“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.

Plan on Future Adjustments to Your Retirement Plan Part II

This post is a follow-up to our post of April 16, 2023. In that post, we said,

“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:

• Annual investment returns (i.e., past performance is not a guarantee of future results),

• Longevity,

• Annual inflation (or other rates of increases or decreases in household expenses),

• Spending (this is a huge source of potential variability) and spending goals,

• Sources of income (i.e., Social Security or rental income)

• Assumptions about the future

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.

Automatic Funded Status Adjustments for Social Security is a Great Idea

This month, in Any Social Security Legislative Package Should Include an Automatic Adjustment Mechanism, 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. 

Actuaries Continue to Ignore the “Valuation Date Creep” Elephant in the Social Security Financing Room

This post is a follow-up to my July 3, 2023 Advisor Perspectives article, Applying the Actuarial Process to Retirement Planning, 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:

1. Make reasonable assumptions about the future (generally deterministic, not stochastic).
2. Calculate present values of assets (including future sources of income) and liabilities based on relevant demographic information, system provisions and assumptions made.
3. Periodically (generally annually) compare estimated present values of assets to liabilities to determine the system’s funded status (snapshot comparison).
4. Maintain a history of the system’s funded status over time and note trends.
5. 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).
6. Periodically evaluate/stress test assumptions to see if they need to be changed or to assess risk.

Is 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:

• 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 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 post of January 9, 2023. We will also discuss a few other considerations that may affect your decision to buy a SPIA at this time.

Manage Your Financial Risks in Retirement Like an Actuary

In his August 7, 2023 Advisor Perspectives article, 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:

• historically high equity valuations;
• historically low bond yields;
• increasing longevity;
• the potential need for expensive long-term care;
• the failure of government to fully fund the Social Security and Medicare programs;
• the likelihood of slower economic growth due to the rising debt-to-GDP ratio; and
• the end (and even likely reversal) of favorable tailwinds for corporate profits (falling interest rates, profits growing faster than GDP, and falling tax rates).”

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. 

Retirement Planning is Not an Event; It’s a Process

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,

“Retirement planning isn’t an event… it’s a process, Ken.”

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.