tag:blogger.com,1999:blog-82682771837936917342024-03-16T14:50:21.412-04:00How Much Can I Afford to Spend in Retirement?Financial Decisions in Retirement Made Easier by Focusing on Your Funded StatusHow much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comBlogger496125tag:blogger.com,1999:blog-8268277183793691734.post-55128429905036197102024-03-15T21:02:00.005-04:002024-03-15T21:02:48.550-04:00Financial System Sustainability Superstars<p></p><p>Actuaries measure and monitor the health of financial systems by
systematically comparing assets and liabilities and making adjustments
when necessary to ensure system sustainability.</p><p>You can do the
same thing for your personal financial system/retirement plan with
assistance of the Actuarial Financial Planner (AFP) and by following the
general actuarial process.</p><p>For more discussion of the general actuarial process, see our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/08/retirement-planning-is-not-event-its.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/08/retirement-planning-is-not-event-its.html" target="_blank">post of August 23, 2023</a>.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-19378271362658905332024-03-13T20:17:00.003-04:002024-03-13T20:17:50.148-04:00Simplify Your Retirement Planning<p></p><p>As discussed in prior posts, the key to successful retirement planning is to</p><ul><li>annually determine your Funded Status,</li><li>monitor it from year to year and</li><li>Adjust spending when your Funded Status falls outside pre-determined guardrails (suggested: 95%, 120%)</li></ul><p>In her recent <a data-mce-href="https://www.gobankingrates.com/retirement/planning/draw-up-retirement-budget-6-key-steps/" href="https://www.gobankingrates.com/retirement/planning/draw-up-retirement-budget-6-key-steps/" target="_blank">Go Banking Rates article</a>,
Hanna Horvath outlines six key steps to building an effective
retirement plan and spending budget. We agree that the steps outlined by
Ms. Horvath are important, but each of these steps (and much more) is
anticipated in the simpler process we recommend. </p><p>Why does
simplicity matter? You are much more likely to adopt and follow an
approach if it is relatively easy to understand and to implement.
Entering relevant data into the Input section of the Actuarial Financial
Planner enables you to quickly develop your household Funded Status,
and therefore, build a more effective retirement plan and spending
budget.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-68768933845295539692024-03-09T11:08:00.005-05:002024-03-09T11:08:42.909-05:00We’ve Updated the Actuarial Financial Planner Models<p></p><p>In response to suggestions from several of our readers, we have added
cells to the AFP models to permit inputting of additional non-recurring
income and expense items. These new cells will enable you to estimate
present values of items such as:</p><ul><li>Social Security survivor benefits</li><li>Survivor benefits under Joint and Survivor annuities</li><li>Future home sales</li><li>Possible future Social Security cuts, and</li><li>Many types of expected future non-recurring expenses</li></ul><p><strong><span></span></strong></p><a name='more'></a><strong>Why is this important? </strong>Household
income and expenses are typically not linear from year to year and can
be front-loaded, back-loaded, or even middle-loaded. Successful planning
should anticipate real-world income and spending patterns.<p></p><p>Check out the revised AFP spreadsheets and, as always, feel free to share your suggestions for possible improvements.</p><p>Remember to change items only in the designated cells in the Input section. Don’t change cells that use formulas.</p><p>Also remember to increase amounts inputted in Column E as necessary for any periods of expected deferred commencement. </p><p>Happy Planning!</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-87972207639508130742024-03-02T15:59:00.000-05:002024-03-02T15:59:06.894-05:00Simple Key to Retirement Planning Success<p></p><p>Key: You should determine your <strong>Funded Status</strong> annually and monitor it from year to year.</p><p>Why?
Your Funded Status is a summary statistic that reflects actual
experience and can keep you on track to meet your spending goals in
retirement.</p><p>For more discussion of the importance of determining
and monitoring your Funded Status, and why doing so is superior to using
the 4% Rule (and its many variations) or typical Monte Carlo models,
see our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/04/plan-on-future-adjustments-to-your.html" target="_blank">post of April 16,2023</a>.</p><p>To determine your Funded Status,
download and complete one of our Actuarial Financial Planners from the
Spreadsheets section of our website.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-74054311598793415622024-02-26T21:10:00.001-05:002024-02-26T21:10:34.470-05:00A Planning Process That Works<p>You are
responsible for your finances in retirement and need a plan that works.
The Actuarial Approach, with its Funded-Status-focused process can help
you:</p><ul><li><em>Grow your assets,</em></li><li><em>Protect your assets, </em></li><li><em>Spend your assets in a manner consistent with your goals, and</em></li><li><em>Make better financial decisions. </em></li></ul><p>To
read more about the proven actuarial process we recommend, including a
few hints for using the Actuarial Financial Planning models we provide,
see our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2024/01/its-that-time-once-again-for-retired.html" target="_blank">post of January 5, 2024</a>. </p><p>Check out our most recent <a data-mce-href="https://www.advisorperspectives.com/articles/2024/02/26/social-securitys-deterioration-implications-future-reform" href="https://www.advisorperspectives.com/articles/2024/02/26/social-securitys-deterioration-implications-future-reform" target="_blank">Advisor Perspectives article</a> if you are concerned about how future Social Security reforms may affect your plan.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-91611847704502036592024-02-21T21:30:00.002-05:002024-02-21T21:30:42.347-05:00Want a More Realistic Retirement Plan?<p></p><p>If you (or your financial advisor) aren’t planning for non-recurring
expenses in retirement, you probably don’t have a realistic retirement
plan. </p><p>If you use a Strategic Withdrawal Approach (like the 4%
Rule or its many variations) or your financial advisor uses a
traditional Monte Carlo approach, your annual spending budget is usually
expressed as a constant real dollar amount each year. Assuming constant
real dollar spending for your entire period of retirement can either
overstate or understate the assets you need to fund your retirement.
This can occur because:</p><ul><li>Some non-recurring expenses (such as
travel expenses, new cars, pre-Medicare healthcare premiums, home
remodeling expenses) are primarily front-loaded during retirement, or</li><li>Some non-recurring expenses (such as long-term care or bequest motives) are primarily back-loaded during retirement</li></ul><p>If
you want to develop a more realistic financial plan during retirement
that reflects non-linear spending, we recommend you use a model like the
Actuarial Financial Planner (AFP). The AFP distinguishes between future
expected essential, discretionary, recurring and non-recurring
expenses. See our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2022/04/planning-for-non-recurring-expenses-in.html" target="_blank">post of April 16, 2022</a> for more discussion of this
topic and our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/12/estimating-present-values-of-long-term.html" target="_blank">post of December 8, 2023</a> for discussion of steps you can
take if there are an insufficient number of cells in the AFP to perform
calculations of the present values of your non-recurring expenses (or
other present values). <br /></p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-3314884631190144912024-02-19T14:20:00.004-05:002024-02-19T14:20:54.569-05:00Time to Reduce Your Investment Risk?<p></p><p>With the
S&P creeping up over 5,000, it may be time for retirees to look into
decreasing their investments in risky assets, especially if their Floor
Portfolio of non-risky assets/investments does not cover the present
value of their expected future essential expenses. </p><p>You can read
more about what we consider to be the most important planning decision
in retirement in our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2022/10/the-most-important-retirement-planning.html" target="_blank">post of October 16, 2022</a>.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-2961088241995161842024-01-29T19:35:00.002-05:002024-01-29T19:35:12.321-05:00American Academy of Actuaries Reinserts Caveat Language into Their Social Security Challenge/Game<p></p><p>Kudos
to the American Academy of Actuaries (AAA) for reinserting the
following caveat language in its Social Security Challenge tool. <span></span></p><a name='more'></a><p></p><p>“The following should be noted when interpreting results from the Social Security Game:</p><ul><li>The
75-year actuarial balance calculation used in the game does not
consider significant revenue shortfalls expected to occur after the end
of the 75-year projection period, and thus possible solutions
illustrated in this game are generally not sufficient to achieve
“sustainable solvency,” a concept discussed in the Trustees Report.</li><li>The
possible solutions assume immediate adoption of System changes, rather
than gradual implementation. If changes to the System are gradually
implemented, the required increases in tax revenue or benefit decreases
will need to be larger than noted in the game to achieve actuarial
balance.</li><li>The success of reforms will depend on how well actual
future experience compares with the assumptions made by the trustees and
the Social Security actuaries. There is no mechanism in current Social
Security law to maintain the program’s actuarial balance once it has
been achieved. Thus, there can be no guarantee that the System’s
long-term problem will be “solved” for any specific length of time by
enacting various system changes.”</li></ul><p>We discussed the deletion of these important caveats in our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/07/why-did-american-academy-of-actuaries.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/07/why-did-american-academy-of-actuaries.html" target="_blank">post of July 29, 2023</a>.</p><p>Now
if only we can get the Academy to stop ignoring the Valuation Date
Creep and its impact on Social Security’s funded status deterioration
since 1983 as discussed most recently in our posts of <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/actuaries-continue-to-ignore-valuation.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/actuaries-continue-to-ignore-valuation.html" target="_blank">September 23, 2023 </a>and <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2024/01/actuaries-confuse-primary-causes-of.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2024/01/actuaries-confuse-primary-causes-of.html" target="_blank">January 20, 2024</a>. <br /></p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-86919280220865992982024-01-20T13:26:00.005-05:002024-01-20T13:26:53.018-05:00Actuaries Confuse the Primary Causes of the Social Security Funding Shortfall<p>The American Academy of Actuaries (Academy) recently published its <a data-mce-href="https://www.actuary.org/sites/default/files/2024-01/pension-brief-2023-socsec-TR.pdf" href="https://www.actuary.org/sites/default/files/2024-01/pension-brief-2023-socsec-TR.pdf" target="_blank">annual Actuarial Perspective</a>
on the annual OASDI (Social Security) Trustees Report. Usually, these
briefs are published by the Academy shortly after release of the
trustee’s report, but this year’s brief (covering last year’s 2023
report) was significantly delayed for some reason.</p><p>Among other
things, this year’s actuarial perspective on Social Security attempts to
convince us that system’s current funding shortfall “was mostly caused
by economic factors that came up short of expectations, including the
growth of taxable payroll, and trust fund investment returns.” This is
apparently the same conclusion reached by the system’s Chief Actuary as
discussed in the article entitled, “<a data-mce-href="https://www.msn.com/en-us/money/retirement/here-s-the-real-cause-of-the-social-security-funding-shortfall-according-to-the-program-s-chief-actuary/ar-AA1hkEcT?ocid=msedgntp&cvid=ef83daa12eb84a3286b6fc94f4912f53&ei=10" href="https://www.msn.com/en-us/money/retirement/here-s-the-real-cause-of-the-social-security-funding-shortfall-according-to-the-program-s-chief-actuary/ar-AA1hkEcT?ocid=msedgntp&cvid=ef83daa12eb84a3286b6fc94f4912f53&ei=10" target="_blank">Here’s the real cause of the Social Security funding shortfall, according to the program’s chief actuary</a>”<span></span></p><a name='more'></a><p></p><p>As
discussed in several of our prior posts, there are two primary causes
of the current Social Security funding shortfall (deterioration of the
long-range actuarial imbalance since 1983):</p><ol><li>Congressional inaction to address the system’s consistently deteriorating actuarial status, and</li><li>Actual system experience less favorable than assumed since 1983.</li></ol><p>As discussed in our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/actuaries-continue-to-ignore-valuation.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/actuaries-continue-to-ignore-valuation.html" target="_blank">post of September 23, 2023</a>,
Table 1 of the Social Security Administration’s Actuarial Note 2023.8
serves as a very effective analysis of the difference between actual and
assumed system experience by primary assumption source since 1983 (item
2 above). </p><p>The key take-aways from SSA Actuarial Note 2023.8 include:</p><ul><li>The
system’s funded status (long-range actuarial balance) has declined
fairly continuously over the past 40 years from 0.02% of taxable payroll
in 1983 to -3.61% in 2023.</li><li>Of this decline, 64% is attributable
to annual changes in the valuation period (which I refer to as “the
Valuation Date Creep”), 30% of the decline is attributable to economic
data and assumptions and about 13% of the decline is attributable to
disability data and assumptions.</li><li>Demographic data and
assumptions, which is frequently cited as a major factor in the system’s
funded status decline since 1983, has actually had a small positive
effect (-3%).</li><li>Even if all assumptions are realized in the
future, the system’s funded status is expected to keep deteriorating
under current law because of the “Valuation Date Creep.”</li></ul><p>Note that while Actuarial Note 2023.8 does support a conclusion that less favorable than assumed <b>economic</b>
experience contributed to the current funding shortfall, it shows that
this source is only 30% of the total shortfall and less than one-half of
the size of the Valuation Date Creep source, and therefore certainly
not mostly responsible for the system’s current shortfall or the “real”
cause of the system’s funded status deterioration. </p><p>As discussed in our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/actuaries-continue-to-ignore-valuation.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/actuaries-continue-to-ignore-valuation.html" target="_blank">post of September 23, 2023</a>,
the Valuation Creep results from the implicit assumption adopted by the
Trustees and system’s Chief Actuary that system revenue will equal
system income for years after the 75-year projection period. This has
been an unreasonable assumption since 1983 and, in our opinion, should
be fixed and its negative effect on the system’s funding should be
acknowledged by the Academy.</p><p>I do credit the Academy for raising
the possibility of implementing automatic adjustments as a means of
addressing the number 1 cause of Social Security’s funding deterioration
noted above. We advocated such an approach in our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/automatic-funded-status-adjustments-for.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/automatic-funded-status-adjustments-for.html" target="_blank">post of September 28, 2023</a>, Automatic Funded Status Adjustments for Social Security is a Great Idea.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-72866251994789490562024-01-05T16:46:00.001-05:002024-01-05T16:46:12.038-05:00It’s that Time Once Again for Retired Households to Perform Their Actuarial Valuations<p></p><p>At
the beginning of each calendar year, we encourage our retired (or
near-retired) readers to perform an actuarial valuation of their
household assets and spending liabilities to see whether changes should
be made to their financial plans. A household actuarial valuation
involves calculating and comparing present values of household assets
and household spending liabilities for the purpose of determining the
household’s <strong>Funded Status</strong>. To do this, we suggest you
follow the easy 5-step valuation process outlined below using our
Actuarial Financial Planner (AFP) models.</p><p>2023 was a better year
for retirees after a pretty tough 2022. Most of us experienced
better-than-assumed investment return experience, rising interest rates
and lower levels of price inflation. As a result, we increased the
default assumptions used in the AFP to estimate future investment
returns and decreased the default assumption for future inflation (as
discussed in our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/11/weve-changed-default-assumptions-in.html" target="_blank">post of November 16, 2023</a>). The combined effect of more
favorable experience during 2023 and changes in our default assumptions
will generally increase household funded statuses as of January 1,
2024. <span></span></p><a name='more'></a><p></p><p>To help you with your actuarial valuation this year, we
suggest that you review your entries in previous year’s valuations
(which we hope you printed out, made notes on and filed away in a place
you can find). Since the actuarial valuation process is a
self-correcting process, we strongly encourage you to maintain a record
of the progress of your funded status from year to year. This record
will provide you with important trend information that will enable you
to make better future financial decisions.</p><p><strong>Easy 5-Step actuarial valuation process</strong></p><p>As
discussed in our post of August 23, 2023, here is a summary of our
recommended annual actuarial valuation process (and a few hints):</p><p>Step
1: Make reasonable assumptions about the future. You can use our
default assumptions, or you can override these assumptions by using the
override function by clicking on the appropriate cell in column D,
changing it to enable the override option and entering the override
assumption in column F. Assumptions also need to be made for specific
future increases in inputted assets or liabilities. Note that the
default assumptions for lifetime planning periods are based on 25%
probability of survival for non-smokers in excellent health from the
Actuaries Longevity Illustrator. They assume passing will occur after
the LPP and no “pieces” of a household member will die prior or after
that time. Note that, unlike most other models you may see, separate
investment return assumptions can be assumed for non-risky and risky
investments.</p><p>Step 2A: Enter Asset information (Rows 7-17 for the
Single Retiree workbook and Rows 8-28 for the Retired Couple workbook).
