If the assumptions used in your retirement decumulation plan (including the important assumptions that the assets you plan to receive, and the expenses you expect to incur in the future) are exactly realized, your Funded Status should remain approximately the same from year to year. If your (or your financial advisor’s) assumptions are too conservative, future experience will be more favorable than assumed, and your Funded Status will increase over time. Conversely, if your assumptions are too aggressive, future experience will be less favorable than assumed and your Funded Status will decrease over time.
Most retirees prefer to be somewhat more conservative than aggressive in the funding of their retirement liabilities. They prefer the possibility of future spending increases to future spending decreases, even if such spending decreases involve discretionary expenses that presumably are not as critical as essential expenses. On the other hand, most retirees don’t want to be overly conservative and prefer to enjoy increased spending early in retirement if at all possible. This conflict of preferences and the uncertainty of the future make retirement planning difficult. Some financial advisors attempt to address this issue by administering risk tolerance questionnaires and by asking clients to select between spending strategies that have varying “probabilities of success” or “probabilities of future changes.”
In this post, we will attempt to quantify how conservative certain sets of assumptions are when using the Actuarial Financial Planner (AFP) with different Funding Status targets. We will do this by using an example hypothetical individual and comparing calculated withdrawal rates for this individual with withdrawal rates under the 4% Rule.
