The Society of Actuaries (SOA) recently released a retirement planning guide for older retirees entitled, “Late-in-Life Decisions Guide.” According to the Society’s website, the guide was written by Financial Finesse (a financial wellness consulting firm), but the guide itself states, “In collaboration with Financial Finesse, the SOA Aging and Retirement Strategic Research Program prepared this guide as a resource to help older retirees and those who assist them.” Irrespective of who was responsible for writing this guide, we found the retirement planning calculator prepared by Financial Finesse and included in the guide to be of interest. We will discuss the calculator in this post
As retired actuaries and Fellows of the Society of Actuaries with a special interest in the application of basic actuarial principles to help retirees make better financial decisions in and near retirement, we pay particular attention when a major U.S. actuarial organization wades into this arena (with or without the help of outside experts). And, of course, as dues paying members of the SOA, we are always interested in how our dues are being spent by the SOA on outside vendors.
Financial Finesse Calculator (FFC)
While overly simplistic, the basic structure of the FFC (at least the Reverse Calculation portion of the tool) is not a great deal different from the basic structure of our Actuarial Financial Planner. Both require input of:
- Accumulated Savings
- Lifetime streams of benefits (only Social Security or inflation indexed lifetime income for FFC)
- Expected (or desired) expenses (only those expected to remain unchanged in real dollars over the entire lifetime planning period for FFC)
- Expected investment return, and
- Expected inflation
A positive aspect of the FFC is that it’s basic structure would enable users to adjust spending from year to year based on the results of “annual valuations” and would enable users to stress-test different assumptions. These features are important actuarial practices that would facilitate retirement planning. It is important to note that this basic dynamic structure involving assumptions about the future and periodic valuations is different from the static structure (or strategy) currently recommended by the Society of Actuaries in its Managing Retirement Decisions brief entitled “Designing a Monthly Paycheck in Retirement.” This SOA brief refers to the strategy advocated as the 4% Rule of Thumb, but the description of this rule in the brief is not entirely consistent with our understanding of the 4% Rule.
FFC Shortcomings
As noted above, the FFC could be a better financial planning tool than the 4% Rule (or the SOA’s intended version of the 4% Rule). However, some of the potential shortfalls of the FFC are significant and include:
- No guidance on reasonable assumptions. Amazingly, the tool does not refer the user to the Actuaries Longevity Illustrator (ALI) for reasonable lifetime planning periods to use in the Reverse Calculator portion of the tool. The ALI is a tool jointly developed by the SOA and the American Academy of Actuaries and is considered “crucial” (as expressed by the organizations in the FAQs for the ALI) for financial planning in retirement. Also, there is no guidance on reasonable investment return and inflation assumptions to input for planning purposes
- Expenses and income in retirement are generally not linear as assumed by the FFC. This is a huge problem for the FFC as the tool does not consider non-recurring expenses such as long-term care expenses, unexpected expenses, mortgage repayments, expenses after the death of the first spouse, etc. Also, many sources of income are not inflation-indexed and may not be payable for the entire retirement period as assumed by the FFC. This potential problem can be even worse for married couples.
Is FFC safe?
The brief states, “Some defined income sources (e.g., Social Security, certain annuities) provide lifetime guaranteed income, whereas lump-sum assests (sic) can be depleted if spent too quickly. Use this calculator to estimate how much you may be able to safely withdraw from assets without running out of money.”
Since the FFC can be a dynamic approach that anticipates periodic valuations, this statement can be true if the retired household uses the Reverse Calculator portion of the tool, inputs reasonable assumptions and is willing to live with variability in annual spending resulting from experience gains and losses from year to year (differences between assumed and actual investment return, lifetime planning periods and inflation or changes in those assumptions).
Is there a better alternative that doesn’t have these shortfalls?
We thought you would never ask. Of course there is. The Actuarial Financial Planner is also a dynamic actuarial approach, but it doesn’t suffer from the FFC shortfalls noted above and enables users to develop a Liability Driven Investing (LDI) strategy to separately fund future expected essential and discretionary expenses.
Summary
We applaud the Society of Actuaries/Financial Finesse for developing the Late in Life Decision Guide, particularly as it relates to non-retirement financial planning issues, and we were able to verify the accuracy of the FFC with our AFP for Single Retirees. We do feel, however, that the guidance provided with respect to retirement financial planning is somewhat lacking, particularly with respect to couples. We like the Society’s apparent movement away from endorsing the 4% Rule to a more actuarially based dynamic approach, but we would like to see the profession encourage adoption of even more robust actuarial models (like ours) to help retirees of all ages make even better financial decisions.