Enter the percentage of these assets/investments considered to be risky
asset investments (Upside) vs. non-risky investments (Floor). Increase
last year’s Social Security benefits to reflect the cost-of-living
increase starting in 2024. </p><p>Step 2B. Enter your planned spending
in retirement (Rows 19-31 for the Single Retiree workbook and Rows 29-42
for the Retired Couple workbook). Be honest with yourself about your
expected and unexpected recurring and non-recurring expenses for 2024
(or later years if they are expected to start later than 2024), as well
as future expected annual increases to these expenses. Estimate the
percentage of these expenses you believe to be “essential” vs.
“discretionary.”</p><p>Hints: </p><ul><li>You might want to start with
the same amounts you entered last year (or actual spending for last year
if significantly different) and increase these relevant amounts with
expected inflation for 2024.</li><li>Hover your cursor over red triangles in the spreadsheet for specific cell hints</li><li>Enter
new data into data input cells. Don’t change cells that are not data
input cells or you may overwrite the spreadsheet formulas. </li><li>See
our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2020/12/how-should-future-social-security.html" target="_blank">post of December 6, 2020</a> for discussion of possibly adjusting the
present value of Social Security benefits to anticipate future reform
reductions.</li><li>See our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/12/estimating-present-values-of-long-term.html" target="_blank">post of December 8, 2023</a> for discussion of
estimating Long-Term Care expense present values and how to calculate
present values inside or outside the AFP to enter into unassigned PV
cells.</li><li>See our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/05/dont-forget-your-taxes.html" target="_blank">post of May 6, 2023</a> regarding taxes, especially
if you expect your taxes will be significantly different from today’s
taxes (i.e., once you commence Required Minium Distributions from your
tax-deferred accounts).</li><li>See our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2022/04/planning-for-non-recurring-expenses-in.html" target="_blank">post of April 16, 2022</a> regarding planning for non-recurring expenses.</li><li>Some expenses (for example future medical expenses) may be expected to increase at a rate faster than assumed inflation.</li><li>Research
has shown that real-dollar essential expense spending in retirement
generally does not decrease over time, but discretionary expense
spending does, so it may be reasonable to assume less than assumed
inflation increases for some or all recurring discretionary spending.</li></ul><p>Step
3A. Compare the present value of your planned essential expense
spending with the present value of your non-risky asset/investments. As a
result of this comparison, you may wish to consider changing your
risky/non-risky asset investment mix to be consistent with the
Safety-First Investment Strategy. </p><p>Step 3B. Compare the total
present values of household assets and spending liabilities (balance
sheet) to determine the household’s <strong>Funded Status</strong> (snapshot
comparison) and the size of your Rainy-Day Fund (surplus). Maintain a
history of your household Funded Status from year to year and note
trends.</p><p>Step 4. When warranted, make changes to assets or
liabilities (or both) to restore desired Funded Status (and/or to
address possible cash flow issues). See our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/01/automatic-funded-status-adjustments-to.html" target="_blank">post of January 7, 2023 </a>for
our recommend algorithm for determining when plan changes should be
implemented. Once you have “finalized” your inputs and produced an
Actuarial Balance Sheet, the section below the Actuarial Balance Sheet
will show you the components of your spending budget for 2024 that you
have inputted. See the section below for discussion of actions that you
may wish to consider this year. </p><p>Step 5. Periodically
evaluate/stress test assumptions to see if they need to be changed or to
assess risk and revisit the above steps at least annually to reflect
changes in your spending plan, retirement assets or in the assumptions
used to calculate present values.</p><p><strong>Actions to Consider</strong></p><p>Most
likely, your Funded Status will increase comfortably above 100% as of
January 1, 2024. You may still wish to consider some of the following
actions as a result of this year’s valuation:</p><ul><li>Do nothing. You can let your Rainy-Day Fund grow to mitigate future risks</li><li>Increase investments in non-risky assets to match the present value of household essential expenses if this is an issue</li><li>Increase discretionary spending this year</li><li>Strengthen the balance sheet by purchasing one or more life annuities,</li><li>Use more conservative assumptions with respect to the future,</li></ul><p>In
order to help households decide which actions they should consider; it
may be worthwhile this year to stress-test their plan by considering:</p><ul><li>What if future inflation is higher (or lower) than the default assumption of 3% per annum?</li><li>What if other assumptions are not as favorable as assumed?</li><li>What if their Social Security benefits are reduced as part of Social Security reform?</li><li>What if one of the household members dies earlier (or later) than assumed?</li></ul><p>These contingencies can all be fairly easily modeled in the AFP.</p><p><strong>Summary</strong></p><p>Retirement
planning is definitely easier (and more fun) when investment returns
exceed expectations, inflation is lower and your Rainy-Day Fund is
growing (i.e., “fish are jumpin and the cotton is high” from the song
“Summertime.”). Unless your 2023 spending far exceeded your 2023
spending budget, it is likely that your Funded Status grew from last
year.</p><p>The first step in your ongoing planning process is to
measure how you stand financially. That is, how your assets compare with
your spending liabilities (your Funded Status) and how big your
Rainy-Fund is. The AFP can help you employ the same general process used
by actuaries for defined benefit pension plans and for Social Security.
It’s time for you (and your spouse) to sit down and crunch your numbers
to see where you stand at the beginning of 2024. And, once you
determine where you stand, then you can consider the actions you should
consider.</p><p>Happy New Year and Happy Planning!</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-25761919876763827442023-12-27T08:25:00.003-05:002023-12-27T08:25:41.587-05:00Fixed Dollar SPIAs vs. Fixed Rate Cola SPIAs<p>In our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/12/is-it-good-time-to-buy-that-single.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/12/is-it-good-time-to-buy-that-single.html" target="_blank">last post,</a>
we asked whether now (or actually earlier this month) might be a good
time to purchase a single premium immediate annuity (SPIA) to strengthen
Floor Portfolios used to fund essential expenses. In that post (and
prior posts) we focused on SPIAs that provide fixed dollar payments each
month for life. In this post, we will discuss SPIAs that provide
lifetime payments with annual fixed rate “cost of living adjustment” (or
Cola) increases, and why you might want to consider this type of
annuity rather than a fixed dollar SPIA to strengthen your Floor
Portfolio. We include an example.<span></span></p><a name='more'></a><p></p><p><strong>SPIAs with fixed rate Cola increases</strong></p><p>Instead
of purchasing a SPIA with monthly fixed dollar payments for life, one
can purchase lifetime payments that increase annually by a fixed rate
(generally between 1% and 5% per annum). This rate is agreed upon in
advance in the insurance contract, and the annual rate of increase is
independent of actual inflation. Because payments are designed to
increase each year, they will start out less than an equally priced
fixed dollar SPIA and eventually increase above the fixed dollar SPIA if
the beneficiary lives long enough. The higher the contractual fixed
rate cola, the lower the initial starting payment, all things being
equal. Most SPIA sales in the U.S. involve fixed dollar (non-increasing)
payments and U.S. insurance companies no longer offer products that
increase payments based on the actual increase in inflation (i.e., based
on increases in a consumer price index).</p><p>The expected present
values of insurance company premium income and the present value of
payments made to beneficiaries who purchase these contracts, be they
fixed dollar payment SPIAs or the various fixed rate cola SPIAs, should
be roughly equal based on investment returns assumed by the insurance
company actuaries (net of expenses and insurance company profit margins)
and assumed life expectancies of the anticipated pool of purchasers. Of
course, the actuaries at different insurance companies make different
assumptions, and the prices of SPIA products can vary significantly from
company to company at any given time. This is why it is important to
obtain quotes from several different highly rated carriers before
actually making a purchase.</p><p>Once again, we remind you that we are
not insurance agents or financial advisors and have no financial
interest in any annuity purchase you may (or may not) make.</p><p><strong>Why consider a SPIA with a fixed rate cola</strong></p><p>Let’s assume you have the following goals/objectives with respect to your plan in retirement:</p><ul><li>Throughout
retirement you want to match the present value of your non-risky
investments with the present value of your expected future essential
expense spending consistent with the Safety-First Investment Strategy</li><li>You anticipate your future essential expenses will increase each year with inflation, and</li><li>You anticipate you will live longer than your life expectancy</li></ul><p>The
example below shows that a SPIA with a fixed rate cola can help you
better accomplish your objectives than a fixed dollar SPIA and can also
reduce your reinvestment risk.</p><p><strong>Example</strong></p><p>Let’s
assume that Bill is a single 65-year-old male. He is receiving an
annual Social Security benefit of $18,000 and he estimates his annual
recurring essential expenses at $25,000. Bill anticipates that these
expenses will increase by inflation increases of 3% per annum. Using the
default assumptions in the Actuarial Financial Planner (AFP) for Single
Retirees (including a lifetime planning period of 29 years and a 5%
discount rate), Bill calculates the present value of his annual
recurring essential expenses as $561,069. </p><p>Bill then calculates
the present value of his Social Security benefit using the same default
assumptions to be $403,970. To match his Floor Portfolio assets with his
estimated essential expense liabilities, he calculates he will need
additional non-risky investments with a present value of $157,099
($561,069 - $403,970) to cover the remaining $7,000 of annual real
dollar essential expenses.</p><p>Let’s assume that Bill can purchase
$8,000 per annum of fixed dollar lifetime income payable monthly
starting in one month for a premium of $100,000. Based on his recent
review of CANNEX annuity pricing, our friend and fellow actuary Joe
Tomlinson tells us that reasonable pricing for a comparably priced
lifetime annuity increasing by 2% per annum is about 83% of the 0% cola
price, or in this example, $6,640 per annum for a $100,000 premium. </p><p>Using
the AFP and the default assumptions, Bill determines the present value
of the $100,000 fixed dollar lifetime income contract to be $127,185, or
27% greater than the contract’s purchase price.</p><p>It is a little
more complicated for Bill to determine the present value of the $100,000
2% cola contract, but Bill accomplishes this by inputting the $6,640
annual amount as an indexed life annuity and overriding the inflation
assumption and entering 2% per annum to determine the present value of
this contract under default assumptions at $132,135, or 32% greater that
the contract’s purchase price. (He could have also used our separate
Present Value Calculator spreadsheet).</p><p>He determines that if he
spends $125,000 instead of $100,000 on the contract premiums, he will
have sufficient present values under either contract to more than match
his essential expense liabilities. In this event, then, Bill will either
receive $10,000 per annum for life under the fixed dollar contract, or
$7,968 per annum, under the 2% increasing contract.</p><p>Both of these
contracts will provide more than Bill needs initially to satisfy his
essential expense spending ($3,000 more for the fixed dollar contract
and $968 more for the 2% increasing contract). In order for Bill to use
either of these contracts to match his anticipated essential expense
spending, he will therefore have to save and invest the excess received
in the early years in order to satisfy later year real dollar spending
needs. This timing issue can create reinvestment risk. </p><p>In
addition to providing a higher present value based on Bill’s assumptions
for the future, the 2% increasing contract involves less reinvestment
risk. Perhaps Bill should also explore purchasing a 3% per annum
increasing contract.</p><p><strong>Summary</strong></p><p>Effective
retirement planning involves matching household assets with household
spending liabilities. If you are going to be conservative about how long
you expect to live for determining your liabilities, you should
presumably use consistent assumptions for how long you expect to live
for determining your assets. This is why you should look at lifetime
guaranteed insurance contracts because they favor those who live longer.
And, as demonstrated in the example above, you may also wish to look at
fixed cola SPIAs. To quote Joe Tomlinson,</p><p>“If I was purchasing a
SPIA today, and wanted match up with expected fixed expenses not covered
by Social Security, I would likely choose a COLA at a rough estimate of
future inflation (2.5%?) rather than trying to get a bit extra with a
level SPIA.”</p><p>Happy planning!</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-65087313340462043912023-12-10T18:45:00.002-05:002023-12-10T18:46:45.427-05:00Is It a Good Time to Buy That Single Premium Immediate Life Annuity, Updated<p>In
prior posts, we discussed possible assumptions used by life insurance
company actuaries in pricing single premium immediate life annuities
(SPIAs). In those posts, we provided implied discount rates consistent
with quotes obtained from ImmediateAnnuities.com under two different
mortality assumptions:</p><ul><li>based on life expectancy, or 50% probability of survival, and</li><li>based
on a 25% probability of survival, which is the longer expected lifetime
basis we recommend using in our website for planning purposes.</li></ul><p>In
this post, we will again examine the implied interest rate assumptions
built into recent quotes from ImmediateAnnuities.com and compare the
quotes and the implied interest rates with the results of the similar
exercise we performed and summarized in our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/is-it-good-time-to-buy-that-single.html" target="_blank">post of September 17, 2023</a>.
We will also discuss a few other considerations that may affect your
decision to buy a SPIA at this time.<span></span></p><a name='more'></a><p></p><p>The key takeaway from this
post is that implied interest rates (rates of return) on SPIAs have
generally increased somewhat in the past three months and are higher
than they have been for some time. We have no idea, however, if they are
going to increase even more in future months, or possibly decrease, for
that matter.</p><p>Remember that we receive zero direct or indirect
compensation from visits to this website or from any activity associated
with this blog, including this post. Therefore, any decision you make
with respect to annuity purchases will not affect us financially.</p><p><b>Updated Implied Interest Rates in Current SPIAs</b></p><p>The
second column of the tables below show monthly life annuity quotes for
males of different ages per $100,000 of premium from
Immediateannuities.com as of December 10, 2023 and September 17, 2023.
