Nobody Knew Couples Budgeting Could be So Complicated

After we announced our new and improved ABC for retirees, Lori Fassman, (a fellow employee at The Wyatt Company in Boston and a singing goddess) asked us the simple question of how to use the ABC for Retirees spreadsheet to develop a spending budget or Actuarial Budget Benchmark (ABB) for a couple. This turned out to be a great question, and one that was also somewhat embarrassing to us, as we had clearly not given it sufficient thought.   So, this post will address budgeting for couples.  As we researched it, we felt a little like how our President felt about health care when he said, “Nobody knew [it] could be so complicated.”

What Makes Couples Budgeting So Complicated?

The short answer to the matter of couples budgeting is that applying the Basic Actuarial Equation is more complicated for couples than for individuals.

As we have discussed many times before, our approach to developing a spending budget in retirement is to apply the Basic Actuarial Equation, which balances the PV of total assets with the PV of total spending liabilities, of:

Accumulated Savings

+

PV Income from Other Sources

=

PV Future Non-Recurring Expenses

+

PV Future Recurring Annual Spending Budgets

The primary problem with the current version of the ABC for Retirees spreadsheet as it applies to couples is that it uses the same LPP to calculate

• PV of Income from Other Sources
  

 as it does for the

• PV of Future Recurring Annual Spending Budgets.
  

This is a problem because, if a couple’s Income from Other Sources (such as Social Security benefits, pension benefits, or life annuities) is expected to decrease or cease upon the death of one of the individuals, the left-hand side of the Basic Actuarial Equation (the assets) can be overstated by assuming the longer of the LPPs of each of the individuals in the couple.  Additionally, depending on the desired level of budget following the death of one individuals of the couple, the right-hand side of the equation (spending liabilities) may be understated.

How to Handle Couples Budgeting

We will add better budgeting for couples to our list of items to address in the next version of the ABC for Retirees.  In the meantime, this post will discuss two possible approaches that you can use in the interim:

• a simple approximate approach and 
• a more complicated (but more accurate) actuarial approach.
  

Simple Approximate Approach

The Actuaries Longevity Illustrator, which we recommend using to determine LPPs (no smoking, excellent health, 25% probability of survival) provides four planning horizons (or LPPs) for a couple:

• Person #1 
• Person #2 
• Either Alive, and 
• Both Alive
  

If you don’t want to crunch the numbers required under the more complicated (but more accurate) approach described below, we suggest that you use the Either Alive period for the LPP in the spreadsheet.  In most instances, this will probably produce a result that is sufficiently accurate for budgeting purposes.

More Complicated Actuarial Approach

If you want a more accurate budget, we encourage you to go back to the basics and perform the present value calculations in the Basic Actuarial Equation.  For this purpose, you can either use the PV calculation functions in the ABC for Retirees spreadsheet or the Present Value Calculator spreadsheet.

The Basic Actuarial Equation above can be restructured to solve for the current year’s spending budget as follows:

Current year’s spending budget

=

Accumulated Savings + PV IFOS ‒ PV Future Non-Recurring Expenses                         PV of Future Years with Desired Increases

So, to determine current year’s spending budget, we need to determine:

• Accumulated Savings 
• PV Income from Other Sources (IFOS) 
• PV Future Non-Recurring Expenses, and 
• PV of Future Years with Desired Increases
  

Accumulated Savings and PV Future Non-Recurring Expenses for a couple are as determined for an individual, so they do not need to be specifically addressed here.

The first step in calculating a couple’s spending budget using the Basic Actuarial Equation is to calculate the PV of Income from Other Sources (IFOS), separately for each individual, based on the individual Person #1 and Person #2 LPPs, rather than one LPP for both and sum the results.  Remember that some benefits may continue or be reduced after the first expected death.

The second step is to calculate the PV of Future Years with Desired Increases for the couple. If you have followed us so far, this is where it just may get just a little too actuarial for you.

