Time to Perform Your January 1, 2020 Actuarial Valuation

As part of our ongoing effort to encourage you to think more like an actuary when it comes to your personal finances, this post will recommend that you to perform an actuarial valuation based on your personal data as of January 1, 2020. We also encourage you to prepare an “Actuarial Report” to document your thought process and your planning decisions.  The purposes of this year-end planning exercise are to:

Looking to Calm Those Retirement Spending Fears?

Are you losing sleep because you think you’re spending too much in retirement?  Or maybe you’re spending too little now because you are worried about possible future expenses?  A recent article by Christopher Carosa, entitled, “Why Are We Seeing More Cases of ‘Fear of Spending’ Among Retirees?” discusses this latter fear.  Mr. Carosa notes, “After a career focused on saving, when it comes time to retire, the saving tap is turned off and the spending tap is (supposed to be) turned on.  For many retirees, that’s when the sudden fear of spending kicks in.  And there may be indications this phobia is reaching pandemic levels.”

Actuarial Budget Calculator (ABC) Tips

One of the basic building blocks for the actuarial approach that we advocate for developing a spending budget and for basic personal financial retirement planning is the Basic Actuarial Balance Equation for personal finance.  We provide several Excel workbooks in the “Spreadsheets” section of our website to help individuals and couples perform the present value calculations required to solve this equation, based on their data:

Actuaries Promote Actuarial Methods/Tools for Retirement Planning

The actuarial profession has recently released two items that support the use of actuarial methods/tools for personal financial retirement planning.  The American Academy of Actuaries (AAA) released an Issue Brief titled, “Actuarial Observations on Retirement Income Approaches” and The Society of Actuaries (SOA), in conjunction with Stanford Center on Longevity, issued, “Viability of the Spend Safely in Retirement Strategy.”  While it should be noted that while neither of these two releases specifically endorses the Actuarial Approach advocated in this website, they do acknowledge that actuarial methods/tools can provide sound personal retirement planning analysis.  This post will briefly discuss these two releases and our response to them.

Do You Want to be More Aggressive with Your Upside Portfolio?

One of the advantages of the “Floor and Upside”, or “Safety-First”, retirement planning strategy is that once you have established a floor portfolio of low-risk investments intended to fund your future essential expenses, you can be more aggressive when investing and spending from the upside portfolio intended to fund your future discretionary expenses.  This is because, theoretically, it should not pose an undue hardship for you to reduce your future discretionary expenses if the need should arise.  It is important to note, however, that we are not pushing you to be more aggressive with investment or spending from your upside portfolio, but if being more aggressive with respect to spending from your upside portfolio is something that appeals to you, this post will show you how you can override the default assumptions applicable to discretionary spending to implement a more aggressive overall spending strategy.  We also include an example that utilizes results from our Actuarial Budget Calculator (ABC) workbooks.

Use the Actuarial Approach to Implement Your “Safety-First” Retirement Income Plan

Several of our readers have asked us to compare:

• the retirement planning strategy discussed in Dr. Wade Pfau’s recent Forbes article and his new book, “Safety-First Retirement Planning:  An Integrated Approach for a Worry-Free Retirement” with
• the seven-step planning process outlined in our post of August 25, 2019, which is designed to help users determine the amount of assets necessary to fund essential and discretionary expenses (floor and upside portfolios) in addition to determining recurring and non-recurring spending budget data points.

Good News/Bad News—We Have Changed Our Default Assumptions for 2020 Spending Budget Calculations

In order to compare the market value of your assets with the market value of your spending liabilities and help you develop a reasonable spending budget for the year, we recommend default assumptions that are intended to be consistent with assumptions currently used to price inflation-adjusted annuities.  For 2019 spending budget calculations, these assumptions were: 

Developing a Reasonable Spending Budget—Monte Carlo Modeling vs. Actuarial Approach

In this post, we will once again push back on those who believe the most important characteristic of a retirement planning approach is whether the model used in the process is “deterministic” or “stochastic.”  We believe that the purpose of the calculations and the assumptions and processes employed in the approach are more important factors for developing a reasonable result than the type of the model.  In this post, we will focus on why we believe the Actuarial Approach can be a better approach than Stochastic (or probabilistic or Monte Carlo) models for the specific purpose of developing a reasonable spending budget for individuals or couples, especially for DIYers.  We also note that Social Security actuaries use a very similar approach to measure Social Security’s financial condition and the impact of proposed changes to the program.  This post is a follow-up to several of our posts on this subject, including our post of April 6, 2018.   Feel free to skip this post if you are just looking for a reasonable spending budget number and are not all that interested in diving into the technical details of spending budget calculation models.

Who Will be Responsible for Your Retirement?