Life expectancies shown in third column are 50% probabilities of
survival from the Actuaries Longevity Illustrator (ALI) for non-smoker
males in excellent health (which have not been updated yet for this
year) in months. The fourth column (Implied Interest Rate) shows our
calculation of the fixed investment rate of return that would be earned
if a person bought the annuity and died at his current age plus his life
expectancy from the ALI table. This investment return is net of
insurance company expenses and profits (but not net of taxes). These
rates are nominal rates and not real (net of assumed inflation) rates. </p><p><b>Implied Interest Rates based on ALI Life Expectancy as of 12/10/2023</b></p><table border="1" data-mce-style="width: 90%;" style="width: 90%;"><tbody><tr><td width="96"><p><b>Current Age </b></p></td><td width="144"><p><b>Fixed Monthly Life Annuity</b></p></td><td width="138"><p><b>Life Expectancy in Months (based on AAA Longevity Illustrator 50% planning horizon for a non-smoking male in excellent health)</b></p></td><td width="156"><p><b>Implied Interest Rate</b></p></td></tr><tr><td width="96"><p>55</p></td><td width="144"><p>$584</p></td><td width="138"><p>396</p></td><td width="156"><p>6.0%</p></td></tr><tr><td width="96"><p>60</p></td><td width="144"><p>$620</p></td><td width="138"><p>336</p></td><td width="156"><p>6.1%</p></td></tr><tr><td width="96"><p>65</p></td><td width="144"><p>$677</p></td><td width="138"><p>276</p></td><td width="156"><p>6.1%</p></td></tr><tr><td width="96"><p>70</p></td><td width="144"><p>$758</p></td><td width="138"><p>216</p></td><td width="156"><p>6.0%</p></td></tr><tr><td width="96"><p>75</p></td><td width="144"><p>$869</p></td><td width="138"><p>168</p></td><td width="156"><p>5.8%</p></td></tr><tr><td width="96"><p>80</p></td><td width="144"><p>$1,040</p></td><td width="138"><p>108</p></td><td width="156"><p>2.6%</p></td></tr></tbody></table><p><b><br data-mce-bogus="1" /></b></p><p><b>Implied Interest Rates based on ALI Life Expectancy as of 09/17/2023</b></p><table border="1" style="width: 90%;"><tbody><tr><td width="96"><p><b>Current Age</b></p></td><td width="132"><p><b>Fixed Monthly Life Annuity for Male ($100,000 Single Premium</b></p></td><td width="148"><p><b>Life Expectancy in Months (based on AAA Longevity Illustrator 50% planning horizon for a non-smoking male in excellent health</b></p></td><td width="152"><p><b>Implied Interest Rate</b></p></td></tr><tr><td width="96"><p>55</p></td><td width="132"><p>$ 541</p></td><td width="148"><p>396</p></td><td width="152"><p>5.4%</p></td></tr><tr><td width="96"><p>60</p></td><td width="132"><p>$ 583</p></td><td width="148"><p>336</p></td><td width="152"><p>5.5%</p></td></tr><tr><td width="96"><p>65</p></td><td width="132"><p>$ 637</p></td><td width="148"><p>276</p></td><td width="152"><p>5.5%</p></td></tr><tr><td width="96"><p>70</p></td><td width="132"><p>$ 711</p></td><td width="148"><p>216</p></td><td width="152"><p>5.2%</p></td></tr><tr><td width="96"><p>75</p></td><td width="132"><p>$ 844</p></td><td width="148"><p>168</p></td><td width="152"><p>5.3%</p></td></tr><tr><td width="96"><p>80</p></td><td width="132"><p>$ 1,027</p></td><td width="148"><p>108</p></td><td width="152"><p>2.3%</p></td></tr></tbody></table><p>The
more recent table shows that annuity quotes from ImmediateAnnuities.com
have increased somewhat since September 17 and so have the implied
interest rates. As noted above, the implied interest rates consistent
with the ALI mortality table (50% probability of survival) for older
non-smoking annuitants in excellent health are much lower than for
younger annuitants, indicating that insurance company pricing for older
annuitants may assume longer life expectancies and/or lower interest
rates due to shorter assumed durations.</p><p>The tables below tell a
different story for individuals who live until their 25% probability of
survival age rather than their 50% probability of survival. It can be
argued that these implied rates of return are more applicable to
individuals considering an annuity purchase if their plan includes
living approximately five/six years longer than their life expectancy.</p><p><b>Implied Interest Rates based on 25% Probability of Survival as of 12/10/2023</b></p><table border="1" data-mce-style="width: 90%;" style="width: 90%;"><tbody><tr><td width="96"><p><b>Current Age </b></p></td><td width="144"><p><b>Fixed Monthly Life Annuity</b></p></td><td width="138"><p><b>Lifetime Planning Period (based on AAA Longevity Illustrator 25% planning horizon for a non-smoking male in excellent health)</b></p></td><td width="156"><p><b>Implied Interest Rate</b></p></td></tr><tr><td width="96"><p>55</p></td><td width="144"><p>$584</p></td><td width="138"><p>468</p></td><td width="156"><p>6.4%</p></td></tr><tr><td width="96"><p>60</p></td><td width="144"><p>$620</p></td><td width="138"><p>408</p></td><td width="156"><p>6.7%</p></td></tr><tr><td width="96"><p>65</p></td><td width="144"><p>$677</p></td><td width="138"><p>348</p></td><td width="156"><p>7.1%</p></td></tr><tr><td width="96"><p>70</p></td><td width="144"><p>$758</p></td><td width="138"><p>276</p></td><td width="156"><p>7.4%</p></td></tr><tr><td width="96"><p>75</p></td><td width="144"><p>$869</p></td><td width="138"><p>228</p></td><td width="156"><p>8.2%</p></td></tr><tr><td width="96"><p>80</p></td><td width="144"><p>$1,040</p></td><td width="138"><p>168</p></td><td width="156"><p>8.8%</p></td></tr></tbody></table><p><b><br data-mce-bogus="1" /></b></p><p><b>Implied Interest Rates based on 25% Probability of Survival as of 9/17/2023</b></p><table border="1" data-mce-style="width: 90%;" style="width: 90%;"><tbody><tr><td width="96"><p><b>Current Age </b></p></td><td width="144"><p><b>Fixed Monthly Life Annuity</b></p></td><td width="138"><p><b>Lifetime Planning Period (based on AAA Longevity Illustrator 25% planning horizon for a non-smoking male in excellent health)</b></p></td><td width="156"><p><b>Implied Interest Rate</b></p></td></tr><tr><td width="96"><p>55</p></td><td width="144"><p>$541</p></td><td width="138"><p>468</p></td><td width="156"><p>5.8%</p></td></tr><tr><td width="96"><p>60</p></td><td width="144"><p>$583</p></td><td width="138"><p>408</p></td><td width="156"><p>6.1%</p></td></tr><tr><td width="96"><p>65</p></td><td width="144"><p>$637</p></td><td width="138"><p>348</p></td><td width="156"><p>6.5%</p></td></tr><tr><td width="96"><p>70</p></td><td width="144"><p>$711</p></td><td width="138"><p>276</p></td><td width="156"><p>6.7%</p></td></tr><tr><td width="96"><p>75</p></td><td width="144"><p>$844</p></td><td width="138"><p>228</p></td><td width="156"><p>7.8%</p></td></tr><tr><td width="96"><p>80</p></td><td width="144"><p>$1,027</p></td><td width="138"><p>168</p></td><td width="156"><p>8.6%</p></td></tr></tbody></table><p>It
is interesting to note that implied interest rates (or rates of return)
for older annuitants are higher than implied returns for younger
annuitants on this alternate “planning” mortality basis. This is because
moving from 50% probability of survival to 25% probability of survival
generally adds about five/six years to the expected time of death, and
an additional five/six years is a much more significant increase for an
80-year-old than it is for a 55-year-old (and may explain why insurance
companies may be more likely to assume greater anti-selection by older
annuitants in their pricing).</p><p>The above charts develop implied
interest rates on two mortality bases for current annuity quotes for
males. Based on a quick review, it appears that comparable implied rates
of return at the illustrative ages shown would also be developed for
current SPIA quotes for females.</p><p><b>Is Now the Right Time to Buy a SPIA? Some Other Considerations</b></p><p>There
are many plusses and minuses associated with buying SPIAs vs. investing
your retirement assets in other vehicles that we are not going to
repeat here. We know that there are many intelligent people out there
who buy many forms of insurance to protect their assets but find the
thought of purchasing longevity risk protection sold by insurance
companies (in the form of an SPIA) to be an anathema. If you are one of
those people, you probably haven’t made it this far in the post. For
those readers still reading, here are a few other considerations that
you might want to think about before making your decision regarding
annuity purchases.</p><ul><li>Buying an SPIA will generally strengthen
your Funded Status as determined by the Actuarial Financial Planner. For
example, based on current default assumptions for the AFP, a
65-year-old male who spends $100,000 on a SPIA at today’s rates will
increase the present value of his retirement assets by $29,156. A
65-year-old male who plans to live to 100 (rather than the default
assumption of 94) will increase the present value of his assets by
$39,675 by making the same purchase.</li><li>With recent
higher-than-expected levels of price inflation, the present value of
your non-risky assets may no longer cover the present value of your
essential expenses and you may want to strengthen your “Floor Portfolio”
at this time.</li><li>Many individuals are convinced that investment in SPIAs is less liquid than investment in bonds. If your bond investments are <b>dedicated</b> to funding your essential expenses, this sense of increased liquidity over annuities may be illusory.</li></ul><p><b>Conclusion</b></p><p>Increases
in interest rates in the recent past have generally increased the
amount of current monthly immediate life annuity that may be purchased
with a given premium amount and has increased implied interest rates (or
rates of return) on currently available SPIAs. We have no way of
knowing whether additional increases in interest rates used to price
SPIAs can be expected at this time. We are not investment advisors or
insurance brokers and cannot provide advice on timing or the financial
advisability of SPIA purchases. We do plan to continue to monitor
implied rates of return on SPIAs in this blog (on both a pricing and
planning basis).</p><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 455.3666687011719px; height: 4px; width: 915px; " data-row="0" style="cursor: row-resize; height: 4px; left: 8px; margin: 0px; padding: 0px; position: absolute; top: 455.367px; width: 915px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 496.95001220703125px; height: 4px; width: 915px; " data-row="1" style="cursor: row-resize; height: 4px; left: 8px; margin: 0px; padding: 0px; position: absolute; top: 496.95px; width: 915px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 538.5333251953125px; height: 4px; width: 915px; " data-row="2" style="cursor: row-resize; height: 4px; left: 8px; margin: 0px; padding: 0px; position: absolute; top: 538.533px; width: 915px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 580.11669921875px; height: 4px; width: 915px; " data-row="3" style="cursor: row-resize; height: 4px; left: 8px; margin: 0px; padding: 0px; position: absolute; top: 580.117px; width: 915px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 621.7000122070312px; height: 4px; width: 915px; " data-row="4" style="cursor: row-resize; height: 4px; left: 8px; margin: 0px; padding: 0px; position: absolute; top: 621.7px; width: 915px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 663.2833251953125px; height: 4px; width: 915px; " data-row="5" style="cursor: row-resize; height: 4px; left: 8px; margin: 0px; padding: 0px; position: absolute; top: 663.283px; width: 915px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 703.2833251953125px; height: 4px; width: 915px; " data-row="6" style="cursor: row-resize; height: 4px; left: 8px; margin: 0px; padding: 0px; position: absolute; top: 703.283px; width: 915px;"></div><div class="mce-resize-bar mce-resize-bar-col" data-col="0" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: col-resize; margin: 0; padding: 0; position: absolute; left: 175.11666870117188px; top: 371.6166687011719px; height: 336px; width: 4px; " style="cursor: col-resize; height: 336px; left: 175.117px; margin: 0px; padding: 0px; position: absolute; top: 371.617px; width: 4px;"></div><div class="mce-resize-bar mce-resize-bar-col" data-col="1" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: col-resize; margin: 0; padding: 0; position: absolute; left: 420.26666259765625px; top: 371.6166687011719px; height: 336px; width: 4px; " style="cursor: col-resize; height: 336px; left: 420.267px; margin: 0px; padding: 0px; position: absolute; top: 371.617px; width: 4px;"></div><div class="mce-resize-bar mce-resize-bar-col" data-col="2" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: col-resize; margin: 0; padding: 0; position: absolute; left: 655.5499877929688px; top: 371.6166687011719px; height: 336px; width: 4px; " style="cursor: col-resize; height: 336px; left: 655.55px; margin: 0px; padding: 0px; position: absolute; top: 371.617px; width: 4px;"></div><div class="mce-resize-bar mce-resize-bar-col" data-col="3" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: col-resize; margin: 0; padding: 0; position: absolute; left: 918.5499877929688px; top: 371.6166687011719px; height: 336px; width: 4px; " style="cursor: col-resize; height: 336px; left: 918.55px; margin: 0px; padding: 0px; position: absolute; top: 371.617px; width: 4px;"><br /></div>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-82017426057495972112023-12-08T20:07:00.007-05:002023-12-08T21:40:14.107-05:00Estimating Present Values of Long-Term Care Costs and Survivor Benefits Payable After the First Death Within a Couple<p></p><p>The
Actuarial Approach recommended in this website involves periodically
(generally annually) comparing the present value of a retired
household’s assets with the present value of its anticipated household
spending liabilities to develop its <b>Funded Status</b> as of
a valuation date (generally the beginning of the current year). The
present value of assets used in this comparison is the current market
value of accumulated savings plus discounted values of future lump sum
payments or streams of payments from other income sources. The present
value of household spending liabilities is the discounted value of
future lump sum expenses or streams of expenses. To help retired
households allocate their assets between risky (Upside Portfolio) and
non-risky (Floor Portfolio) investments, separate rates (investment
return assumptions) are used to discount future essential
expenses/non-risky asset sources and future discretionary expenses/risky
asset sources. <span></span></p><a name='more'></a><p></p><p>If relevant information is entered into the Input
tab of the Actuarial Financial Planners (AFP), the necessary present
values used in the Funded Status calculation are calculated in the AFP
model, and results are shown in the PVCalcs tab and are summarized in
the Actuarial Balance Sheet. Alternatively, present values may be
calculated outside the AFP model and separately entered into relevant
“other PV” asset or liability cells. We provide a separate Present Value
Calculator spreadsheet to facilitate present value calculations not
directly calculated in the AFP for this purpose.</p><p>In order to avoid
the classic Garbage-In, Garbage-out problem when using the AFP, care
needs to be taken to accurately input asset and expense items into the
model (only in the input section) and to avoid double counting of asset
information or understating future expenses. Also, changes in the AFP
spreadsheet should not be made in any cell other than the appropriate
input cell in the Input section of the Input/Results tab. Hint on this:
Don’t input or change values in cells that utilize formulas to develop
values. If you do, you may ruin the spreadsheet and then you may need to
download and enable a new spreadsheet and start over.</p><p>Recently,
we have received several inquiries about how to use the AFP to estimate
the present values of long-term care expenses (a liability) and survivor
benefits expected to be received after the first death within a couple
(an asset). In this post we will discuss how to do this and include an
example. We will also discuss what to do if there are an insufficient
number of cells in the AFP to perform these or other PV calculations.
Readers may wish to re-visit our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2022/04/planning-for-non-recurring-expenses-in.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2022/04/planning-for-non-recurring-expenses-in.html" target="_blank">post of April 16, 2022</a> for discussion of determining present values of non-recurring expenses, including Long-Term Care expenses, and our <a data-mce-href="Within" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2017/11/survivor-payments-anticipated-after.html" target="_blank" title="https://howmuchcaniaffordtospendinretirement.blogspot.com/2017/11/survivor-payments-anticipated-after.html">post of November 21, 2017 </a>for discussion of how to develop present values of survivor benefits. </p><p><b>Example Calculations</b></p><p><i>Survivor Benefits</i></p><p>Roger
is 74 years old and his spouse, Susan, is 66. Roger has a Social
Security benefit of $28,000 per annum that he is currently receiving,
and Susan’s Social Security benefit is $14,000 per annum that she
expects to start this year. Roger also has two fixed dollar pension
benefits currently paying him $5,000 and $8,000 per annum with 100% of
his benefit to continue to Susan if she survives him. Roger’s expected
lifetime planning period (LPP) using the AFP default assumptions is 19
years and Susan’s is 30 years. Therefore, under the default planning
assumptions, Roger is expected to pass 11 years before Susan.</p><p>Roger
separately develops the present values of his and Susan’s Social
Security benefits payable over their respective LPPs by entering their
current benefits in cells 9E and 19E of the AFP for Retired Couples. The
present value of Roger’s Social Security benefit payable over his
remaining lifetime under the default assumptions is $449,935. Roger
wants to also include in household assets the present value of Susan’s
higher Social Security benefit that she is expected to receive after his
death (which he determines will be $14,000 in today’s dollars). In cell
E 27 (other income #1), he enters $24,549 ($14,000 increased by 19
years of assumed 3% cost of living increases). In the remaining cells in
row 27, he enters the amounts for the Soc. Sec. Survivor item shown
below. Going to cell I 6 of the PVCalcs tab, he sees that the present
value of Susan’s Social Security survivor benefits is $97,246 based on
the input amounts below and default assumptions. </p><p>Because he has
at least three “other income” sources of income (He may want to downsize
his house in the future and he has life insurance), he decides to zero
out the Other Income #1 cell after calculating the Social Security
survival present value, separately calculate the present values of the
survivor benefits for his two fixed pensions, add all three survivor
present values together and insert the sum in cell D 26 (PV Other
Sources of Income)</p><table border="1" cellpadding="1" cellspacing="1" style="width: 100%;"><tbody><tr><td width="96"><p>Item Name</p></td><td width="76"><p>Annual Amount</p></td><td width="72"><p>Deferral Period</p></td><td width="78"><p>Payment Period</p></td><td width="84"><p>Annual Rate of Increase</p></td><td width="96"><p>% Upside (Assets)/ % Essential (Liabilities)</p></td><td width="74"><p>Present Value</p></td></tr><tr><td width="96"><p>Soc. Sec. Survivor</p></td><td width="76"><p>$24,549</p></td><td width="72"><p>19</p></td><td width="78"><p>11</p></td><td width="84"><p>3%</p></td><td width="96"><p>0%</p></td><td width="74"><p>$97,246</p></td></tr><tr><td width="96"><p>Pension #1 Survivor</p></td><td width="76"><p>$5,000</p></td><td width="72"><p>19</p></td><td width="78"><p>11</p></td><td width="84"><p>0%</p></td><td width="96"><p>0%</p></td><td width="74"><p>$17,257</p></td></tr><tr><td width="96"><p>Pension #2 Survivor</p></td><td width="76"><p>$8,000</p></td><td width="72"><p>19</p></td><td width="78"><p>11</p></td><td width="84"><p>0%</p></td><td width="96"><p>0%</p></td><td width="74"><p>$27,612</p></td></tr></tbody></table><p><i>Long-Term Care Costs</i></p><p>Estimating
the present value of expected long-term care costs is a very tricky
proposition. Just a few of the factors to consider include:</p><ul><li>Whether or not you have long-term care insurance</li><li>Whether or not you will have children or others who may be available (or who will want) to take care of you</li><li>Expected costs of long-term care in the future</li><li>Your gender and life expectancy</li><li>Whether you will want semi-private or private rooms during long-term care</li><li>The general costs of long-term care in your region, and</li><li>Whether you anticipate using home equity values to fund these costs</li></ul><p>As indicated in our April 16,2022 post, you may access the <a data-mce-href="https://www.genworth.com/aging-and-you/finances/cost-of-care.html/" href="https://www.genworth.com/aging-and-you/finances/cost-of-care.html/" target="_blank">Genworth Cost of Care Survey</a> to find average costs of various long-term care services in your state.</p><p>Roger
and Susan decide to include an estimate of the present value of their
long-term care costs in their spending liabilities (as opposed to
assuming it will be paid with their home equity). They decide it is more
likely that Susan will need long-term care near the end of her lifetime
rather than Roger and, as recommended in our Overview assumption
recommendations, they plan to fund 60% of two years of assisted living
and one year of nursing home care for the final three years of Susan’s
life. As discussed in previous posts, the 60% factor results from
assuming recurring expenses in the final three years of life while in
long-term care will be significantly reduced. </p><p>They determine that
the average annual current cost where they live is about $50,000 for
assisted living care and $100,000 for nursing home care (or an average
annual cost during the 3-year period of care of about $67,000 in today’s
dollars). They also assume that these expenses will increase in the
future by assumed inflation plus 1% each year (4% per year), so they
enter $115,911 (.6 X $67,000 X 1.04**27) as the annual amount to be paid
in cell E 38 of the AFP (Expected Non-Recurring Expense #1) starting 27
years from now. The other entries and resulting present value shown in
cell I 28 in the PV Calcs tab is shown below. </p><table border="1" cellpadding="1" cellspacing="1" data-mce-style="width: 100%;" style="width: 100%;"><tbody><tr><td width="84"><p>Item Name</p></td><td width="84"><p>Annual Amount</p></td><td width="84"><p>Deferral Period</p></td><td width="78"><p>Payment Period</p></td><td width="90"><p>Annual Rate of Increase</p></td><td width="95"><p>% Upside (Assets)/ % Essential (Liabilities)</p></td><td width="67"><p>Present Value</p></td></tr><tr><td width="84"><p>Long-Term Care</p></td><td width="84"><p>$115,911</p></td><td width="84"><p>27</p></td><td width="78"><p>3</p></td><td width="90"><p>4%</p></td><td width="95"><p>100%</p></td><td width="67"><p>$92,255</p></td></tr></tbody></table><p>Roger
and Susan decide to reserve more than $92,255 to fund expected
long-term care costs as Roger may need some care before he passes, and
they simply want to be more conservative with respect to this possible
expense. Since Roger has another expense to input in row 38 of the
spreadsheet, he zeros out the above calculation and inputs the amount
they decided to reserve for long-term care expenses in cell D 36 of the
Input/Results tab.</p><p>When he “finalizes” his spreadsheet, Roger
prints it out and makes notes on it so that he can remember how he
developed this year’s numbers (including those above) when it comes time
to perform next year’s asset/liability valuation. Roger understands
that most of the numbers will change next year. </p><p>Have fun playing with your AFP, everyone!</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-86110420605501724872023-11-25T16:15:00.002-05:002023-11-25T16:15:15.796-05:00“Safe” Withdrawal Rate Brouhaha<p>Periodically,
we read articles from William Bengen, the inventor of the safe
withdrawal rate (otherwise known as the 4% Rule), from various esteemed
retirement academics, from the retirement researchers at Morningstar or
from other retirement experts about this year’s version of the 4% Rule.
