American Academy of Actuaries Reinserts Caveat Language into Their Social Security Challenge/Game

Kudos to the American Academy of Actuaries (AAA) for reinserting the following caveat language in its Social Security Challenge tool. 

Actuaries Confuse the Primary Causes of the Social Security Funding Shortfall

The American Academy of Actuaries (Academy) recently published its annual Actuarial Perspective 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.

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, “Here’s the real cause of the Social Security funding shortfall, according to the program’s chief actuary”

It’s that Time Once Again for Retired Households to Perform Their Actuarial Valuations

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 Funded Status. To do this, we suggest you follow the easy 5-step valuation process outlined below using our Actuarial Financial Planner (AFP) models.

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 post of November 16, 2023). 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. 

Fixed Dollar SPIAs vs. Fixed Rate Cola SPIAs

In our last post, 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.

Is It a Good Time to Buy That Single Premium Immediate Life Annuity, Updated

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:

• based on life expectancy, or 50% probability of survival, and
• based on a 25% probability of survival, which is the longer expected lifetime basis we recommend using in our website for planning purposes.

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 post of September 17, 2023. We will also discuss a few other considerations that may affect your decision to buy a SPIA at this time.

Estimating Present Values of Long-Term Care Costs and Survivor Benefits Payable After the First Death Within a Couple

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 Funded Status 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. 

“Safe” Withdrawal Rate Brouhaha

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.

We’ve Changed the Default Assumptions in the Actuarial Financial Planner Models

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:

• Increase Investment return on Floor Portfolio assets from 4.5% per annum to 5.0% per annum,
• Increase Investment return on Upside Portfolio assets from 7.5% per annum to 8.0% per annum, and
• Decrease annual rate of inflation from 3.5% per annum to 3.0% per annum.

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.

Confidently Boost Your Spending in Retirement with the Actuarial Approach

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 Funded Status 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.

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 Kitces.com post of November 8, 2023 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. 

Bucketing by Expense Type with the Actuarial Approach

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, “Michael Kitces warns Advisors About Sequence Risk, Defends 4.0% Rule.” Mr. Kitces is a well-known retirement thought leader for financial advisors. 

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.