total 2019 spending budget of $95,226, it represents only 5.5% of the total present value as of January 1, 2019 of the present value of their total assets of $1,729,897. 
  • They spent less than their total spending budget for 2018 and probably will do the same for 2019. 
  • They can always cut back on some of their non-essential spending. 
  • They can always change their deferral strategy for Betty’s Social Security and pension if they are concerned about cash-flow. 
  • After they pay off their mortgage and extra health-care costs in the next few years, their non-recurring spending is expected to decrease.
They agree, therefore, that they do not necessarily need to cut back on their non-essential spending for 2019.

Investment Strategy

They use their 2019 spending budget process to revisit their investment strategy.  Using the present value of future years factor of 25.1520 in M(18) of their 2019 ABC workbook and assuming their 2018 essential recurring spending remains at about $40,000 in real dollars each year, Betty calculates that the present value of the assets needed to cover their future essential recurring spending liabilities is about $1,006,080 (25.1520 x $40,000).  To this amount, she adds the present values of essential non-recurring expenses of $103,215 ($57,722 for mortgage, $19,493 for extra healthcare costs and $26,000 for unexpected expenses) to obtain the total present value of their assets necessary to cover their total future essential expenses of $1,109,295.  By comparison, the present value as of January 1, 2019 of their future income streams was $1,069,327, and less than $300,000 of their total present value of assets of $1,729,897 (about 17%) is invested in equities.  So, if Betty’s assumptions about expenses are reasonable, she concludes that the risk of their future spending falling below their estimated essential spending level is very low.  Betty’s calculations also lead to a family discussion of whether they should increase the portion of their accumulated savings allocated to equities at some point during 2019.


The actuarial approach advocated in this website, involving calculations of present values of assets and spending liabilities and application of the basic actuarial equation, is a powerful tool for developing reasonable spending budgets and for use in personal financial planning.  To make it even more robust, we recommend that retirees separate their expenses into at least the four categories discussed above and compare the present values of their assets and spending liabilities (both essential and non-essential) to help them refine their investment strategy.