For example, in 2021, Morningstar experts told us that the initial safe
withdrawal rate was 3.3%. Then in 2022, they told us that it was 3.8%,
and this year, it is back up to 4% as long as equity investments don’t
exceed 40% of the retiree’s portfolio. And while the basic safe
withdrawal rate may vary somewhat from year to year based on current
economic conditions and whether or not it is followed blindly without
adjustment (increasing the initial withdrawal amount by inflation each
year), researchers generally have determined that historical investment
experience supports a conclusion that an annual withdrawal in the
neighborhood of 3-5% of a retiree’s portfolio at retirement, increased
annually by inflation, has a high probability of lasting at least 30
years without depleting portfolio assets, assuming about 50% of the
portfolio assets is invested in equities.<span></span></p><a name='more'></a><p></p><p>Therefore, the
retirement researcher community was rather surprised when Dave Ramsey,
nationally syndicated financial radio personality and host of The Ramsey
Show, recently indicated in his YouTube <a data-mce-href="https://www.youtube.com/live/Xg4Z8EQY3Ao?si=_uD9IF2q75pGiXSO" href="https://www.youtube.com/live/Xg4Z8EQY3Ao?si=_uD9IF2q75pGiXSO" target="_blank">November 2, 2023 podcast</a>
(starting at about 1:13) that retirees who invest 100% of their
portfolio in equities can safely withdraw 8% of their portfolio in the
first year of retirement and increase that amount by inflation each year
indefinitely without depleting their portfolio. In his podcast, Mr.
Ramsey warned his listeners to “stay away from the 4% morons” and
“goobers [stupid nerds] who put 4% out on the market.”</p><p>In response
to Mr. Ramsey’s podcast, esteemed retirement academics David Blanchett,
Michael Finke and Wade Pfau wrote an article for Think Advisor
entitled, “<a data-mce-href="https://www.thinkadvisor.com/2023/11/13/supernerds-unite-against-dave-ramseys-8-safe-withdrawal-rate-guidance/" href="https://www.thinkadvisor.com/2023/11/13/supernerds-unite-against-dave-ramseys-8-safe-withdrawal-rate-guidance/" target="_blank">Supernerds Unite Against Dave Ramsey’s 8% Safe Withdrawal Rate Guidance</a>.”
They do a good job of defending themselves and the rationale behind the
4% Rule rather than Mr. Ramsey’s 8% Rule, and we will not repeat their
arguments here. </p><p>Notwithstanding the recent brouhaha between Mr.
Ramsey and the Supernerds (and the majority of the retirement expert
community), we are not big fans of the 4% Rule. In fact, we are not big
fans of any static fixed percentage [X%] rule. In this post, we will
once again briefly remind our readers why we believe the Actuarial
Approach is superior to static withdrawal rules for planning near or
during retirement, and we encourage you to utilize the Actuarial
Approach either on a standalone basis or as an independent check of the
approach you are currently using.</p><p><strong>Advantages of the Actuarial Approach</strong></p><p>The
Actuarial Approach employs a model (Actuarial Financial Planner) and a
process that involves systematic comparison of household assets and
liabilities and tracking of the resulting household <strong>Funded Status </strong>over
time for the purpose of making better financial decisions in
retirement, including decisions relating to spending and investment.
This is the same general process used by actuaries to help ensure the
financial sustainability of many other financial systems, such as Social
Security and defined benefit pension plans.</p><p>The advantages of using the Actuarial Approach over a fixed percentage static withdrawal rule include:</p><ul><li>The Actuarial Approach is based future expectations, not on historical experience that may or may not be repeated in the future</li><li>It
develops a robust spending plan that reflects all user assets and
user-specific spending goals, not a simple withdrawal plan that ignores
non-portfolio assets and outputs only constant real- dollar annual
portfolio withdrawals.</li><li>It produces a dynamic spending plan, not a
static head-in-the-sand withdrawal plan designed to last for at least
30 years, but with no recourse if portfolio assets are depleted or
become larger than desired.</li><li>It automatically adjusts the
expected longevity planning period based on user age(s). The default
longevity planning periods may be overridden by the user if desired. </li><li>It
permits entry of alternative future assumptions for investment returns
on non-risky investments, investment returns on risky investments,
longevity planning periods and expected increases in future expenses.
This feature can be used to stress-test the user’s plan for alternative
future experience or to make the users plan more or less conservative.</li><li>It
produces a simple metric (funded status) that helps users decide when
their spending plan may be increased or should be decreased. This metric
is automatically adjusted from year to year to reflect variations in
investment returns, inflation, longevity, spending, sources of income
and assumptions about the future. By comparison, it is not clear how the
4% Rule is adjusted for these variations. As a simple example, how is
the 4% Rule adjusted for excess withdrawals in prior years or for
changes in the 4% Rule from year to year?</li><li>It permits users to
distinguish between user-selected-essential expenses and discretionary
expenses to facilitate risky vs. non-risky asset investment allocation
decisions</li><li>It permits users to distinguish between recurring and
non-recurring expenses, to select a reduction in spending upon the first
death within a couple and to assume different rates of future increases
in expenses to facilitate more accurate costing of expected future
spending.</li></ul><p><strong>Recommendation/Take Away</strong></p><p>As
with many other things these days, there does not appear to be complete
agreement among individuals with respect to a given topic. In this
case, the topic is the real-dollar amount that may be safely withdrawn
from a portfolio each year for the next 30 years (or more) without
depleting the portfolio. Retirement academics generally argue that the
amount to be safely withdrawn in the first year of a 30-year retirement
is about 4% of a portfolio invested about 50% in equities and 50% in
bonds. Dave Ramsey argues that 4% is way too conservative (stupid) and
he believes the amount should be closer to 8% of the individual’s
portfolio and the portfolio should be 100% invested in equities.</p><p>While
we tend to side with the Supernerds on most retirement-related issues,
we don’t necessarily have a problem if more aggressive retirees want to
push the spending envelope and use a higher withdrawal rate (but
probably closer to 4% than 8%). For those that do (or for those who
don’t), however, we recommend that they annually compare their plan with
the plan produced by the Actuarial Approach (inputting override
assumptions consistent with their plan) so that they can make necessary
spending adjustments in the future if warranted.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-60438369986035534282023-11-16T21:23:00.005-05:002023-11-16T21:23:40.792-05:00We’ve Changed the Default Assumptions in the Actuarial Financial Planner Models<p></p><p>The last time we changed the default assumptions in our Actuarial
Financial Planner (AFP) models was May of last year. Because interest
rates on government-issued securities have increased significantly since
then, implied investment returns on immediate annuities have also
increased and expectations for future inflation have decreased, we have
decided to change the default assumptions used in the AFPs as follows:</p><ul><li>Increase Investment return on Floor Portfolio assets from 4.5% per annum to 5.0% per annum,</li><li>Increase Investment return on Upside Portfolio assets from 7.5% per annum to 8.0% per annum, and</li><li>Decrease annual rate of inflation from 3.5% per annum to 3.0% per annum.</li></ul><p>Note
that we have increased the “real” assumed rates of return on Floor and
Upside Portfolio assets by 1% per annum. We have not changed the default
assumptions used in the model for lifetime planning periods.<span></span></p><a name='more'></a><p></p><p>You
are not required to use the default assumptions. They are provided to
give you our best estimate of future experience over your lifetime
planning period. To override the default assumptions, simply click on
the “Default” box in Column D and select “Override.” Then type the
override assumption in column F. So, for example, if you wanted to see
what the impact of using the new default assumptions is, you could enter
the old assumptions as override assumptions and compare the results
with the results produced by the new default assumptions. </p><p>The new
investment default investment return on Floor Portfolio assets of 5.0%
is less than the implied interest rate for immediate annuities for
retirees aged 70 and younger as discussed in our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/is-it-good-time-to-buy-that-single.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/is-it-good-time-to-buy-that-single.html" target="_blank"><u>post of</u><u>September 17, 2023</u></a> but
it is greater than the implied interest rate for immediate annuities
for retirees aged 75 and older. As discussed in our post of <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2020/04/discount-rate-investment-return.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2020/04/discount-rate-investment-return.html">April 11, 2020</a>, older retirees may wish to use a more conservative (lower) interest rate assumption for Floor Portfolio assets.</p><p>As discussed in our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2022/03/planning-on-temporary-higher-levels-of.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2022/03/planning-on-temporary-higher-levels-of.html" target="_blank">post of March 20, 2022</a>,
more conservative users may want to use a higher inflation assumption
to reflect expectations of temporary or longer-term higher levels of
inflation.</p><p>We will continue to monitor general interest rates,
implied rates of returns in immediate annuity contracts and rates of
inflation to see if additional changes in the default economic
assumptions used in the AFP may be warranted. We have not made similar
changes to our other spreadsheets, but you can change the default
assumptions in those workbooks by using the override feature discussed
above.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-43286684340282225142023-11-11T18:02:00.005-05:002023-11-11T18:02:55.957-05:00Confidently Boost Your Spending in Retirement with the Actuarial Approach<p></p><p>As
discussed many times in this website, the Actuarial Approach employs a
model and a process that involves systematic comparison of household
assets and liabilities and tracking of the resulting household <strong>Funded Status </strong>over
time for the purpose of making better financial decisions in
retirement, including decisions relating to spending and investment.
This is the same general process used by actuaries to help ensure the
financial sustainability of many other financial systems, such as Social
Security and defined benefit pension plans.</p><p>And while we tend to
focus on avoiding over-spending in retirement, there are certain
households that could probably afford to spend more if they wanted. In
his well-written <a data-mce-href="https://www.kitces.com/blog/retirement-spending-increase-financial-advisor-client-guardrails-guaranteed-income/?utm_source=ActiveCampaign&utm_medium=email&utm_content=RSS%3AITEM%3ATITLE++%5BNEV%5D&utm_campaign=NEV+Wednesday+Email+%28Copy%29+TEST&vgo_ee=PosnIiGfEWUTKXwP2sI0o9GTQw1SXepzxHbqKsusq6jmndM%3D%3Ae1qLjfVQOKNJjqHdyJczQBdkX9jwt%2FPZ" href="https://www.kitces.com/blog/retirement-spending-increase-financial-advisor-client-guardrails-guaranteed-income/?utm_source=ActiveCampaign&utm_medium=email&utm_content=RSS%3AITEM%3ATITLE++%5BNEV%5D&utm_campaign=NEV+Wednesday+Email+%28Copy%29+TEST&vgo_ee=PosnIiGfEWUTKXwP2sI0o9GTQw1SXepzxHbqKsusq6jmndM%3D%3Ae1qLjfVQOKNJjqHdyJczQBdkX9jwt%2FPZ" target="_blank">Kitces.com post of November 8, 2023</a>
Adam Van Deusen outlines several technical framing strategies and
behavioral tactics to help spending-hesitant clients increase their
spending in order “to have a more enjoyable retirement.” We generally
agree with Mr. Van Deusen’s recommendations and encourage you to read
his article. In this post, we will focus on his recommended technical
framing strategies (summarized below) and discuss how these strategies
are easily accomplished using the Actuarial Approach. <span></span></p><a name='more'></a><p></p><p> Kitces Framing Strategy Recommendations to Boost Retirement Spending</p><ol><li>Avoiding Success Vs. Failure Framing of Monte Carlo Analysis</li><li>Segmenting Spending into “Core” and “Adaptive” Buckets</li><li>Boosting Guaranteed Income Sources</li></ol><p><strong>Avoiding Success Vs. Failure Framing of Monte Carlo Analysis</strong></p><p>Mr.
