Sunday, August 2, 2020

Actuaries Discuss Retirement Budgeting Approaches

On July 13, 2020, the American Academy of Actuaries (AAA) released an Issue Brief entitled, “Actuarial Perspectives on Determining a Retirement Income Budget.”  This post will provide the perspectives of two retired actuaries on this AAA Actuarial Perspectives Issue Brief.

Background

The AAA Issue Brief describes three approaches that can be used “in addressing the challenges of lifetime income budgeting”:
  • The RMD Approach
  • The Deterministic Scenario Approach, and
  • The Probabilistic Scenario Approach
and discusses some of the pros and cons of each approach.  The Issue Brief indicates that,
“It is important that retiree [sic] find an approach that creates a structure for retirement finances.”
and concludes by saying,
“There is no universal approach that will work best for all retirees, but all retirees could be better informed by considering any or all of the above methods in determining their drawdown strategy.”   
We agree with these Academy statements.  We find ourselves disappointed, however, with the general lack of practical budgeting help contained in this Issue Brief.  Frankly, we expected more from an organization whose expressed mission is to “serve the public and the United States actuarial profession” and one that makes the Actuaries Longevity Illustrator (the one we use in our workbooks) available to individuals and couples to assist with their retirement planning.  We also expected somewhat more in this Issue Brief since this topic had previously been discussed in the Academy’s October, 2019 Issue Brief, Actuarial Observations on Retiree Income Approaches.

Our brief perspectives on this Issue Brief follow.

Confusing terminology

The Issue Brief talks about:
  • Income budgets
  • Spending budgets
  • Drawdown strategies and
  • Approaches that create a structure for retirement finances
as if these were interchangeable terms.  They are not.  This was a source of confusion to us.

The Probabilistic Scenario Approach

This approach is typically beyond the comprehension of most retirees, and it is generally available only to the small percentage of retirees who retain a financial advisor to help them determine some type of spending budget.  The approach can be effective when considering changes in one’s retirement plan, particularly changes in investment strategy, but it is generally not as effective as the Actuarial Approach in developing a robust spending budget.

The Deterministic Scenario Approach

We weren’t entirely sure what the “Deterministic Scenario Approach” was.  The description in the Issue Brief certainly didn’t describe the Actuarial Approach we advocate in our website.  Our approach is not a spreadsheet used to determine an income budget or drawdown strategy.  Our approach is a time-proven process based on fundamental actuarial principles, which is used to:
  • compare retirement assets with spending liabilities to develop an annual spending budget,
  • keep spending on track throughout retirement via annual actuarial valuations and
  • assess retirement risks through scenario or stress testing.   
And while we may provide a deterministic spreadsheet for our readers to use in this process, our approach is not defined by such deterministic model any more than deterministic models used by pension actuaries to determine contribution requirements for their clients or any more than deterministic models used by Social Security actuaries to determine the System’s financial status define their approaches.  Can we expect similar Issue Briefs in the future from the Academy discussing the pros and cons of using deterministic vs. stochastic models for pension contribution calculations and Social Security funded status measurements?

Links would be helpful

The Issue Brief notes that one of the pros associated with the Deterministic Scenario Approach is:
“Calculators that use this approach can be found on the internet, including from investment managers, brokers, and financial bloggers.”
If the Academy believes that it is important for retirees to find an approach for developing a reasonable spending budget, then it might be nice for an organization committed to serving the needs of the public to actually share a few of the more robust internet links.  We know that we would be interested in visiting such sites. Sadly, none are provided in this Issue Brief.

Actuarial Approach vs. RMD or Typical Stochastic Models

Our website is filled with discussions of why we believe our approach is superior to the RMD approach and most current stochastic models used by Financial Advisors for the purpose of developing a robust spending budget.  We aren’t going to repeat ourselves in this post, but if you are interested, feel free to visit the following recent posts:
Summary

We agree with the Academy that it is important that most retirees (and retired couples) find a reasonable budgeting approach in retirement.  In furtherance of its mission, we would like to see the Academy be more helpful in this effort.  How much to spend in retirement is a classic actuarial problem that can benefit from a classic actuarial solution.  We understand that some retirees simply do not want to own their own retirement and want to rely on their financial advisor for management of their retirement.  For DIYers who aren’t afraid to crunch their own numbers or for those retirees who would like to double check their financial advisor’s stochastic model results, we encourage use of the Actuarial Approach located right here in this website.  It is free, robust and quite accessible.
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