Better Planning Starts with Granular Budgeting, Part II

This post is a follow-up to our post of November 19, 2024.  In it, we discuss how updating your spending budget each year is an important step in the process of successfully managing your finances in retirement.  We will also provide some tips on how to accomplish this task using the Actuarial Financial Planner.

For most retired households, spending is not linear from year to year.  It can vary significantly, especially if spending on non-recurring items is involved.  Therefore, static financial planning approaches that assume constant real-dollar spending from year to year (like the 4% Rule or Monte Carlo models that develop a probability that the household will be able to spend $X per year) can lead to under- (or over) spending in retirement, and just as important, can lead to spending that is inconsistent with household spending goals.

As part of your planning process in retirement, we encourage you to annually develop a relatively granular spending budget consisting of the four general types of spending:

1. Essential Recurring Spending
2. Essential Non-Recurring Spending
3. Discretionary Recurring Spending, and
4. Discretionary Non-Recurring Spending

and compare the present value of your assets (including present values of streams of future payments from Social Security, annuities, pensions, etc.) with the present value of your budgeted spending liabilities to develop your annual Funded Status.

Here is an example table that you can use to gather your annual spending data:

Spending Data Table

Essential Recurring Spending	Current Year Expected Amount	Comment1
Essential Groceries
Taxes, including federal, state, and property
Healthcare costs, including prescription cost and insurance
Utilities and phone
Home related costs, including repair and maintenance, insurance, mortgage HOA fees and/or rent
Personal care costs
Transportation costs including gas, maintenance and insurance
Gifts (Holidays, birthdays and anniversaries) and essential charity donations
Other
Total Essential Recurring
Essential Non-Recurring Spending	Current Year Expected Amount	Comment1
Mortgage payments
Loan payments
Pet Care
Essential long-term care costs
Essential estate bequests
Other
Total Essential Non-Recurring
Discretionary Recurring Spending	Current Year Expected Amount	Comment1
Discretionary Groceries
Subscription services
Dining out
Entertainment
Clothing
Gym memberships
Hobbies
Non-bucket list travel
Non-essential gifts/charitable donations
Other
Total Discretionary Recurring
Discretionary Non-Recurring Spending	Current Year Expected Amount	Comment1
Non-essential long-term care costs
Non-essential estate bequests
New automobiles
Bucket list travel
Home remodeling
Discretionary family support
New appliances/electronics
New recreation vehicles
Other
Total Discretionary Non-Recurring

1. Note expenses that are either assumed to increase in the future at a faster (or slower) rate than assumed inflation. For non-recurring expenses expected to commence in a future year, estimate amount of annual expense (in future dollars) and note when such expenses are expected to start and end.   For non-recurring expenses expected in the current year, note when such expenses are expected to end.

Tips for entering your spending data in the Actuarial Financial Planner (AFP) to determine present values and to develop your Funded Status

1. Combine recurring expenses with the same expected rate of future increases and input that amount in the appropriate cell of the AFP. Some recurring expenses, like future taxes or future healthcare expenses may be expected to increase at a faster rate than general inflation in the future.  Other expenses in retirement, like recurring discretionary expenses, may be expected to increase at a rate less than inflation (or even decrease in real dollars) in the future.  You can combine recurring expenses that have equal future assumed rates of increases when entering them into the AFP to determine their present values.
2. Expenses entered at the beginning of each year are estimated expenses for that year and will usually be higher than expenses entered in last year’s AFP due to inflation. Also, some non-recurring expenses will no longer apply, or will be expected to commence one year earlier or end one year earlier than entered in the previous year’s AFP.  Most of the input items will change from year to year.
3. Present values of non-recurring expenses are generally entered into the AFP by entering data into the following cells:

Annual Amount

Deferral Period

Payment Period

Annual Rate of Increase

% Upside (assets) or %Essential (Liabilities)

Where “annual amount” is increased by inflation (or some other reasonable rate) from the current year until the expected year of first payment; the deferral period is the period in which no payments are assumed; payment period is the number of expected years of payment for this expense after the deferral period; annual rate of increase is the expected rate of increase once payments are expected to commence, and % upside/% essential is the users estimate of how essential this particular expense is.   Note that if the user expects to have more than six non-recurring expenses in retirement, he or she can use one of the five “other income” cells, except negative annual amounts should be input.

4. Calculations of the present values of non-recurring expenses (as well as recurring expenses) are shown in the PV Calcs tab and can be checked there for reasonableness.
5. If your Funded Status is less than 95%, you may wish to revise your inputted desired spending for the year.

Conclusion

As noted in prior posts, the Actuarial Approach to determining how much you can afford to spend in retirement is based on the following three M’s:

• Measuring your Funded Status each year
• Monitoring your Funded Status from year to year, and
• Making changes in your assets or you spending liabilities if your Funded Status falls outside reasonable corridors.

In addition, we encourage you to periodically stress-test important planning assumptions to assess possible risks (that your assumptions won’t be realized in the future) so that you can better Manage such risks. 

At the beginning of 2025, we will remind you that it is time once again to re-determine your Funded Status.  If you want to get a jump on this task, feel free to use the Spending Data Table supplied in this post.