Van Deusen correctly points out several of the potential deficiencies
of Monte Carlo probability-of-success modeling. He says:</p><p>“Retired
clients who have ample assets to spend but are spending less than they
would like because they are afraid of plan failure could be particularly
sensitive to their plan's Monte Carlo results. For instance, these
clients might want to curb their spending now to maximize the
probability of success or to preclude the potential for dramatic
reductions to their income in the future, even though the need for such
major spending reductions in the future might be highly unlikely.”</p><p>By
comparison, the Actuarial Approach does not calculate “hard to
understand” probabilities of success. Instead, we encourage households
to focus on the relatively simple ratio of assets to spending
liabilities (Funded Status) and the progress of the household’s Funded
Status over time. So, if the household Funded Status is currently
significantly in excess of 100% and/or if its Funded Status has
increased relatively steadily over time, the household may be encouraged
to explore possible spending increases. Also, households can supplement
this easy to-understand Funded Status information with additional
information obtained from “what-if” testing to further increase spending
confidence.</p><p>Another reason we believe the Actuarial Approach is
superior to Monte Carlo modeling for encouraging spending-hesitant
households to increase spending is its ability to:</p><ul><li>distinguish between recurring vs. non-recurring expenses,</li><li>anticipate reductions in expenses after the first death within the couple, and to</li><li>assume lower than inflationary rates of increases in future discretionary spending.</li></ul><p>These
features are generally not available in Monte Carlo models, but are
available in the Actuarial Approach. For example, if a household with a
30-year time horizon has a goal to enjoy traveling only for the next 15
years, it is unnecessary to fund travel expenses each year for the
expected remaining lifetime of the couple. It is also more reasonable to
assume some drop in anticipated expenses after the first death within
the couple. Finally, research has shown that discretionary spending
generally decreases in real dollars as we age, so it may be reasonable
to assume such future spending will not keep up with assumed rates of
inflation.</p><p><strong>Segmenting Spending into “Core” and “Adaptive” Buckets</strong></p><p>This
is another framing suggestion that we don’t normally see in Monte Carlo
modeling but we recommend in the Actuarial Approach. As discussed in
our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/11/bucketing-by-expense-type-with.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/11/bucketing-by-expense-type-with.html" target="_blank">previous post</a>,
we recommend the use of two separate buckets to fund future essential
and discretionary spending expenses with the present value of low-risk
guaranteed investments (including the present values of Social Security
benefits, pensions, annuities, etc.) comprising the Floor Portfolio used
to fund the present value of essential spending and risky investments
comprising the Upside Portfolio used to fund future discretionary
spending. Since these spending categories are selected by the household
in a manner consistent with their spending desires and tolerance for
risk, we fail to see any significant benefit in renaming such buckets as
“core” and “adaptive” vs. essential and discretionary as suggested by
Mr. Van Deusen.</p><p><strong>Boosting Guaranteed Income Sources</strong></p><p>As
noted above, the Actuarial Approach promotes the use of a Floor
Portfolio of low-risk guaranteed income sources to fund essential
spending. Also, as discussed above, we leave it up to the household to
decide which expenses and assets should be classified as essential and
which discretionary. We agree with Mr. Van Deusen that matching
investment in low-risk guaranteed income with funding of essential
expenses can increase household spending confidence if utilized.</p><p><strong>Summary</strong></p><p>We
thank Mr. Van Deusen for pointing out the framing deficiencies in Monte
Carlo modeling approaches typically used by financial advisors and for
giving us the opportunity to tout the Actuarial Approach as a better
alternative for encouraging spending-resistant households to increase
their spending if desired and warranted.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-46709561598586259982023-11-05T16:25:00.000-05:002023-11-05T16:25:59.221-05:00Bucketing by Expense Type with the Actuarial Approach<p>Many financial advisors employ time
segmentation buckets (sometimes simply referred to as “bucketing”) to
help their clients fund their desired retirement spending. This usually
involves three buckets based on the expected timing of future spending:
short-term, intermediate-term and long-term spending. The Actuarial
Approach advocated in this website encourages the use of a different
bucketing strategy that involves two buckets that separate future
expenses into “essential” and “discretionary” spending. This strategy
was recently discussed in the October 30 Financial Advisor article
entitled, “<a data-mce-href="https://www.fa-mag.com/news/now-is-the-time-to-defend-against-sequence-risk-75228.html?section=43&utm_source=FA+Subscribers&utm_campaign=f0eb67d6a8-EMAIL_CAMPAIGN_2023_09_19_04_41_COPY_01&utm_medium=email&utm_term=0_-d5e82223f7-%5BLIST_EMAIL_ID%5D" href="https://www.fa-mag.com/news/now-is-the-time-to-defend-against-sequence-risk-75228.html?section=43&utm_source=FA+Subscribers&utm_campaign=f0eb67d6a8-EMAIL_CAMPAIGN_2023_09_19_04_41_COPY_01&utm_medium=email&utm_term=0_-d5e82223f7-%5BLIST_EMAIL_ID%5D" target="_blank">Michael Kitces warns Advisors About Sequence Risk, Defends 4.0% Rule</a>.” Mr. Kitces is a well-known retirement thought leader for financial advisors. </p><p>This
post will set forth some of Mr. Kitces’ comments about the
bucketing-by-expense-type strategy we recommend and will supplement Mr.
Kitces’ comments with our commentary.<span></span></p><a name='more'></a><p></p><p>The Financial Advisor
article sets forth the following comments by Mr. Kitces (or comments
attributed to him by the article author) with respect to bucketing
strategies used to mitigate sequence of return risk. We have added our
commentary on his comments in [ ]s.</p><p>“The essentials bucket I'm
going to cover with guaranteed income. These are true essentials: food,
clothing, shelter kinds of things, not the Netflix account I can’t live
without,” he said. “The whole point here is you cannot outlive your
essentials expenses. They’re essential.” [We think he probably meant to
imply that his Netflix account is an example of a discretionary expense
that can actually be lived without, but maybe his Netflix account is
something Mr. Kitces actually considers as an essential expense. Also,
it is important to remember that taxes are usually essential expenses
and may increase in the future, especially if you have large
tax-deferred accounts that will become taxable in the future. It is also
important to remember that in years when inflation rises faster than
expected (like it did in 2022) or essential spending otherwise
increases, the Floor Portfolio used to fund essential expenses may need
to be strengthened. Therefore, the adequacy of your Floor Portfolio
funding should be examined periodically]</p><p>“Many clients in practice
cover the bulk of their essentials bucket with Social Security, he
said, but if they don't have enough they can buy an immediate annuity to
fill in the shortfall. They don’t need to annuitize the whole
portfolio, he said, just enough to cover the essential expenses.” [We
agree. The Floor Portfolio used to fund essential expenses can also be
funded with defined benefit pension benefits and other low-risk
investments]</p><p>“All other spending is considered discretionary
[sic], and that is covered by portfolio withdrawals. “If bad things
happen in the portfolio, the only thing that's at risk are the
discretionary expenses ... wants, not needs,” he said. “So in essense
[sic], we manage the sequence of returns risk by compartmentalizing only
the expenses that we would be able to lose if we have to. We’re hoping
we don’t, but we can compartmentalize the risk down to the spending that
would not be castrophic [sic].” [Agreed. Also, these wants and needs
may change from year to year for many possible reasons.]</p><p>“When a
client covers essential expenses with Social Security plus an annuity
topper as needed, the rest of the portfolio can be invested for growth,
without much concern that a bad market will ruin the client. The value
of the discretionary portion will rise over time.” [We agree with the
first sentence, but the second sentence is based on the assumptions that
essential expense spending will not increase more than expected from
year to year and that the upside portfolio invested for growth will grow
as expected.]</p><p>“From an income perspective, they're just kind of
different channels. But from an asset perspective, they look very
different. My guaranteed-income streams are essentially a proxy for
fixed income. Social Securtity [sic] functions like a government bond,”
he said. “I could carry my Social Security payouts as an actual asset on
my balance sheet. Most of us don't calculate the capitalized value, but
we could.” [Our model does calculate the capitalized values (present
values) of Social Security benefits, pensions, life annuities, etc. and
includes them in the household Actuarial Balance Sheet to be used to
fund the present value of future planned essential expenses and to
compare with the present value of expected expenses to determine the
household Funded Status.]</p><p><strong>“</strong>Dynamic Spending<br />
On top of the safe withdrawal rate, and with or without dynamic asset
allocation, clients can also address sequence risk by tinkering with
their spending through a “ratcheting” strategy or by using floor/ceiling
guiderails.</p><p>For clients who like the feeling of spending more
when times are good and don’t mind reining in their spending in when
times are tough, adjusting spend levels can result in clients enjoying
their retirement more than if they’re forced into a level spend over 30
years, Kitces said.” [We believe the author meant to use the term
“guardrails” rather than “guiderails.” We agree with Mr. Kitces and
recommend increasing or decreasing discretionary spending when the
household Funded Status falls below or above certain specified levels
(or guardrails).]</p><p><strong>Summary</strong></p><p>The Actuarial
Approach recommended in this website is a dynamic, two-bucket approach
that requires the household (and/or the household’s financial advisor)
to distinguish between expenses that they consider to be either
essential or discretionary. Matching the present value of future
essential expenses with the present value of low-risk, or lifetime
guaranteed assets is part of the Actuarial Approach’s recommended
Liability-Driven Investment (LDI) strategy. The Actuarial Approach
involves using a deterministic model (the Actuarial Financial Planner)
to produce an actuarial balance statement and an annual Funded Status
that is remeasured periodically (annually) as part of a general
actuarial process to determine when household spending changes may be
necessary (or desired). It is a relatively straight-forward approach
that can help you manage your risks in retirement, including sequence of
return risk. <br /></p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-44476262803266013492023-10-24T20:39:00.003-04:002023-10-24T21:14:13.919-04:00Plan on Future Adjustments to Your Retirement Plan Part II<p>This post is a follow-up to our<a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/04/plan-on-future-adjustments-to-your.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/04/plan-on-future-adjustments-to-your.html" target="_blank"> post of April 16, 2023</a>. In that post, we said,</p><p>“In
our ‘real world,’ lots of things can happen in the future that can
affect the ratio of household assets to household spending liabilities,
including variations in:</p><ul style="text-align: left;"><li style="text-align: left;">Annual investment returns (i.e., past performance is not a guarantee of future results),</li></ul><ul style="text-align: left;"><li style="text-align: left;">Longevity,</li></ul><ul style="text-align: left;"><li style="text-align: left;">Annual inflation (or other rates of increases or decreases in household expenses),</li></ul><ul style="text-align: left;"><li style="text-align: left;">Spending (this is a huge source of potential variability) and spending goals,</li></ul><ul style="text-align: left;"><li style="text-align: left;">Sources of income (i.e., Social Security or rental income)</li></ul><ul style="text-align: left;"><li style="text-align: left;">Assumptions about the future</li></ul><p>All
these things make it very difficult to predict the future with any
degree of accuracy.” In light of these variations, we therefore
concluded that it was prudent for retirees to plan on future adjustments
in their retirement plans.<span></span></p><a name='more'></a><p></p><p>In his excellent September 23, 2023 article, <a data-mce-href="https://www.troweprice.com/content/dam/retirement-plan-services/pdfs/insights/research-findings/planning-for-spending-volatility-in-retirement/Planning_for_Spending_Volatility_Insights.pdf" href="https://www.troweprice.com/content/dam/retirement-plan-services/pdfs/insights/research-findings/planning-for-spending-volatility-in-retirement/Planning_for_Spending_Volatility_Insights.pdf" target="_blank">Planning for Spending Volatility in Retirement</a>, T Rowe Price Thought Leadership Vice President, Sudipto Banerjee, focuses primarily on spending volatility. He says:</p><p>“Retirees
are likely to experience both increases and decreases in spending
levels, i.e., volatility or fluctuations, during their retirement years.
By planning for and being prepared to adjust to such volatility in
spending, retirees can increase their odds of success in retirement.”</p><p>Unlike
many other retirement thought-leaders, Dr. Banerjee distinguishes
between discretionary and non-discretionary (essential) type expenses.
He concludes that most spending volatility is driven by
non-discretionary expenses, and housing costs are statistically the
largest contributor to spending volatility in retirement.</p><p>Dr.
Banerjee points to the necessity of anticipating events in retirement
that may require tapping into more liquid household assets. He says,</p><blockquote><p>“Our
research also shows that many retirees experience “liquidity
events”—i.e., sudden large increases in spending—and need to have enough
easily accessible liquid assets to meet these needs. In recent years,
discussions about how to generate a steady cash flow from retirement
savings have taken center stage, but in our view, not enough attention
has been paid to the liquidity problem.”</p></blockquote><p>Dr. Banerjee provides a
nice list of household expenses in his article that may be considered as
non-discretionary (essential) and discretionary. You may find his list
helpful in your planning, but 1) don’t forget to consider your taxes (as
discussed in our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/05/dont-forget-your-taxes.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/05/dont-forget-your-taxes.html" target="_blank">post of May 6, 2023</a>)
or any other expenses you expect to incur and 2) feel free to
reclassify expenses classified by Dr. Banerjee as essential if you
believe you can reduce those expenses if financially necessary (or if
you may not want to fund all your essential expenses with low-risk
investments—i.e., liability driven investing.)</p><p><b>Summary</b></p><p>Dr.
Banerjee warns us that, “The retirement journey spans multiple years
and there could be surprises along the way. Retirees need strategies for
both income generation and spending risk mitigation.” As discussed in
our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/manage-your-financial-risks-in.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/09/manage-your-financial-risks-in.html" target="_blank">post of September 2, 2023</a>,
we recommend using the Actuarial Process and the Actuarial Financial
Planner each year to develop your retirement strategy and mitigate all
your retirement risks, including your spending risks.<br /></p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-28111074171737228232023-09-28T20:33:00.006-04:002023-09-28T20:33:52.421-04:00Automatic Funded Status Adjustments for Social Security is a Great Idea<p></p><p>This month, in <a data-mce-href="https://crr.bc.edu/any-social-security-legislative-package-should-include-an-automatic-adjustment-mechanism/" href="https://crr.bc.edu/any-social-security-legislative-package-should-include-an-automatic-adjustment-mechanism/" target="_blank">Any Social Security Legislative Package Should Include an Automatic Adjustment Mechanism</a>,
Alicia Munnell, Director of the Center for Retirement Research at
Boston College, recommended that Congress include an automatic
adjustment mechanism to maintain Social Security’s desired funded status
on an ongoing basis as part of the next round of Social Security
reform. <span></span></p><a name='more'></a><p></p><p>Ms. Munnell said,</p><p>“One way to avoid repeated crises
and restore confidence in the financial stability of the Social
Security program is for any package of solutions to include a mechanism
that automatically adjusts revenues or benefits if shortfalls emerge.”</p><p>She
also presents several other reasons why automatic adjustments should be
adopted and discusses how the automatic adjustment process works in
Canada for their Canada Pension Plan (CPP). </p><p>This is a great idea that I like a lot.</p><p>In fact, I like this idea so much that I recommended that Congress adopt it back in 1982 as discussed in my <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/05/unfortunately-congress-did-not-adopt.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/05/unfortunately-congress-did-not-adopt.html" target="_blank">post of May 21, 2023</a>.</p><p>I
like it so much that I proposed just such an approach and discussed
what Canada was doing back in 2015 for a Contingencies Magazine article
entitled, “<a data-mce-href="https://view.publitas.com/ba55d288-8598-4c1a-8a1f-b0e6140f5b5a/contingencies20150506/page/38-39" href="https://view.publitas.com/ba55d288-8598-4c1a-8a1f-b0e6140f5b5a/contingencies20150506/page/38-39" target="_blank">Look to the North for a Better Financing Approach to Social Security</a>”</p><p>I like it so much that I proposed a similar approach for personal financial planning for retirees in my <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/01/automatic-funded-status-adjustments-to.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/01/automatic-funded-status-adjustments-to.html" target="_blank">post of January 7, 2023</a>.</p><p>In
my opinion, adopting automatic adjustments to the system’s tax
rates/benefit provisions to maintain Social Security’s long-range
actuarial balance on an ongoing basis within acceptable guardrails is
simply common sense. <br /></p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-28024451288258440832023-09-23T21:26:00.001-04:002023-09-23T21:26:28.353-04:00Actuaries Continue to Ignore the “Valuation Date Creep” Elephant in the Social Security Financing Room<p></p><p>This post is a follow-up to my July 3, 2023 Advisor Perspectives article, <a data-mce-href="https://www.advisorperspectives.com/articles/2023/07/03/income-factor-insurance-retirement-ken-steiner" href="https://www.advisorperspectives.com/articles/2023/07/03/income-factor-insurance-retirement-ken-steiner" target="_blank">Applying the Actuarial Process to Retirement Planning</a>,
where I encouraged financial advisors to employ the same actuarial
process for retirement planning that Social Security actuaries employ
for Social Security financing. In that article, I outlined the
following six-step planning process and included an illustration showing
how this process is applied to Social Security:</p><ol><li>Make reasonable assumptions about the future (generally deterministic, not stochastic).</li><li>Calculate
present values of assets (including future sources of income) and
liabilities based on relevant demographic information, system provisions
and assumptions made.</li><li>Periodically (generally annually) compare estimated present values of assets to liabilities to determine the system’s <strong>funded status</strong> (snapshot comparison).</li><li>Maintain a history of the system’s funded status over time and note trends.</li><li>When
warranted or required, make changes to assets or liabilities (or both)
to restore desired funded status (and/or to address possible cash flow
issues).</li><li>Periodically evaluate/stress test assumptions to see if they need to be changed or to assess risk.</li></ol><p><span></span></p><a name='more'></a>This month, the American Academy of Actuaries released an Issue Brief entitled, <a data-mce-href="https://www.actuary.org/sites/default/files/2023-09/pension-brief-social-security-assumptions-2023.pdf" href="https://www.actuary.org/sites/default/files/2023-09/pension-brief-social-security-assumptions-2023.pdf" target="_blank">The Importance of Assumption-Setting for Social Security Valuations</a>
that involves Steps 1-3 and 6 of the actuarial process above, with
emphasis on Step 1. While the Issue Brief discusses the steps the
Social Security Trustees and Social Security Administration actuaries
take to test that assumptions used for Social Security projections are
“reasonable”, it does not specifically mention the importance of
performing an annual gain and loss analysis by assumption source for
this purpose, which is a common actuarial technique for measuring the
reasonableness of individual assumptions (or groups of assumptions),
particularly for larger systems. The exclusion of such discussion from
the Academy Issue Brief is baffling, since the SSA performs just such an
analysis, and it is quite informative in its role as Step 4 of the
actuarial process described above. The gain/loss analysis by assumption
source is summarized each year as part of the annual valuation process
in Social Security Administration Actuarial Note Year.8. <p></p><p>The key take-aways from <a data-mce-href="https://www.ssa.gov/OACT/NOTES/ran8/an2023-8.pdf" href="https://www.ssa.gov/OACT/NOTES/ran8/an2023-8.pdf" target="_blank">SSA Actuarial Note 2023.8</a> include:</p><ul><li>The
system’s funded status (long-range actuarial balance) has declined
fairly continuously over the past 40 years from 0.02% of taxable payroll
in 1983 to -3.61% in 2023.</li><li>Of this decline, 64% is attributable
to annual changes in the valuation period (which I refer to as “the
Valuation Date Creep”), 30% of the decline is attributable to economic
data and assumptions and about 13% of the decline is attributable to
disability data and assumptions.</li><li>Demographic data and
assumptions, which is frequently cited as a major factor in the system’s
funded status decline since 1983, has actually had a small positive
effect (-3%).</li><li>Even if all assumptions are realized in the
future, the system’s funded status is expected to keep deteriorating
under current law because of the “Valuation Date Creep” discussed in
more detail below.</li></ul><p><strong>Valuation Date Creep</strong></p><p>Because
the system’s funded status is measured over a 75-year period, the
shortfalls expected after the end of the 75-year period under current
law are ignored until subsequent years’ valuations. This approach
implicitly assumes that annual system income will be equal to annual
system outgo for years after 75. This <strong>implicit assumption</strong>
has produced consistent actuarial losses for each year since 1983,
which, as noted above, have accounted for 64% of the system’s total
funded status decline since 1983. The effect of this questionable
implicit assumption is to overstate the systems’ actual funded status
under current law, and the consistent actuarial losses attributable to
this source since 1983 all but scream out “unreasonable assumption to be
fixed in future valuations.”</p><p><strong>American Academy of Actuaries Issue Brief on Social Security Assumptions</strong></p><p>The
Academy’s Issue Brief effectively supports the conclusion that the
valuation date creep is an unreasonable implied assumption resulting
from treatment of expected shortfalls after the end of the 75-year
valuation period. It says,</p><p>“Each year, the Social Security
program gains another year of actual experience that can affect the
projections in two ways. First, if experience is more favorable than
projected in the aggregate, the system’s projected financial status
improves; if experience is less favorable, the projected financial
status worsens. Second, emerging experience constitutes additional
evidence that can be used for setting assumptions. For example, if
mortality improves more rapidly than expected, then the assumed future
rate of mortality improvement might be adjusted to reflect that trend.
