How Much Can You Afford to Spend, Not Withdraw, in Retirement?

Since our very first post in 2010, our focus has been on helping households determine how much they can afford to spend each year in retirement (hence the title of our website). By contrast, the focus of most retirement experts has been, and continues to be, how much of your portfolio can you afford to withdraw each year in retirement. If you are looking for a Strategic Withdrawal Plan (SWP) that purports to be the best way to “tap” your retirement savings, you’ve come to the wrong website.

Beware the Retirement Income Death Spiral

In his article, “The Retirement Income Death Spiral,” retirement researcher James B. Sandidge concludes that, “[there] is not a smooth transition from sustainable to failing because principal erosion accelerates abruptly, throwing the portfolio into a death spiral.” To measure the likelihood of portfolio failure, Mr. Sandidge developed a rule of thumb he calls the Momentum Ratio (MoRo). This ratio is determined by dividing the sum of negative percentage changes in the household portfolio account during retirement by the sum of the positive changes. According to Mr. Sandidge:

 “When I applied the MoRo to historical portfolios going back to 1900, I found that portfolios with ratios of more than 100 percent during the first 15 years, 125 percent during years 16–20, and 150 percent during years 21–25 had a high failure rate. Conversely, those with ratios below those thresholds had a high success rate.”

Further, his research showed that deterioration of a retired household’s portfolio may occur much more rapidly than expected.

While Mr. Sandidge’s MoRo rule of thumb has some appeal, we believe that the process of annually Measuring and Monitoring your household Funded Status and Making changes to your spending plan when your Funded Status falls outside a reasonably determined corridor (guardrails), is a much more robust approach for keeping your spending on track, consistent with your spending goals and out of potential “death spirals.”

Retirement Researcher Advocates Actuarial Concepts for Adjusting Spending in Retirement

Dr. David Blanchett, Head of Retirement Research at PGIM DC Solutions, has been recently active on LinkedIn, advocating his 2022 paper “Redefining the Optimal Retirement Income Strategy.” In this paper, Dr. Blanchett suggests several changes to traditional Monte Carlo models currently used by many financial advisors. These changes include:

• Inclusion of a dynamic process, similar conceptually to the Actuarial Approach advocated in this website, to determine how retiree spending should be adjusted from year to year, and
• Development of a better metric for evaluating scenario results than the traditional “probability of success” metric.

Measuring and Managing Your Financial Risks in Retirement

In prior posts, we’ve discussed the three M’s that constitute the actuarial process for keeping your spending in retirement on track and consistent with your spending goals:

1. Measuring your Funded Status each year
2. Monitoring your Funded Status from year to year, and
3. Making changes in your assets or spending liabilities when your Funded Status falls outside a reasonable corridor (guardrails).

In this post, we will discuss two more M’s: Periodically Measuring and Managing your financial risks. If you have completed Steps 1 and 2 above and are contemplating increases in your spending plan this year, we suggest that now may be a good time to measure and possibly manage your financial risks before implementing your plan.

What’s the Present Value of Your Accumulated Savings?

If you are not an actuary, you may not be familiar with present values. This basic actuarial concept is integral to determining your Funded Status (the present value of your household assets/sources of income divided by the present value of your future expected spending) using the Actuarial Financial Planner (AFP) workbooks available on this website. By entering relevant information in the input section of our spreadsheets, the AFPs will calculate your present values and your Funded Status.

Why It’s Important to Monitor Your Funded Status from Year to Year

We encourage you to remember the following 3Ms when determining how much you can afford to spend in retirement:

1. Measure your Funded Status periodically (we recommend at least annually at the beginning of each calendar year)
2. Monitor your Funded Status from year to year, and
3. Make changes when your Funded Status falls outside a reasonable corridor (guardrails)

Some of our readers question why the second M is important. We will answer in this post.