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.
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.
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.