The normal process provides for monitoring experience to detect any
differences between actual experience and past projections and for
fine-tuning assumptions based on the results of this analysis.”</p><p>As
discussed above and as shown in SSA Actuarial Note 2023.8, the system
has incurred significant actuarial losses since 1983 (deteriorating
Funded Status) and the bulk of these actuarial losses are attributable
to the Valuation Date Creep. If the “normal process” (to use the
Academy’s words) calls for “monitoring experience to detect any
differences between actual experience and past projections and for
fine-tuning assumptions based on the results of this analysis”, then the
Valuation Date Creep should be “fine-tuned” to keep it from generating
consistent actuarial losses each year.</p><p>Even though the Valuation
Date Creep is the largest source of actuarial losses over the past forty
years, the Academy’s Issue Brief on the importance of assumptions and
fine-tuning ones that don’t appear to be reasonable isn’t even discussed
as an issue.</p><p><strong>Conclusion</strong></p><p>The Valuation Date
Creep is a problem that Social Security actuaries and the Social
Security Trustees have known about since 1983 (if not before). Like an
unreasonable (non-implied) assumption, it has generated consistent
actuarial losses for the past forty years and is the primary cause of
the System’s deteriorated funded status (in addition to too long delayed
Congressional action to bring the system back into actuarial balance).
Note that neither demographic experience or economic experience over
the past forty years are the primary causes of the system’s funded
status deterioration, as has been argued by several “experts”.</p>The
Valuation Date Creep should be fixed (fine-tuned) so that actuarial
losses from this source are not expected each year. We needn’t wait for
future Social Security reform to implement this change in the
measurement of Social Security’s Funded Status. It’s simply the right
thing to do now. How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-88664371182923944572023-09-17T13:55:00.000-04:002023-09-17T13:55:04.206-04:00Is It a Good Time to Buy That Single Premium Immediate Life Annuity?In
prior posts, we discussed possible assumptions used by life insurance
company actuaries in pricing single premium immediate life annuities
(SPIAs). In those posts, we provided implied discount rates consistent
with quotes obtained from ImmediateAnnuities.com under two different
mortality assumptions:<ul><li>based on life expectancy, or 50% probability of survival, and</li><li>based
on a 25% probability of survival, which is the longer expected lifetime
basis we recommend using in our website for planning purposes.</li></ul><p>In
this post, we will examine the implied interest rate assumptions built
into quotes from ImmediateAnnuities.com as of September 17, 2023 and
compare the quotes and the implied interest rates with the results of
the similar exercise we performed and summarized in our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/01/updated-implied-discount-rates-for.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/01/updated-implied-discount-rates-for.html" target="_blank">post of January 9, 2023</a>. We will also discuss a few other considerations that may affect your decision to buy a SPIA at this time.<span></span></p><a name='more'></a><p></p><p>The
key takeaway from this post is that implied interest rates (rates of
return) on SPIAs have generally increased a little since the beginning
of the year, but are still a little lower than when we measured them in
November of 2022. We have no idea, however, if they are going to
increase even more in future months, or possibly decrease, for that
matter.</p><p><strong>Updated Implied Interest Rates in Current SPIAs</strong></p><p>The
second column of the tables below show monthly life annuity quotes for
males of different ages per $100,000 of premium from
Immediateannuities.com as of January 9, 2023 and September 17, 2023.
Life expectancies shown in third column are 50% probabilities of
survival from the Actuaries Longevity Illustrator (ALI) for non-smoker
males in excellent health (which have not been updated yet for this
year). The fourth column (Implied Interest Rate) shows our calculation
of the fixed investment rate of return that would be earned if a person
bought the annuity and died at his current age plus his life expectancy
from the ALI table (in months). This investment return is net of
insurance company expenses and profits (but not net of taxes). These
rates are nominal rates and not real (net of assumed inflation) rates. </p><p><strong>Implied Interest Rates based on ALI Life Expectancy as of 1/9/2023</strong></p><table border="1" cellpadding="1" cellspacing="1"><tbody><tr><td width="96"><p data-mce-style="text-align: center;" style="text-align: center;"><strong>Current Age </strong></p></td><td width="122"><p data-mce-style="text-align: center;" style="text-align: center;"><strong>Fixed Monthly Life Annuity</strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p><strong>Life Expectancy in Months (based on AAA Longevity Illustrator 50% planning horizon for a non-smoking male in excellent health)</strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p><strong>Implied Interest Rate</strong></p></td></tr><tr><td width="96"><p data-mce-style="text-align: center;" style="text-align: center;">55</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$532</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>396</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>5.3%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>60</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$570</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>336</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>5.3%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>65</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$628</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>276</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>5.3%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>70</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$710</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>216</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>5.1%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>75</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$833</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>168</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>5.1%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>80</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$1,030</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>108</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>2.4%</p></td></tr></tbody></table><p><strong><br data-mce-bogus="1" /></strong></p><p><strong>Implied Interest Rates based on ALI Life Expectancy as of 09/17//2023</strong></p><table border="1" cellpadding="1" cellspacing="1"><tbody><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p><strong>Current Age</strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="120"><p><strong>Fixed Monthly Life Annuity for Male ($100,000 Single Premium</strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p><strong>Life Expectancy in Months (based on AAA Longevity Illustrator 50% planning horizon for a non-smoking male in excellent health</strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="132"><p><strong>Implied Interest Rate</strong></p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>55</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="120"><p>$541</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>396</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="132"><p>5.4%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>60</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="120"><p>$583</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>336</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="132"><p>5.5%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>65</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="120"><p>$637</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>276</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="132"><p>5.5%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>70</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="120"><p>$711</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>216</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="132"><p>5.2%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>75</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="120"><p>$844</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>168</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="132"><p>5.3%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>80</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="120"><p>$1,027</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>108</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="132"><p>2.3%</p></td></tr></tbody></table><p>The more recent table shows that annuity quotes from ImmediateAnnuities.com have generally increased a little since January 9<sup>th</sup>
of this year and so have the implied interest rates. As noted above,
the implied interest rates consistent with the ALI mortality table (50%
probability of survival) for older non-smoking annuitants in excellent
health are much lower than for younger annuitants, indicating that
insurance company pricing for older annuitants may assume longer life
expectancies and/or lower interest rates due to shorter assumed
durations.</p><p>The tables below tell a different story for individuals
who live until their 25% probability of survival age rather than their
50% probability of survival. It can be argued that these implied rates
of return are more applicable to individuals considering an annuity
purchase if their plan includes living approximately five/six years
longer than their life expectancy.</p><p><strong>Implied Interest Rates based on 25% Probability of Survival as of 1/9/2023</strong></p><table border="1" cellpadding="1" cellspacing="1"><tbody><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p><strong>Current Age </strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p><strong>Fixed Monthly Life Annuity</strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p><strong>Lifetime Planning Period (based on AAA Longevity Illustrator 25% planning horizon for a non-smoking male in excellent health)</strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p><strong>Implied Interest Rate</strong></p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>55</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$532</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>468</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>5.7%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>60</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$570</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>408</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>5.9%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>65</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$628</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>348</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>6.3%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>70</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$710</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>276</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>6.7%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>75</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$833</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>228</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>7.6%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>80</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$1,030</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>168</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>8.7%</p></td></tr></tbody></table><p><strong><br data-mce-bogus="1" /></strong></p><p><strong>Implied Interest Rates based on 25% Probability of Survival as of 9/17/2023</strong></p><table border="1" cellpadding="1" cellspacing="1"><tbody><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p><strong>Current Age </strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p><strong>Fixed Monthly Life Annuity</strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p><strong>Lifetime Planning Period (based on AAA Longevity Illustrator 25% planning horizon for a non-smoking male in excellent health)</strong></p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p><strong>Implied Interest Rate</strong></p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>55</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$541</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>468</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>5.8%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>60</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$583</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>408</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>6.1%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>65</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$637</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>348</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>6.5%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>70</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$711</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>276</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>6.7%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>75</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$844</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>228</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>7.8%</p></td></tr><tr><td data-mce-style="text-align: center;" style="text-align: center;" width="96"><p>80</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="122"><p>$1,027</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="180"><p>168</p></td><td data-mce-style="text-align: center;" style="text-align: center;" width="136"><p>8.6%</p></td></tr></tbody></table><p>It
is interesting to note that implied interest rates (or rates of return)
for older annuitants are higher than implied returns for younger
annuitants on this alternate “planning” mortality basis. This is because
moving from 50% probability of survival to 25% probability of survival
generally adds about five/six years to the expected time of death, and
an additional five/six years is a much more significant increase for an
80-year-old than it is for a 55-year-old (and may explain why insurance
companies may be more likely to assume greater anti-selection by older
annuitants in their pricing).</p><p>The above charts develop implied
interest rates on two mortality bases for current annuity quotes for
males. Based on a quick review, it appears that comparable implied rates
of return at the illustrative ages shown would also be developed for
current SPIA quotes for females.</p><p><strong>Is Now the Right Time to Buy a SPIA? Some Other Considerations</strong></p><p>There
are many plusses and minuses associated with buying SPIAs vs. investing
your retirement assets in other vehicles that we are not going to
repeat here. Here are a few other considerations that you might want to
think about before making your decision regarding annuity purchases.</p><ul><li>Buying
an SPIA will generally strengthen your Funded Status. Based on current
default assumptions for the Actuarial Financial Planner, a 65-year-old
male who spends $100,000 on a SPIA at today’s rates will increase the
present value of his retirement assets by $27,983. A 65-year-old male
who plans to live to 100 (rather than the default assumption of 94) will
increase the present value of his assets by $39,478 by making the same
purchase.</li><li>With recent higher-than-expected levels of price
inflation, the present value of your non-risky assets may no longer
cover the present value of your essential expenses and you may want to
strengthen your “Floor Portfolio” at this time.</li><li>Many individuals
are convinced that investment in SPIAs are less liquid than investment
in bonds. If your bond investments are dedicated to funding your
essential expenses, the sense of increased liquidity over annuities may
be somewhat illusory. There are retirement experts (like Dr. Wade Pfau)
that we have cited in this website who advocate purchasing annuities vs.
