We don’t tell people how much they should spend each year. The amount you spend is your business (or your and your spouse’s business). We provide actuarial tools designed to facilitate your decisions regarding how much you can afford to spend and still meet your financial goals based on your financial situation and the assumptions you make about the future. If you use the default assumptions in our Actuarial Budget Calculators (ABCs) to calculate your Actuarial Budget Benchmark (ABB), you are calculating a current year spending budget based on assumptions roughly consistent with those used to price inflation-adjusted annuities. You might expect that using these assumptions would produce a reasonably conservative annual current spending budget. But, we find that even before applying the adjustments discussed below, your ABB spending budget may be higher than spending budgets developed using other approaches.
Of course, you don’t have to actually spend your spending budget every year. In any given year, you can spend more or less than your spending budget. The purpose of the ABB is to gauge how conservative or aggressive your current spending strategy is. Armed with this benchmark, you can choose the level of current spending with which you are comfortable (including smoothing your spending from year to year if you desire), and just as important, you can monitor how aggressive your spending is each year in the future by annually comparing it with your annually recalculated ABB.
The Actuarial Approach balances your assets with your estimated future spending liabilities to develop your current spending budget. Therefore, we are going to separate the discussion of the ten ways to increase your current spending budget into two categories:
- Ways that increase your assets, and
- Ways that decrease your estimated future spending liabilities
Increasing Your Current Spending Budget by Increasing Your Assets
1. Work part-time. One of the ways to increase your assets is to work part-time in retirement. Our Actuarial Budget Calculator (ABC) workbooks include this item as an input item. You should be aware, however, that the ABC treats the present value of estimated future part-time income the same as other sources of retirement income and spreads this present value over the present value of your expected years in retirement. Yes, you could be more aggressive and simply add your part-time income for the current year to amounts withdrawn from savings and other sources of income for the current year to develop your spending budget, but this would leave you in the position of potentially experiencing a significant drop in your spending budget at the time you ceased your part-time employment. You should also remember that there are limits on the amount of part-time income you may receive without affecting your Social Security benefit if you haven’t yet reached your Social Security Normal Retirement Age.
2. Consider all your assets. Another way to find more assets is include the present value of other sources of income (or future sales of assets) in your ABC calculations. For example, you may plan to sell your house, business or boat, collectable art, etc. at some time in the future. You may also believe that you will receive an inheritance from a family member or win the Lottery in the future. We generally caution individuals from including inheritances or future Lottery winnings as assets in their spending budget calculations unless (until) they become reasonably certain that they will be receiving such assets. If you do consider all your assets in your spending budget calculations, we also encourage you to consider all your spending liabilities.
3. Defer commencement of Social Security or purchase a fixed life annuity. If you are using the default assumptions to determine your ABB, deferring commencement of Social Security and/or purchasing a fixed dollar life annuity policy with some of your assets will generally increase your current spending budget somewhat.
4. Marry someone with lots of assets who is willing to share them with you. If you marry someone and that person agrees to develop a couple’s budget with you and brings more assets to the spending budget table than spending liabilities, your current spending budget will be increased.
Increasing Your Current Spending Budget by Decreasing Your Estimated Future Spending Liabilities
5. Treat some of your expenses as “Non-Recurring” instead of “Recurring.” If you believe that some of your future expenses will cease or will be significantly reduced in the future, you can treat these expenses as non-recurring rather than funding for them over your entire period of retirement (as the ABC does for recurring expenses). For example, you may not have mortgage (or car) payments for the entire period of your retirement or you may plan to significantly reduce your travel expenses once you reach age 80. Instead of developing your current spending budget assuming these expenses will last for the entire period of your retirement, you can calculate the present value of these expected expenses and input the result in the present value of non-recurring expenses cell of the ABC workbook. This will reduce your current recurring spending budget, but the total of your current recurring and current non-recurring spending budgets will increase.
6. Decrease your desired estate. Many individuals wish to leave money to their heirs upon death. Since the Actuarial Approach is a dynamic spending approach that automatically increases your expected age at death as you age, there is a high probability that you will die with some assets left unspent. Further, if you:
- have established a reserve for long-term care expenses,
- have establish a Rainy-Day reserve fund to mitigate spending budget fluctuations,
- have a home that you don’t consider as part of your assets
7. Assume decreasing expenses after first death (for couples). After the first death within a couple, it is reasonable to assume that some expenses will be reduced. Our ABC calculator for couples permits you to input a specific desired reduction in recurring expenses upon the first death within the couple.
The remaining ways to reduce estimated future spending liabilities involve overriding the default assumptions used in our ABCs. While you will still be employing the Actuarial Approach to develop your spending budget, you will not be developing your Actuarial Budget Benchmark (ABB).
8. Assume declining future real dollar recurring expenses as you age. Research tends to show that our spending decreases in real dollars as we age, even though some expenses (like medical costs) tend to increase faster than general inflation. You can increase your current spending budget by entering a percentage less than assumed inflation (the default assumption) for desired increases in future spending budgets.
9. Decrease the default lifetime planning period (LPP) assumption(s). The default assumption in our ABCs is the 25% chance of survival for non-smokers in excellent health from the Actuaries Longevity Illustrator. This is a more conservative assumption than your life expectancy (which is the 50% chance of survival) and you (or your spouse) may not be in excellent health. If you are not in excellent health and you have a family history of dying as a result of a heart attack (for example), you may wish to consider overriding the default LPP assumption with a shorter period. In this example, you may also wish to consider not establishing as large a reserve for long-term-care expenses. Both of these changes will increase your current spending budget.
10. Increase the default investment return assumption. We receive many comments from our readers that the default approximately 2% real investment return assumption is just too conservative. As we have indicated previously, we select the default assumptions to be roughly consistent with assumptions used to price current inflation-adjusted annuities (a relatively low-risk investment). You may expect to earn a higher rate of return if you invest in higher risk securities, but you will be taking on greater investment risk if you do so. However, if you are comfortable assuming your more-risky investment strategy will actually earn a higher rate of return, you can override the default assumption in the ABC workbook with a higher rate and your calculated current spending budget will increase.
As we have said many times in this blogsite, when it comes to spending “you can spend it now or you (or your heirs) can spend it later.” If you increase your current spending, you are increasing your risk of having to reduce future spending, all things being equal. Even though we are actuaries, we don’t know what the future holds for you. The Actuarial Approach is a robust spending strategy that is very flexible. We believe the Actuarial Approach blows the socks off of Structured Withdrawal Plans (SWPs) like the 4% Rule or the IRS RMD approach in terms of functionality and flexibility. You are unlikely to find many ways (let alone ten) to modify an SWP approach to increase your current spending budget. And SWPs frequently don’t properly coordinate with other sources of income to produce a reasonable spending budget.
While we provide you with default assumptions to use with the Actuarial Approach based on current annuity market information, it is ultimately up to you to decide how conservative or aggressive you want to be in your spending. If you do override the default assumptions in our ABC workbooks, we encourage you to compare your resulting spending budget with your ABB (calculated with the default assumptions) just to measure (currently and over time) how conservative or aggressive your spending strategy may be.