Depending on the desired budget after one of the couple dies as a percentage of the budget while they were both alive (Y%), the PV of Future Years with Desired Increases for the couple can be determined by applying the following formula:
 

PV of Future Years with Desired Increases (couple)

=

Y% of PV (Person #1 LPP)

+

Y% of PV (Person #2 LPP)

–

[2Y% -100%] of PV (Both Alive LPP)

Example Using More Complicated Actuarial Approach
So, for example, let’s say our couple consists of Jim, a 67-year-old male, and Mary, a 61-year-old female.  The Actuaries Longevity Illustrator tells us that the relevant LPPs for this couple, based on the recommended assumptions, are

• 27 years for Jim 
• 35 years for Mary 
• 36 years for Either Alive and 
• 24 years for Both Alive
  

The present values are at cell K18 of the Input and Results tab of the ABC for Retiree spreadsheet.  They are determined by entering the relevant LPPs in cell G25 of the ABC for Retiree spreadsheet with the current assumptions (4% discount rate, 2% inflation and 2% desired future increases).  In this example, they are:
 

Age	Sex	LPP	PV of Future Years with Desired Increases (from cell G25 of the Input and Results tab G25 of the ABC for Retiree spreadsheet)
67	Male	27	21.2172
61	Female	35	25.6462
n/a	n/a	24	19.3707

Let’s assume that this couple agrees that the target spending budget after one of them dies is 67% (.6667) of the spending budget while they are both alive

Their PV of Future Years with Desired Increases is calculated as follows:

     .6667 x (21.2172) + .6667 x (25.6462) - .3333 x (19.3707) = 24.7876
 
Don’t want to go through these calculations?  Fine, as discussed above in the simple approximate approach, we suggest that you use the “Either Alive” years for your LPP.  In this example, you would be using a PV of Future Years with Desired Increases of 26.1530 (based on the 36-year Either Alive period in this example), but remember that you might be overstating your PV Income from other Sources (IFOS) and possibly understating your spending budget somewhat, depending on actual benefits and the desired decrease in the couple spending budget after the first death.

Thanks again to Lori Fassman for bringing this to our attention.  If anyone else has questions about the workbook or suggestions for improvement, we are always happy to receive them.

Using the Actuarial Budget Benchmark (ABB) to Find Your Retirement Spending Comfort Zone

The title of our website is “How Much Can I Afford to Spend in Retirement?”, so quite a few of our posts and articles address the question of whether you might be spending too much or too little in retirement.  For example, just this year:

• our May 24 post was “Are You Being Too Frugal in Retirement?  The Actuarial Budget Benchmark Can Help You Decide,” 
• our March 20 post was “You Can Spend It Now or You (or Your Heirs) Can Spend It later, Part II” and 
• we published an article in Advisor Perspectives that was originally titled, “Give Your Retired Clients Another Data Point Each Year to Help Them Make Better Financial Decisions.”
  

In this post, we will refer you to a nice Wade Pfau post that approaches this subject from a slightly different angle than we have, but in a way that we believe still supports the use of our recommended approach.

In his post of May 30, 2017 “Taking Portfolio Spending into the Real World for Retirees”, Dr. Pfau lists the following four factors that he believes should be considered when evaluating the trade-off between spending too much (and increasing the risk of undesired cutbacks later in retirement) and not spending enough (to better protect future spending potential):

• Longevity risk aversion: How fearful are you about outliving your investment portfolio in retirement? This is an emotional characteristic unrelated to whether you may outlive your portfolio in an objective sense. 
• Reliable income sources: What proportion of your retirement spending is covered through reliable income sources from outside the investment portfolio? 
• Spending flexibility: Is it possible to reduce portfolio distributions without harming your standard of living in a significant way? 
• Availability of reserves: What other resources are available that have not been earmarked to manage spending and can be used to cover contingencies?”
  

Dr. Pfau concludes “For someone who worries about outliving their portfolio, doesn’t have much additional income from outside the portfolio, faces mostly fixed expenses without much room to make cuts, and doesn’t have much in the way of back-up reserves, it may be necessary to plan for a high probability of success. This will imply using a lower stock allocation and a lower spending rate.”

Since we focus on total spending rather than just portfolio spending, we tend to combine the first and third factors listed by Dr. Pfau into the following factor:

• Spending cut aversion:  What is your risk tolerance for unplanned future real dollar spending cuts?
  

Whether we look at Dr. Pfau’s four factors or just three factors, we agree with Dr. Pfau’s conclusions with respect to investment and spending strategies:  Depending on the answers to these questions, some retirees may benefit from either more aggressive or more conservative investment strategies and spending strategies.

