Sunday, October 20, 2019

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: 

  • 4% investment return
  • 2% inflation
  • 2% desired increases in future recurring expenses, and
  • Lifetime planning periods based on 25% probability of survival for a non-smoker in excellent health from the Actuaries Longevity Illustrator (ALI).
On October 11, the American Academy of Actuaries and the Society of Actuaries announced that the ALI had been “updated.”  According to these actuarial bodies, “The back-end mortality tables used to generate the illustrator’s results have been updated from Social Security’s 2010 to 2016 tables, and the mortality improvement scale has been updated from SOA MP-2015 to MP-2018.  Improvements also have been made to the factors used to adjust for smoking and health status.”
 

Since our ABC workbooks use results from the ALI to determine lifetime planning periods, we have incorporated the new updated results.  We also took this opportunity to reflect lower interest rates and investment return assumptions in annuity purchase rates.  Therefore, the new default assumptions for 2020 budget calculations are:
  • 3.5% investment return
  • 1.5% inflation
  • 1.5% desired increases in future recurring expenses, and
  • Lifetime planning periods based on 25% probability of survival for a non-smoker in excellent health from the (updated) Actuaries Longevity Illustrator
The new ABC workbooks on our website have replaced the old versions. 

The Good News - Somewhat surprisingly, LPPs at a given age and gender under the updated mortality table are generally either the same or one year shorter than under the old table.  So, the good news is that you may have one fewer year of retirement to fund.  The actual difference is probably closer to one-half year, but the ALI rounds to the nearest whole year.
 

If you have fixed income annuities or pensions, the present value of those investments will be somewhat higher under the new default assumptions compared with the old default assumptions.
 

These two changes tend to increase your spending budget relative to the spending budget developed under the old default assumptions.
 

The Bad News - The present value of your fixed dollar expenses may be somewhat higher under the new assumptions than under the old assumptions.  Also, assumed investment return is lower.  This change will tend to decrease your spending budget, all things being equal, especially for pre-retirees.
 

Summary - For the most retired users, the results of the revised model should not be significantly different from the results you would come up with under the old default assumptions.  Pre-retirees, however, will generally find that the revised model will require them to save more in order to achieve their retirement spending goals.