Prior to adoption of Social Security in the U.S., many individuals and couples were dependent upon their families and their own personal savings to support themselves in retirement.  Post WWII, family support was mostly replaced by the three-legged stool concept of retirement funding, consisting of Social Security benefits, employer-sponsored defined benefit pension benefits and personal savings.  Over the last thirty years, however, with the advent of 401(k) type defined contribution (DC) plans, declining interest rates and longer lifespans, many defined benefit plans have been terminated by plan sponsors and replaced by DC plans.  Generally, benefits payable from today’s DC plans are lump sum distributions (that may be rolled over to individual retirement accounts), with relatively few DC plans today offering lifetime income distribution options.

Is $1 Million of Savings Enough?

According to the 18th Annual Transamerica Retirement Studies Survey, about 64% of respondents indicated that they needed to save less than $1 million at the time of retirement in order to feel financially secure.  The median amount cited as being needed in the 2017 survey was $500,000.  To develop their response,

Recommended Financial Planning Process for Retirees and Near-Term Retirees

Several of our readers have asked us to briefly summarize the financial planning process that we have been discussing in the past few months in our posts.  So, this post contains our recommended seven-step process designed to help you make better decisions about:

Make Sure Your Retirement Plan Properly Funds Your “Lumpy Expenses”

While most retirement plans anticipate smooth, constant-dollar spending from year to year throughout retirement, most of us just don’t spend that way.  Our actual expenses in retirement can vary significantly from year to year and therefore, the pattern of our future expenses may be “lumpier” than expected by our plan.  Not only is it likely that we will incur unexpected expenses but it is also likely that some of our expected expenses won’t be incurred every year.   As we said in our post of February 7, 2019, if you aren’t separately budgeting for these non-recurring lumpy expenses, you probably don’t have a robust retirement spending budget (or plan).

The Real Problems with Using the 4% Rule to FIRE

Shortly after our July 9 post encouraging retirees to consider shoring up their floor portfolios by establishing budget buckets of low-risk investments to fund their future essential expenses, Michael Kitces released “The Problem With FIREing AT 4% And The Need For Flexible Spending Rules” aimed at very early retirees (Financially Independent/Retire Early individuals, or FI’ers).   His post discussed “safe” withdrawal approaches based on the 4% rule.  This rule of thumb anticipates at least 60% investment in equities, and, when assets are equal to 25 times expected annual expenses, may indicate when assets for an individual with a thirty year lifetime planning period are sufficient to retire (1/.04 = 25 times expected expenses).

Ok Retirees, Now May be a Good Time to Shore Up Your Floor Portfolio

This post is a brief follow-up to our post of April 23, 2018, Ok Retirees, What’s Your Plan for Dealing with the Upcoming Bear Stock Market?  In that post we said, “At some point in the future, we are going to experience another bear market.  We don’t know when it will occur, but we feel pretty safe in predicting that it will happen.”  We suggested in that post that you use our five-year projection tab to stress test your spending budget for potential poor investment returns.

Better Budgeting with “Actuarial Budget Buckets”

In this website we encourage you to use the full functionality of the Actuarial Approach and our workbooks to help you develop a better spending budget and a better sustainable spending plan in retirement.  In 2019 alone, our posts on this topic have included:

Establishing Dedicated Asset Reserves to Fund Different Types of Retirement Expenses

In his post of June 12, 2019 entitled “Segmenting Retirement Expenses Into Core Vs. Adaptive To Create Retirement Buckets”, Michael Kitces encourages his readers to consider separating expenses into “core” and “adaptive” expenses and creating separate “buckets” of assets dedicated to funding such types of expenses in the future.   We think this is excellent advice.  While we are not necessarily convinced that the terms “core” and “adaptive” suggested by Mr. Kitces are superior to “essential” and “non-essential” (or other similar terms commonly used), we are in complete agreement with the general reserving/bucket concept advocated in Mr. Kitces’ post, and, in fact, we have been advocating this concept for some time in our posts.  

Will Actuaries Miss the Boat Again on Social Security?

Every year, the Social Security trustees release a new report discussing the financial status of the Social Security system and every year, the American Academy of Actuaries (AAA) releases their “Actuarial Perspective” issue brief explaining the new report and the Academy’s recommendations for possible system changes.  In an effort to provide our U.S. readers a slightly different perspective on the system’s finances (so they can attempt to plan for future possible changes to the program), this post will discuss some of the issues with which we agree and disagree with the AAA issue brief.  This post updates our posts of June 27, 2018 and August 3, 2017 on this subject.  Clearly, the comments in our previous posts had very little effect on AAA thinking, as most of the language in their 2019 Actuarial Perspective remains unchanged from the language contained in their prior issue briefs.  For additional discussion of the various points discussed below, we encourage you to revisit our prior posts.