owning bonds in retirement.</li><li>IRS 10-year Constant Maturity
Treasury (often cited as a proxy for insurance company interest rates
for annuity pricing) have ticked above 4.3% and are now higher than they
were last October/November when SPIA rates were approximately 5% higher
than they are today (and are higher today than any time in the past 10
years). Will these recent increases translate into even higher SPIA
amounts and returns in the near future or have SPIA amounts peaked? We
don’t know.</li></ul><p><strong>Conclusion</strong></p><p>Increases in
interest rates in the recent past have generally increased the amount of
current monthly immediate life annuity that may be purchased with a
given premium amount and has slightly increased implied interest rates
(or rates of return) on currently available SPIAs. We have no way of
knowing whether additional increases in interest rates used to price
SPIAs can be expected at this time. We are not investment advisors or
insurance brokers and cannot provide advice on timing or the financial
advisability of SPIA purchases. We do plan to continue to monitor
implied rates of return on SPIAs in this blog (on both a pricing and
planning basis).</p><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 412.3999938964844px; height: 4px; width: 557px; " data-row="0" style="cursor: row-resize; height: 4px; left: 8px; margin: 0; padding: 0; position: absolute; top: 412.3999938964844px; width: 557px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 452.3999938964844px; height: 4px; width: 557px; " data-row="1" style="cursor: row-resize; height: 4px; left: 8px; margin: 0; padding: 0; position: absolute; top: 452.3999938964844px; width: 557px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 492.3999938964844px; height: 4px; width: 557px; " data-row="2" style="cursor: row-resize; height: 4px; left: 8px; margin: 0; padding: 0; position: absolute; top: 492.3999938964844px; width: 557px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 532.4000244140625px; height: 4px; width: 557px; " data-row="3" style="cursor: row-resize; height: 4px; left: 8px; margin: 0; padding: 0; position: absolute; top: 532.4000244140625px; width: 557px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 572.4000244140625px; height: 4px; width: 557px; " data-row="4" style="cursor: row-resize; height: 4px; left: 8px; margin: 0; padding: 0; position: absolute; top: 572.4000244140625px; width: 557px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 612.4000244140625px; height: 4px; width: 557px; " data-row="5" style="cursor: row-resize; height: 4px; left: 8px; margin: 0; padding: 0; position: absolute; top: 612.4000244140625px; width: 557px;"></div><div class="mce-resize-bar mce-resize-bar-row" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: row-resize; margin: 0; padding: 0; position: absolute; left: 8px; top: 651.4000244140625px; height: 4px; width: 557px; " data-row="6" style="cursor: row-resize; height: 4px; left: 8px; margin: 0; padding: 0; position: absolute; top: 651.4000244140625px; width: 557px;"></div><div class="mce-resize-bar mce-resize-bar-col" data-col="0" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: col-resize; margin: 0; padding: 0; position: absolute; left: 109px; top: 320.3999938964844px; height: 335px; width: 4px; " style="cursor: col-resize; height: 335px; left: 109px; margin: 0; padding: 0; position: absolute; top: 320.3999938964844px; width: 4px;"></div><div class="mce-resize-bar mce-resize-bar-col" data-col="1" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: col-resize; margin: 0; padding: 0; position: absolute; left: 236px; top: 320.3999938964844px; height: 335px; width: 4px; " style="cursor: col-resize; height: 335px; left: 236px; margin: 0; padding: 0; position: absolute; top: 320.3999938964844px; width: 4px;"></div><div class="mce-resize-bar mce-resize-bar-col" data-col="2" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: col-resize; margin: 0; padding: 0; position: absolute; left: 421px; top: 320.3999938964844px; height: 335px; width: 4px; " style="cursor: col-resize; height: 335px; left: 421px; margin: 0; padding: 0; position: absolute; top: 320.3999938964844px; width: 4px;"></div><div class="mce-resize-bar mce-resize-bar-col" data-col="3" data-mce-bogus="all" data-mce-resize="false" data-mce-style="cursor: col-resize; margin: 0; padding: 0; position: absolute; left: 561px; top: 320.3999938964844px; height: 335px; width: 4px; " style="cursor: col-resize; height: 335px; left: 561px; margin: 0; padding: 0; position: absolute; top: 320.3999938964844px; width: 4px;"><br /></div>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-85192192372235212742023-09-02T18:14:00.006-04:002023-09-02T18:14:57.599-04:00Manage Your Financial Risks in Retirement Like an Actuary<p>In his <a data-mce-href="https://www.advisorperspectives.com/articles/2023/08/07/insurance-stock-allocation-challenges-retirement-swedore" href="https://www.advisorperspectives.com/articles/2023/08/07/insurance-stock-allocation-challenges-retirement-swedore" target="_blank">August 7, 2023 Advisor Perspectives article</a>,
Larry Swedroe, head of financial and economic research for Buckingham
Wealth Partners, discusses what he calls the seven great “challenges” to
retirement plans today. According to Mr. Swedroe, these challenges are:</p><ul><li>historically high equity valuations;</li><li>historically low bond yields;</li><li>increasing longevity;</li><li>the potential need for expensive long-term care;</li><li>the failure of government to fully fund the Social Security and Medicare programs;</li><li>the likelihood of slower economic growth due to the rising debt-to-GDP ratio; and</li><li>the
end (and even likely reversal) of favorable tailwinds for corporate
profits (falling interest rates, profits growing faster than GDP, and
falling tax rates).”</li></ul><p>Six of Mr. Swedroe’s challenges involve
the asset side of a retired household balance sheet while two of them
(increased longevity and the potential need for expensive long-term
care) primarily involve the spending liability side of the household
balance sheet. These challenges (and others discussed below) translate
into increased “risks” that the historical assumptions frequently used
in retirement planning projections by many financial advisors in Monte
Carlo models or in other static planning approaches (like the 4% Rule)
may be too optimistic. Fortunately for retirees, these risks can be
managed by using the basic actuarial principles and processes advocated
in this website and discussed below. <span></span></p><a name='more'></a><p></p><p><strong>Background</strong></p><p>Actuaries
help financial systems manage their financial risks. For personal
financial systems (households), the assumptions used to measure
household assets and spending liabilities for planning purposes include
explicit expectations with respect to:</p><ul><li>lifetime planning periods,</li><li>timing of future planned expenses (separated into recurring and non-recurring as well as essential and discretionary),</li><li>increases in future planned expenses,</li><li>timing and amounts of future lump sum or streams of income payments, and</li><li>returns on invested assets.</li></ul><p>In addition to these explicit assumptions, more implicit assumptions may include:</p><ul><li>No future changes in Social Security law or in other sources of income,</li><li>No future marital dissolution or early death of a spouse, and</li><li>No spending in excess of budgeted spending</li></ul><p>If
planning assumptions or expectations about the future are wrong (and
they will be), we must be prepared to make adjustments in our spending
or somehow increase our assets to keep our finances in balance. And,
unfortunately, a lot can potentially go wrong with personal financial
assumptions. For example,</p><ul><li>We may live longer than our expected lifetime planning periods</li><li>The value of properties we own may decrease or not increase as expected</li><li>Our long-term care or other medical expenses may be more costly than we assumed</li><li>The household member with greater lifetime income assets may die early or we may divorce,</li><li>Our taxes or our premiums for various types of insurance may increase faster than expected</li><li>Our future Social Security benefits may be reduced (or not fully indexed with inflation)</li><li>Higher than assumed Inflation may make some or all our planned expenses higher than assumed,</li><li>Our investments may experience periods of lower-than-expected returns</li><li>We may suffer uninsured losses or be a victim of fraud,</li><li>We, or other members of our family, may experience emergencies requiring unexpected expenses, or</li><li>We may, for whatever reason, simply spend more than we thought we would</li></ul><p>The
events described above (and potentially others) will generally either
increase our spending liabilities relative to our assets or decrease our
assets relative to our spending liabilities. In response, we may have
to reduce planned spending, increase household assets or we will have to
temporarily dip into our rainy-day funds to keep spending liabilities
in approximate balance with our assets. </p><p>In the current economic
environment, we are looking at real possibilities of
higher-than-expected levels of inflation, longer life expectancies,
other unexpected increases in spending, lower than historical returns on
investments and reductions in future Social Security benefits. These
risks are definitely enough to give a retiree a bad case of agita and
cause him or her to lose some sleep.</p><p>So, what is a retiree to do today to mitigate financial risks and sleep better at night?</p><p><strong>Manage Your Financial Risks in Retirement Like an Actuary</strong></p><p>Instead
of simply having faith that historical returns will continue in the
future and believing your financial advisor’s assessment that you have a
90% probability of not running out of money if you spend exactly $X per
year, we recommend using the steps outlined below to better manage your
financial risks in retirement. </p><p><strong>#1 General Actuarial Process</strong></p><p>Instead
of using a static spending approach (like the 4% Rule or a Monte Carlo
projection) which will subject you to greater sequence of returns
investment risk, we recommend following the General Actuarial Process
most recently outlined in our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/08/retirement-planning-is-not-event-its.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/08/retirement-planning-is-not-event-its.html" target="_blank">post of August 23, 2023</a>.
This process calls for annually measuring your Funded Status using the
Actuarial Financial Planner (AFP) and, as described in Step 5 of that
process,</p><p>“When warranted, make changes to assets or liabilities (or both) to restore desired <strong>Funded Status</strong> (and/or to address possible cash flow issues). See our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/01/automatic-funded-status-adjustments-to.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/01/automatic-funded-status-adjustments-to.html">post of January 7, 2023</a> for our recommend algorithm (guardrails) for determining when plan changes should be implemented”</p><p>Changes that involve increasing (or strengthening) your assets may include:</p><ul><li>Going back to work or working in part-time employment</li><li>Selling an asset that was previously not considered a retirement asset</li><li>Renting a vacation home, parking space, boat or room in your house</li><li>Deferring commencement of Social Security</li><li>Purchasing an immediate annuity</li></ul><p>Changes that involve decreasing your spending liabilities may include:</p><ul><li>Decreasing discretionary spending</li><li>Reclassifying recurring expenses as non-recurring</li><li>Decreasing desired estate</li><li>Assuming some expenses will decrease as you age</li><li>Minimizing taxes</li><li>Decreasing assumed expenses after first death within the couple</li></ul><p>By
using this dynamic, self-correcting process, spending may vary from
year to year, but it can be smoothed to some degree (within the spending
guardrails). Further, as discussed below, if discretionary spending is
adjusted first, it may not be necessary to adjust essential expense
spending. See our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/04/plan-on-future-adjustments-to-your.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/04/plan-on-future-adjustments-to-your.html" target="_blank">post of April 16, 2023</a>
encouraging you to plan on making future changes to your plan. It is
important to note that while static approaches imply more spending
stability, such stability is based on assumptions that will likely not
materialize and stability is not guaranteed by your financial advisor. </p><p><strong>#2 Use a Floor Portfolio to Fund Essential Expenses</strong></p><p>The
second way to mitigate financial risks in retirement is to find the
proper balance between investment in non-risky and risky assets. Here
at <em>How Much Can I Afford to Spend in Retirement</em>, we encourage
retired households to consider establishing two separate investment
buckets to fund their total spending in retirement:</p><ul><li>A Floor Portfolio comprised of relatively safe (non-risky) investments and assets used primarily to fund Essential Expenses, and</li><li>An Upside Portfolio comprised of more risky investments used primarily to fund Discretionary Expenses.</li></ul><p>This
liability-driven investment (LDI) strategy attempts to match relatively
safe household assets with more critical household spending liabilities
for the purpose of protecting the assets that fund essential expenses,
while using an Upside Portfolio to grow assets that may be used to fund
more discretionary expenses. This LDI risk mitigation strategy has been
variously described in personal finance literature as:</p><ul><li>a Safety-First approach,</li><li>immunization of essential expenses, or</li><li>funding needs vs. funding wants.</li></ul><p>In
our opinion, if you are not using a similar LDI strategy, you may be
assuming too much (or too little) risk in your personal retirement plan.
And, while you may need to reduce expenses in the future if the
assumptions used in the AFP turn out to be too optimistic, it is likely
that such reductions will involve discretionary expenses and not
essential expenses.</p><p>While it is important to fully fund one’s
Floor Portfolio with non-risky assets, it is also important to have
adequate funding of one’s Upside Portfolio. Investments in both
non-risky and risky assets enable households to balance their needs to
protect and grow their assets, and discretionary spending from the
Upside Portfolio can be more flexible than essential expense spending.
It is important to remember that the expenses you designate as
“essential” or “discretionary” are under your control and can change
over time depending on your tolerance for risk and investment
preferences. </p><p><strong>#3 Use Conservative Assumptions</strong></p><p>The
third way to mitigate personal financial risks is to use more
conservative assumptions. If your expectations about the default
assumptions used in the AFP change, you can input different “override”
assumptions to perform “what if” scenario testing. For example, see our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2022/03/planning-on-temporary-higher-levels-of.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2022/03/planning-on-temporary-higher-levels-of.html">post of March 20, 2022</a> for
override inflation assumptions that may be used in lieu of the current
default inflation assumption. This action will change the amounts shown
in the Actuarial Balance Sheet by increasing the present values of
essential and discretionary expenses. This, in turn, may cause you to
consider changes to your financial plan to rebalance your assets and
your liabilities under the override assumption. So, decreases in your
spending budget can either occur “by evolution” over time as actual
experience emerges, or they can occur “by revolution” by changing
assumptions. </p><p><strong>#4 Spend Less</strong></p><p>The fourth way
to mitigate personal financial risks is to spend less than your current
year spending budget or otherwise increase the size of your Rainy-Day
Fund (strengthen your Funded Status). You are not required to actually
spend all of your current year spending budget every year. Your
Rainy-Day Fund can be used in future years to smooth spending volatility
resulting from unfavorable experience.</p><p><strong>Conclusion and Thank You, Jimmy Buffett</strong></p><p>Successfully
achieving your financial goals in retirement is a risky business.
Financial risks occur when actual future experience differs from
expectations (assumptions). And while it is impossible to completely
eliminate all risks in retirement, some risks can be mitigated through
purchase of insurance, by using conservative assumptions, by using a
dynamic process or by other means. Households must find the proper
balance between protecting their assets, growing their assets and
carefully spending their assets. We believe that using the general
actuarial process and the AFP recommended in this website can help
retirees mitigate their risks, worry less about their financial future
and sleep better at night.</p><p>One of our generation’s
poet/singer/songwriter/(very) successful businessmen passed away
yesterday. I don’t consider myself a Parrott Head, but I do appreciate
his music. Relative to this post, Mr. Buffett is credited with saying,
“I can’t change the direction of the wind, but I can adjust my sails to
reach my destination.” We encourage you to follow this philosophy and
the dynamic general actuarial process when sailing your financial boat
through retirement.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-81151395932376204602023-08-23T19:48:00.001-04:002023-08-23T19:48:25.842-04:00Retirement Planning is Not an Event; It’s a Process<p></p><p>I recently received an email from the folks at Retirement Researcher
inviting me to attend their latest Retirement Challenge. The preamble to
their invitation said,</p><p>“Retirement planning isn’t an event… it’s a process, Ken.”</p><p>We
couldn’t agree more, and although we have tried many times in this
website to do so, we can’t say it any better. Successful ongoing
planning in retirement depends less on the planning model employed and
the accuracy of the assumptions used in the model and more on the
process used to address deviations of actual and assumed experience as
they occur.<span></span></p><a name='more'></a><p></p><p>In our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/06/systematic-comparison-of-assets-and.html" target="_blank">post of June 11, 2023</a>, we outlined the general
process used by actuaries to ensure ongoing sustainability of financial
systems such as pension plans and Social Security and encouraged you to
employ the same process for your household retirement planning. We
repeat the six steps of this recommended process below. </p><p>The General Actuarial (or Focus on Funded Status) Process has six steps:</p><ol><li>Make reasonable assumptions about the future (generally deterministic, not stochastic),</li><li>Calculate
present values of household assets (including future sources of income)
and household spending liabilities based on relevant demographic
information, desired future spending and assumptions made,</li><li>Periodically
(generally annually) compare calculated present values of household
assets and spending liabilities (balance sheet) to determine the
household’s <strong>Funded Status</strong> (snapshot comparison),</li><li>Maintain a history of the household’s <strong>Funded Status</strong> over time and note trends,</li><li>When warranted, make changes to assets or liabilities (or both) to restore desired <strong>Funded Status</strong>
(and/or to address possible cash flow issues). See our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/01/automatic-funded-status-adjustments-to.html" target="_blank">post of January 7, 2023</a> for our recommend algorithm for determining when plan changes
should be implemented, and</li><li>Periodically evaluate/stress test assumptions to see if they need to be changed or to assess risk</li></ol><p>Our
Actuarial Financial Planners (AFPs) for single and retired couples can
help you with steps 1-3 (particularly the necessary present value
calculations) and step 6. It is a one-tab Excel spreadsheet that is not
particularly complicated but permits consideration of non-linear
spending not normally considered in more “sophisticated” Monte Carlo
models generally used by financial advisors.</p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-36490266214437050922023-08-05T14:57:00.002-04:002023-08-05T14:59:43.005-04:00American Academy of Actuaries New Social Security Tool is Also Deficient in Alerting the Public to Potential Cash Flow Issues <p>This post is a follow-up to our <a data-mce-href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/07/why-did-american-academy-of-actuaries.html" href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/07/why-did-american-academy-of-actuaries.html" target="_blank">post of July 29, 2023</a>
where we took the Academy to task for removing three important caveats
about the Social Security Challenge tool and, therefore, potentially
misleading the public about the long-term effectiveness of possible
system “fixes.” In this post, we will discuss yet another feature of the
tool that may also mislead the public about the effectiveness of these
possible “fixes.” This feature ignores the potential negative impact on
system assets of overly deferring the revenue increases or benefit
reductions necessary to restore system’s actuarial balance. Thus, while
certain changes may achieve actuarial balance (and even earn a “You’ve
Solved It” pat on the back from the tool), these changes aren’t expected
to keep the OASDI Trust fund from running out of money during the
entire 75-year projection period, and therefore, should not be
considered as viable, much less as a “fix.” After providing some
background, we will discuss an example.<span></span></p><a name='more'></a><p></p><p><b>Background</b></p><p>The
figure below from the 2023 OASDI Trustees report shows the projection
of OASDI income and cost measured a percentage of projected taxable
payroll under the Trustees intermediate assumptions.</p><p data-mce-style="text-align: center;" style="text-align: center;">Figure II.D2.—OASDI Income, Cost, and Expenditures as Percentages of Taxable Payroll</p><p data-mce-style="text-align: center;" style="text-align: center;">[Under intermediate assumptions]</p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnA0r_AOU-3fbOp-JOzkXGj2Q8t-LoCRNiMJAzu8qM9VTleS-HV9QB_Hsl07ajG-IVfA7W9sP23exmL_x7QIe6wLwQV6SMEoBSaFr519kQK7N3c642IwKGdA2__QBc5JOXkZl8E8FEbOhYm1nPHbmYaqn_tB3hT4A9maOQs2k1hcrJ25ftD7515eGMGCQ/s628/Image1.png" style="clear: left; float: left; margin-bottom: 1em; margin-right: 1em;"><img border="0" data-original-height="467" data-original-width="628" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhnA0r_AOU-3fbOp-JOzkXGj2Q8t-LoCRNiMJAzu8qM9VTleS-HV9QB_Hsl07ajG-IVfA7W9sP23exmL_x7QIe6wLwQV6SMEoBSaFr519kQK7N3c642IwKGdA2__QBc5JOXkZl8E8FEbOhYm1nPHbmYaqn_tB3hT4A9maOQs2k1hcrJ25ftD7515eGMGCQ/s16000/Image1.png" /></a></div><br /><p data-mce-style="text-align: center;" style="text-align: center;"><br data-mce-bogus="1" /></p><p data-mce-style="text-align: left;" style="text-align: left;">This
figure shows, that without adoption of reform changes, system costs are
expected to increase rapidly relative to system income until 2034, at
which time system assets are expected to be completely exhausted. At
that time, system income is expected to be sufficient to cover 80% of
system cost. The annual shortfall is estimated to be 3.21% of taxable
payroll in 2035 (expected cost of 16.48% of taxable payroll and expected
income of 13.27% of taxable income), increasing to 5.02% of taxable
payroll in 2075 and 2080 and then decreasing to only 4.42% of estimated
taxable payroll in 2100. </p><p>Social Security’s funded status is
measured each year by comparing the present value of expected system
revenue with the present value of the expected expenditures over the
next 75 years under the Intermediate assumptions. Long-range actuarial
balance (a snapshot measurement) is achieved by balancing the present
value of system costs and revenues. Projected costs and revenues after
the 75-year projection period are ignored, but enter the funded status
measurements in subsequent years. The above figure shows that the system
is clearly not currently in actuarial balance and the actuarial balance
measure is expected to deteriorate in future years as the significant
shortfalls in years subsequent to the current 75-year projection period
are recognized.</p><p>The figure also shows that system costs are not
expected to increase all that much after 2060, so any system reform
enacted after 2030 that solves the funding problem for thirty years
stands a reasonably good chance of solving the system’s funding problems
over much longer periods based on the Intermediate assumptions.</p><p>Under
current law, Congress decides when (and what) changes are necessary to
strengthen the system’s financing. There is no requirement under current
law for system changes to be made automatically to maintain the
system’s actuarial balance from year to year. Further, there is no
requirement under current law for reform changes to restore the system’s
long-range actuarial balance, but congressional action in the past has
generally also restored it. Most experts agree that changes are required
at this time (or, more accurately, are long overdue) to strengthen
system financing.</p><p>The figure above clearly shows that if the next
round of Social Security reform anticipates grandfathering of benefits
for those in or close to beneficiary status (e.g., reforms that involve
no benefit reductions for those age 60 and over as of the effective date
of reform), it will be very difficult (or impossible) to accomplish
such grandfathering without increasing system revenue in some manner,
particularly if the effective date of reform changes continues to be
deferred. Therefore, reform proposals that involve significantly
deferring reductions in benefits and/or increases in revenue need to be
closely scrutinized to make sure trust fund assets will be sufficient to
support such reform proposals.</p><p>Restoring Social Security’s
long-range actuarial balance will not necessarily ensure that trust fund
assets will be expected to be positive throughout the 75-year
projection period. If actuarial balance is achieved by “back-loading”
increases in expected system revenue or benefit reductions, assets may
reasonably be expected to be exhausted during the projection period.