Which brings us back to the Actuarial Budget Benchmark (ABB).  Annually benchmarking your spending budget against your ABB provides you with a measure of how aggressive your current investment and spending strategy is relative to a relatively low-risk annuity-based pricing strategy.  And while we also agree with Dr. Pfau’s conclusion as it also applies to investment strategies, we will not “wade” into that area, as it is not within our field of expertise.  We do, however, believe that the answers to these questions, in combination with using the ABB, can help retirees find their retirement spending comfort zone.  For an example of how you can find your retirement spending comfort zone, see the example in our recent Advisor Perspectives article.

We Have a New and Improved Actuarial Budget Calculator (ABC) for Retirees

In our continuing effort to make it easier for you to apply the Basic Actuarial Equation discussed in this website to help you develop your Actuarial Spending Budget or Actuarial Budget Benchmark, we (mostly Bobbie) have prepared a new Excel workbook for retirees.  We call this new version the Actuarial Budget Calculator for Retirees V 2.0, and it is now available in our “Spreadsheets” section.  We will maintain the old V 1.0 for a temporary period while you get used to the new version.
 
What’s New with 2.0?
 
In general, the new version has a much cleaner look than the old version and provides more guidance on how to use the spreadsheets.  Negative numbers are shown in red.  We discuss the primary changes below by workbook tab.
 
The Overview Tab
 
We have moved this tab to be the first tab to encourage you to read it first before jumping into the numbers.
 
The Input & Results Tab
 
This is where we have made most of the changes, including:

• Improving organization of this spreadsheet, including placing inputs on the left-hand side and results on the right-hand side 
• Providing a warning of potential future cash flow problems, if applicable 
• Providing a default Lifetime Planning Period (LPP) based on input age and sex.  This default can be changed by the user 
• Allowing the user to enter either monthly or annual amounts 
• Providing guidance on input items through hovering the cursor over the red triangle

PV Calcs Tab
 
We show you all the detail in the calculations used in the workbook.  We try to be as transparent as possible in this regard as we aren’t trying hide anything.
 
Runout (in nominal or today’s dollars) Tab
 
We have reorganized this tab to make it easier to follow
 
Inflation-Adjusted (or real dollar) Runout Tab
 
We have reorganized this tab similarly to the nominal dollar runout tab
 
The Budget by Expense and 5-Year Projection tabs have been better organized and negative numbers are shown in red.
 
We encourage you to kick the tires on our new workbook.  As always, we welcome your feedback on our workbooks or our website and would be happy to have your suggestions for future improvements.

Society of Actuaries Confirms Impact of Continuing to Work on Spending Budget

In our posts of November 14, 2016 and April 28, 2014, we discussed the impact, on a hypothetical retiree’s spending budget, of continuing to work rather than retire.  Using the annuity-based pricing assumptions we recommend in our website to determine your Actuarial Budget Benchmark (ABB), we determined that a typical spending budget may increase by as much as 10% per year because of deferring retirement (assuming annuity purchase rates remain relatively constant throughout the deferral period).

In a recently revised retirement decision brief entitled, “Big Question: When Should I Retire?” the Society of Actuaries (SOA) confirmed our near 10% per year increase calculation for a single female named Joan.  The SOA brief indicates, “Joan would see a 37% increase in monthly income if she delays retirement for four years.”  The SOA reached this conclusion by

• converting Joan’s expected 401(k) balance, at various retirement ages, to a monthly income, 
• using recent inflation-adjusted annuity purchase rate quotes obtained from Hueler Investment Services, Inc., and 
• adding the result to Joan’s projected Social Security benefit payable at the various ages.
  

Like our analysis, the SOA analysis also assumes that annuity purchase rates will remain relatively constant throughout Joan’s projected period of continued employment.

Not only were we pleased to see confirmation of our previous posts, but we were happy to see that the SOA’s monthly spending budget calculations at Joan’s possible retirement ages were very consistent with our ABB calculations.  For example, if she retirees at age 66 and spends her entire Social Security benefit and annuity at that age, the SOA indicates that her monthly spending would be $2,334, or $28,008 for that first year.  By comparison, our ABB calculation for Joan produces a spending budget at age 66 of $2,327 per month, or $27,924 for that year (or about 99.7% of the SOA estimate).

If you like how the SOA used an annuity-based pricing model to develop a spending budget in this relatively simple example for Joan, you will love it when you use our Actuarial Approach to develop a spending budget or ABB for your more complicated situation.

All of the SOA’s retirement decision briefs, including the one referenced above, may be found here.