While our recent posts suggesting that households focus on their Funded Status are perhaps beginning to sound like a broken record, we can’t help but notice that this general approach (also known as the Funded Ratio] is gaining support in the retirement press. For example, in the March 25-26 Kitces.com Weekend Reading post, the author says:
“Ultimately, the key point is that integrating dynamic rules into a retirement income plan can have significant implications on optimal retirement income decisions. And because it takes a comprehensive look at a client’s assets (incorporating both current portfolio balances and future expected income) and allows for spending flexibility in retirement (though the funded ratio’s sensitivity to assumptions can make it tricky to work with in practice), using the funded ratio to determine adjustments in retirement income could help advisors maximize their clients’ spending in retirement compared to more static approaches!”
And while we disagree with the above assertion that “the funded ratio’s sensitivity to assumptions can make it tricky to work with” (or any trickier to work with than other approaches), we will take this opportunity to once again describe the very simple steps involved in determining your household Funded Status using the Actuarial Financial Planner (with slight modifications from previous descriptions), so that you can put it to use in your planning.
Determining Your Household Funded Status Using the Actuarial Financial Planner (AFP)
Step 1: Adjust last year’s spending plan by
- excluding expenses no longer expected to be incurred,
- including new expected expenses, and
- increasing adjusted plan expenses for current year price inflation.
Step 2: Run AFP this year with adjusted spending plan expenses from Step 1, revised assets (like Social Security with cola increase and updated portfolio balances), updated personal data and best-estimate assumptions.
Step 3: Consider matching the present value of your planned essential expense spending with the present value of your non-risky investments. This step may involve increasing investment in non-risky investments/assets, (for example by delaying commencement of your Social Security benefits or by purchase of a lifetime annuity), or decreasing your estimate of essential expenses.
Step 4: Consider whether to employ levers to make the AFP results more conservative or more aggressive based on your tolerance for risk as discussed in our post of February 26, 2023. For example, you may want to be more conservative if you believe your future Social Security benefits may be reduced as part of future Social Security reform. Or, you may want to be more aggressive, if for example, you want to invest a larger percentage of your accumulated savings in risky assets.
Step 5: If the resulting AFP Funded Status is less than 95%, decrease discretionary spending budget for the year to achieve a 95% AFP funded status
Step 6: If the resulting AFP Funded Status is more than 120%, consider increasing discretionary spending budget for the year.
Step 7: Repeat the above steps next year.
That’s it. You don’t have to be a rocket scientist, Nobel prize winner in economics or even an actuary to use the AFP and the annual valuation process to develop a robust retirement plan.
Conclusion
If you are retired or near retirement, we suggest you determine your household Funded Status using the AFP and the simple steps described above. It is very flexible and can be adapted to reflect your tolerance for risk or your feelings about investing in annuities or other non-risky investments. If you already have a current plan, feel free to compare the AFP results with what you are doing. Happy Planning!