Since the Academy’s tool focuses only on achieving actuarial balance, it
does not address this potential cash-flow issue, and therefore reform
options in the tool that involve significant deferrals of increased
revenue or decreased benefits will probably not “solve” the system’s
funding problem. </p><p><b>Example</b></p><p>Let’s assume we
select the following three system changes in the Academy’s tool. The
following chart below shows the tool results for the expected impact on
the 2022 Actuarial Balance deficit of 3.42% of taxable payroll
associated with each change as well as the total expected impact.
References in parenthesis describe the Office of the Actuary change menu
provision used in the tool. The <a data-mce-href="https://www.ssa.gov/oact/solvency/provisions/summary.pdf" href="https://www.ssa.gov/oact/solvency/provisions/summary.pdf" target="_blank">Office of the Actuary change menu</a> also provides the percentage of the 4.25% annual shortfall for the 75<sup>th</sup> year expected to be eliminated by each provision. </p><table border="1" cellpadding="1" cellspacing="1" data-mce-style="width: 100%;" style="width: 100%;"><tbody><tr data-mce-style="height: 49.9833px;" style="height: 49.9833px;"><td data-mce-style="height: 49.9833px;" style="height: 49.9833px;" width="432"><p><b>System Change</b></p></td><td data-mce-style="height: 49.9833px;" style="height: 49.9833px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;"><b>% Reduction in Actuarial Balance</b></p></td><td data-mce-style="height: 49.9833px;" style="height: 49.9833px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;"><b>% Reduction in 75th-year Shortfall</b></p></td></tr><tr data-mce-style="height: 35px;" style="height: 35px;"><td data-mce-style="height: 35px;" style="height: 35px;" width="432"><p>Increase Normal Retirement Age by 2 months per year until is 69, then increase 1 month every 2 years (C.1.4)</p></td><td data-mce-style="height: 35px;" style="height: 35px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;">38%</p></td><td data-mce-style="height: 35px;" style="height: 35px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;">57%</p></td></tr><tr data-mce-style="height: 35px;" style="height: 35px;"><td data-mce-style="height: 35px;" style="height: 35px;" width="432"><p>Reduce benefits for future higher-earner retirees starting in 2030</p></td><td data-mce-style="height: 35px;" style="height: 35px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;">23%</p></td><td data-mce-style="height: 35px;" style="height: 35px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;">44%</p></td></tr><tr data-mce-style="height: 35px;" style="height: 35px;"><td data-mce-style="height: 35px;" style="height: 35px;" width="432"><p>Raise tax rate 0.1% per year starting in 2023 for 20 years until it reaches 14.4%</p></td><td data-mce-style="height: 35px;" style="height: 35px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;">44%</p></td><td data-mce-style="height: 35px;" style="height: 35px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;">47%</p></td></tr><tr data-mce-style="height: 35px;" style="height: 35px;"><td data-mce-style="height: 35px;" style="height: 35px;" width="432"><p>Total</p></td><td data-mce-style="height: 35px;" style="height: 35px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;">105%</p></td><td data-mce-style="height: 35px;" style="height: 35px;" width="96"><p data-mce-style="text-align: center;" style="text-align: center;">148%</p></td></tr></tbody></table><p>This
example package of reform options backloads benefit reductions and
slightly backloads revenue increases and would not be expected to
maintain positive trust fund balance over the entire 75-year projection
period, and especially not if tax rate increases are deferred even later
than 2023 (which seems pretty likely at this time). While this package
of reforms accomplishes actuarial balance (and earns a “You Solved It”
pat on the back from the tool), it does this by anticipating that system
revenue will significantly exceed system costs in the later years of
the 75-year projection period and that this excess system revenue over
costs will somehow be used to fund excesses of costs over revenue in the
early part of the projection period. Since this package of reform
changes isn’t viable, we conclude that it is not effective as a “fix’ to
the system and it shouldn’t be expected to “solve” Social Security’s
financing problem. </p><p><b>Summary</b></p><p>As I indicated in my <a data-mce-href="https://contingencies.org/letters-to-the-editor-4/" href="https://contingencies.org/letters-to-the-editor-4/" target="_blank">March/ April Letter to the Editor of Contingencies Magazine</a>,
I believe that the Academy should take reasonable steps to make sure
that its new Social Security change menu tool does not mislead the
public about Social Security financing and the effectiveness of packages
of system reform options. I believe those steps should include
restoring the caveat language that was included in the prior version of
the tool for almost seven years. It should also include a caution about
the potential cash flow issue discussed in this post as well as any
other significant limitations of the tool. While I understand that the
Academy would like to keep the tool simple and easy to understand by
system stakeholders, I don’t find inclusion of these limitations to be
any more confusing than the current tool caveat language below:</p><p>“The
interactions among the various provision changes which would change
their combined effect on the actuarial balance are not reflected in this
activity.” <br /></p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.comtag:blogger.com,1999:blog-8268277183793691734.post-10643585232460424442023-07-29T14:45:00.003-04:002023-07-29T14:47:56.124-04:00Why Did the American Academy of Actuaries Remove Important Caveats from its Social Security Reform Menu Tool?<p></p><p>Almost seven years ago, the American Academy of Actuaries added the
following language to its Social Security Game to avoid misleading the
public regarding changes that may be required to bring the system back
into actuarial balance:</p><p><u>“The following should be noted when interpreting results from the Social Security Game:</u></p><ul><li><u>The
75-year actuarial balance calculation used in the game does not
consider significant revenue shortfalls expected to occur after the end
of the 75-year projection period, and thus possible solutions
illustrated in this game are generally not sufficient to achieve
“sustainable solvency,” a concept discussed in the Trustees Report.</u></li><li><u>The
possible solutions assume immediate adoption of System changes, rather
than gradual implementation. If changes to the System are gradually
implemented, the required increases in tax revenue or benefit decreases
will need to be larger than noted in the game to achieve actuarial
balance.</u></li><li><u>The success of reforms will depend on how well
actual future experience compares with the assumptions made by the
trustees and the Social Security actuaries. There is no mechanism in
current Social Security law to maintain the program’s actuarial balance
once it has been achieved. Thus, there can be no guarantee that the
System’s long-term problem will be “solved” for any specific length of
time by enacting various system changes. “</u></li></ul><p><span></span></p><a name='more'></a>This year,
the Academy introduced a new version of the Social Security Game and
renamed it “the Social Security Challenge.” Notably, while all three of
the above caveats are still very much applicable today, this language
has been removed from the new version. It appears that this removal was
intentional and not an oversight on the part of the Academy. Apparently,
the above language was removed because, according to Linda Stone, the
Academy’s Senior Pension Fellow (in the July/August issue of
Contingencies magazine), the Challenge<p></p><blockquote><p>“was designed with the
public in mind, and so we started with the basics—and used easy-to
understand language. We were positively recognized for this approach in
many media stories about the Challenge—one of which offered praise since
it did not present like a ‘dense actuarial report’.”</p></blockquote><p>In the same
issue of Contingencies, Ted Gotsch, the Academy’s senior policy analyst
for content and publications, doubled down on the Academy decision to
eliminate the caveat language in an article entitled, <i><a href="https://contingencies.org/challenge-is-embraced-by-stakeholders-seeking-social-security-solution/" target="_blank">’Challenge’ is Embraced by Stakeholders Seeking Social Security Solution</a></i>.</p><p></p><p>While
we support the Academy’s efforts to educate the public about Social
Security and changes that may be required to bring the system back into
actuarial balance (and we believe that the new version of this tool is
an improvement over the older version), we strongly disagree with its
decision to remove the caveat language from the updated version of the
change menu tool. We believe this decision is shamefully inconsistent
with:</p><ul><li>The profession’s Code of Conduct and Actuarial Standard of Practice (ASOP) No. 41,</li><li>The profession’s Strategic Plan (Including three of the four goals enumerated in its Strategic Goals and Objectives),</li><li>The profession’s prior communications on Social Security,</li><li>The profession’s recent guidance on fixed-rate pension plans, and</li><li>Possibly several other professional communications</li></ul><p>I’m
not going to bore you with discussion of the profession’s standards of
practice regarding communications or the professions strategic plan, but
I will briefly discuss the profession’s prior communications on Social
Security and their recent guidance on fixed-rate pension plans and how
that guidance can be interpreted to apply to Social Security.</p><p><b>Sustainable Solvency and the 75-year Valuation Period Problem (caveat #1 above)</b></p><p>The
Academy is keenly aware of the potential problems created by limiting
the valuation period for determining the system’s long-range actuarial
balance to 75 years. Sustainable solvency is a stronger requirement than
the actuarial balance measure used in the Social Security Challenge. In
its <a href="https://www.actuary.org/sites/default/files/2019-05/SSC_Trustee_Report_05222019.pdf" target="_blank">Actuarial Perspective on the 2019 Social Security Trustees Repor</a>t,
the Academy said,</p><p>“The sooner a solution is implemented to ensure
the sustainable solvency of Social Security, the less disruptive the
required solution will need to be”</p><p>and</p><p>“In order to achieve
viability of Social Security in the foreseeable future, any
modifications to the system should include sustainable solvency as a
primary goal.”</p><p>Sustainable Solvency is not addressed or discussed in the new or old versions of the Social Security Challenge. </p><p></p><p><b>Recent Guidance on Fixed-Rate Pension Plans (caveat #3 above)</b></p><p>As
discussed in our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/04/systematic-comparison-of-assets-and.html" target="_blank">post of April 11, 2023, </a>Social Security is essentially
a Fixed-Rate Pension Plan as defined by the Academy in its practice
note, <a href="https://www.actuary.org/sites/default/files/2023-02/Fixed_Rate_Pension_Funding_Practice_Note.pdf" target="_blank">Fixed-Rate Pension Funding</a>. That practice note suggests seven
items for an actuary to consider when consulting on fixed rate plans.
Items 6 and 7 are:</p><p>“6. Work to establish procedures to evaluate and update the fixed rate and possibly benefits in a timely, <b>systematic</b> manner [emphasis added].</p>7. Ensure
that stakeholders are aware of the significant risks associated with
pension funding— most notably investment risk—and that a combination of
fixed benefits and contributions cannot persist indefinitely.”<p>These
two items relate to the third caveat above. Item 7 tells us that a
system (or plan) actuary has a responsibility to educate stakeholders
about the limitations of actuarial funded status calculations. He or she
should stress that even if actuarial balance is restored for a system
(or plan) such a snapshot balance does not guarantee that the system
will remain in actuarial balance for any specified period of years. Item
6 suggests that system (or plan) sustainability can be significantly
enhanced if there exists some systematic mechanism for adjusting
benefits or income sources when the system falls out of actuarial
balance.</p><p></p><p><b>Summary</b></p><p>The
American Academy of Actuaries has removed caveat language from the
Social Security Challenge that had helped explain the limitations of
this tool to stakeholders for almost seven years. Apparently, this
intentional removal was done to make the tool simpler to understand. In
their Contingencies letters and articles, Ms. Stone and Mr. Gotsch both
described the new tool as way for the public to learn “about Social
Security and the reform options to keep the system strong for
generations to come.” Mr. Gotsch also describes the tool as a way “to
consider different scenarios that would close the financial gap so it
[Social Security] could continue to fully fund the benefits older
Americans are entitled to receive under the program.”</p><p>It is
important to note that Social Security Challenge “solutions” are not
necessarily solutions to Social Security’s funding problems. They are
reform options that would restore the system’s actuarial balance on a
snapshot basis with no guarantee as to how long the resulting system
would remain in balance. Restoring the system’s actuarial balance this
year or in a future year definitely does not guarantee that the system
will be “strong for generations to come” or that the system will be
fixed or fully funded. The mere fact that we have to mention this fact
points to the potential misleading nature of the Challenge itself and
the need to restore the caveat language to accurately describe the
limitations of the game.</p><p>If Ms. Stone, Mr. Gotsch and the Academy
truly wanted to ensure that our Social Security system will remain
strong for generations to come, they should suggest that in addition to
restoring the system’s actuarial balance, Congress should also consider
implementing automatic (or systematic) adjustment guardrails to maintain
the system’s actuarial balance (similar to what the Academy recommended
for fixed rate pension plans and what we recommended for individual
households in our <a href="https://howmuchcaniaffordtospendinretirement.blogspot.com/2023/01/automatic-funded-status-adjustments-to.html" target="_blank">post of January 7, 2023</a>) on a going-forward basis. <br /></p>How much can I afford to spend in retirement?http://www.blogger.com/profile/03040818463661298512noreply@blogger.com