Forecasting Future Investment Returns

To help you develop a reasonable annual spending budget, we provide you with Actuarial Budget Calculators (ABCs) that employ default assumptions for future investment returns, future inflation and your expected lifetime planning period.  These default assumptions are selected to be approximately consistent with assumptions used by insurance company actuaries in pricing current inflation-adjusted life annuities (net of expense loads and profit).  Thus, the Actuarial Budget Benchmark (ABB), which uses the default assumptions, provides you with a lifetime spending plan that could theoretically be fully funded through the purchase of relatively low-risk inflation-adjusted annuities at current market rates (the market value of your future spending liabilities).  The default assumptions currently are:

Yes, Determining How Much You Can Afford to Spend in Retirement is More Difficult than Saving for Retirement

Last week, Thomas Heath, a business reporter for the Washington Post concluded that, “Saving for retirement is hard.  Knowing how to spend it down is harder.”  We agree.  On the other hand, as discussed in our post of August 31, 2014, managing spending in retirement is not rocket science.  In order to get it right, you need to periodically:

Crunching the Numbers on Pension Lump Sums—Part II

This post is a follow-up to our post of February 18, 2015 encouraging individuals who are faced with the decision of electing either a lump sum or a lifetime income form of distribution from a defined benefit pension plan to crunch their numbers in order to make a more-informed decision.  The impetus for this post is the recently released guidance in IRS Notice 2019-18 indicating that the IRS would not issue guidance prohibiting  limited period “windows” offering a lump sum option to retirees who are already receiving their pension benefits, and an excellent article on this subject by fellow actuary, Elizabeth Bauer entitled, “What You Need to Know About Pension Lump Sums.” And, while we don’t necessarily see lots of limited period lump sum windows opening up as a result of this IRS guidance, this post may also be of interest to individuals who are offered a lump sum option from a pension plan on termination of employment or retirement as part of their plan’s normal operations.

Building Your Floor Portfolio with Extra Low-Risk Investments

Our last few posts discussed reasons why individuals may wish to consider building a portfolio of relatively low-risk investments to fund their future expected essential expenses (the floor portfolio) with the remainder of their assets invested in more risky assets to fund their non-essential expenses (the upside portfolio).  While there are a number of investments that can lessen investment risk, there are just few types of investments that can also lessen longevity risk by guaranteeing payment for life.  For purposes of this post, we will focus on these relatively low-risk, lifetime guarantee investments as a way to increase one’s floor portfolio.  These strategies/investments (which we refer to as “Extra Low-Risk Investments”) include:

There Are No Guarantees if You Self-Insure Your Retirement—Part 2

This post is a follow-up to our posts of August 8, 2018 and February 26, 2019 and discusses another way that you can use our Actuarial Budget Calculator (ABC) tools to help you better manage your investment and longevity risks in retirement.  We humbly claim that you are unlikely to obtain this level of sophisticated help elsewhere (at least at this price), and we provide an example to support this claim and to give you a guide to performing your own calculations. 

How Much of Your Retirement Assets Should be Allocated to Your “Floor” and “Upside” Portfolios?

As former pension actuaries, we aren’t going to tell you how you should invest your retirement assets.  Our Actuarial Budget Calculators (ABCs), however, can give you a pretty good idea of the value of assets you should currently have to cover your expected future essential expenses.  This information can be useful in helping you decide how much risk you may want to take in your current investment strategy.  

You Need to be Flexible and Have a Plan to Win the Retirement Game

We all enter the “Retirement Game” with our pot of assets to invest and spend.   Many of us are just content to finish the game without running out of assets.  Some of us want to maximize our spending and not leave too much on the table at the end of the game.  Others of us want to leave large amounts to heirs.  Some of us don’t want to have significant spending fluctuations from year to year.  Winning the Retirement Game clearly depends on one’s goals, but it is safe to say that most Retirement Gamers would rather finish their game with too much rather than too little assets.

300th Post—We’ve Added a Smoothing Tab to the Actuarial Budget Calculators (ABC’s) for Retirees

Hard to believe that this is our 300th blogpost.  Almost all of these posts have encouraged our readers to employ the same basic actuarial principles we learned as pension actuaries to help them develop a reasonable spending budget.   During these past nine years, we have continuously refined our messages and improved our tools, but the basic actuarial principles we advocate haven’t changed.  More importantly, we continue to passionately believe that the use of these principles can enable individuals like you to make better financial decisions.

Pension Actuaries to Discuss Solutions to the Lifetime Income Challenge

We’re excited to see that a panel of pension actuaries will be discussing decumulation of retirement savings at the upcoming 2019 Enrolled Actuaries Meeting.  According to the session description:

“Pension actuaries are well positioned to play an important role in developing solutions to the lifetime income challenge.  In this session we explore emerging solutions and strategies to optimize the effectiveness of retirement savings.”

If You Aren’t Separately Budgeting for Non-Recurring Expenses, You Probably Don’t Have a Robust Retirement Spending Budget

We here at “How Much Can I Afford to Spend” are all about the annual spending budget.  But we don’t tell you:

• how to invest your assets;  
• how much of your assets you should actually spend each year, or 
• how you should spend your assets.
  

Expand Your Spending Categories in 2019 for Better Personal Retirement Budgeting & Planning

To help you develop a more robust spending budget and facilitate your retirement planning, we encourage you, in this post, to consider allocating your spending in retirement to a minimum of the following four categories:

• Essential Recurring 
• Non-Essential Recurring 
• Essential Non-Recurring 
• Non-Essential Non-Recurring