One of our readers recently asked whether it was good practice to “roll over” unspent budgeted 2020 travel and entertainment expenses to 2021 or later future years, as long as one does not “double dip” by also counting these unspent amounts as accumulated savings when determining recurring spending budgets. Since this is likely to be a common situation for many of us retirees this year (other than Bobbie, who managed to travel to England early this year), we will address this question in this post.
Actuarial Gains and Losses Overview
All things being equal, budgeted amounts that are not spent during a year become an actuarial gain when measured in the following year’s actuarial valuation. That is, the actual experience for 2020, with respect to this particular item, was financially more favorable than assumed, and all things being equal, will increase spending budgets for future years under the Actuarial Approach. We go into fairly significant detail below about how to calculate aggregate actuarial gains or losses (also called experience gains and losses) each year from all sources using our workbooks. Not all of you will find this level of actuarial detail to be of interest, so we will summarize our answer to the question above here, and you can skip the more detailed “actuarial speak” if you want.
- There is a fair amount of flexibility built into our workbooks to enable you to vary your spending from year to year, particularly your non-recurring and discretionary spending.
- If you are comfortable with the overall level of experience gains during prior years (not just the gain from unspent travel in 2020), you could, if you want, roll-over your unspent travel budget for 2020 to 2021, or perhaps to later years.
- Unless you are very determined, you should be able to avoid double dipping or double counting this unspent travel amount, since inputting an expense as non-recurring in the Actuarial Budget Calculator (ABC) automatically excludes the present value of that expense from your current year recurring expense budget
It is important to note, however, that this year’s gains may turn into next year’s losses. It is generally more aggressive to reflect gains in spending at a faster rate than you reflect losses and to spend more now vs. more later. How much of your accumulated gains should translate into increased current spending and how much should be set aside in a rainy day fund to cover possible future actuarial losses is entirely up to you. Determining how much to spend in retirement is all about finding the proper balance between living for today and living for tomorrow.
How to Calculate Aggregate Actuarial Gains or Losses
After presenting some background about calculating gains and losses from year to year, we will discuss an example involving an unspent travel gain for 2020.
Background
At the beginning of every calendar year, we encourage you to use one of our ABCs to perform an actuarial valuation of your assets and spending liabilities for several purposes, including development of a total spending budget for the year. The total current year spending budget developed in the Input & Results tab is comprised of a current year recurring expense budget and a current year non-recurring expense budget. In general, if all the following conditions apply,
- all assumptions are exactly realized during year 1
- no assumptions are changed during year 1
- exactly the current year recurring and non-recurring spending budget are spent during year 1
- present values input in year 1 are increased by the assumed discount rate in year 2
- input items such as Social Security are increased in year 2 by assumed inflation, and
- lifetime planning periods and periods of deferral and payment are reduced by one year from year 1 to year 2,
there will be no actuarial gains or losses during year 1, and the current year recurring expense budget for year 2 will be equal to the current year expense budget for year 1 increased by the percentage increase inputted for desired increase for future recurring spending budgets. If there are net gains during year 1 and the non-recurring expense budget hasn’t changed, the current year recurring expense budget will be greater than the expected current year recurring expense budget and if there are net losses, it will be less.
Almost all of the time, not all of the conditions described above will apply from one year to the next. Therefore, it is extremely likely that there will be actuarial gains or losses each year. The gains and losses can come from many different sources. One of the larger sources is often investment experience, and another significant source is actual spending that may differ from assumed spending for the year (spending gain/loss). There can be gains from one source that may be offset by losses from another source. In the example below, we will focus on the spending gain that many of us will likely experience during 2020 (unspent travel), and we will assume no other gains or losses occur during 2020.
Example—2020 Unspent Travel Gain
Year 2020 ABC Input & Results tab
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The screen shot shows the Input & Results tab for our hypothetical single retiree, Bob. We are going to assume that he used the current default assumptions for his 2020 budget calculation. While he doesn’t have to spend the Current Year Total Spending Budget of $63,115, the amount shown in cell N23, we are going to assume that he does spend exactly this amount during 2020, including $10,000 on non-recurring travel expenses (in F22 and N22).
Expected Year 2021 ABC Input & Results tab
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The next screen shot shows the expected results as of January 1, 2021 if all the conditions discussed in the Background section above are realized. This screen shot shows that Bob’s Current Year Recurring Spending Budget for 2021 under these assumptions and conditions will increase by the input desired percentage increase of 2% from $53,115 (in cell N20 of Bob’s 2020 ABC) in 2020 to $54,178 (in cell N20 of the expected 2021 ABC) in 2021.
Actual Year 2021 ABC Input & Results tab
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But, because of the Pandemic, Bob didn’t take his vacation. If he earned a 3% investment return, the assumed investment rate, on the $10,000 he was planning to spend on 2020 travel (cell F22 of Bob’s 2020 ABC), he would have $10,300 ($10,000 X 1.03) more accumulated savings than he expected. So as shown in the screen shot above, all things being equal, he would have $997,951 (in cell D7) vs. the expected amount shown in the previous screen shot of $987,651.
Bob has considerable flexibility with regard to how to spend his unspent travel “gain” of $10,300 in the future, including:
- Putting it in his rainy day fund for general future spending
- Spreading it over his future lifetime to increase his future recurring expenses
- Spreading it over the remainder of his original 9-year travel period
- Extending his travel period by a year
- Spending it all in 2021
- Any combination of these
The above screen shot illustrates calculation of his 2021 spending budget calculation if he decides to spend it all in 2021 in addition to the amount he expected to budget for travel in 2021. He does this by inputting the $10,300 spending gain in cell F20 as an additional expected non-recurring expense. It shows that if he does this (or chooses other options that use the gain to fund non-recurring expenses) his recurring spending budget remains as expected (at $54,178 in cell N20). Had he spread this gain over his future lifetime to cover future recurring expenses, his 2021 recurring spending budget determined in this manner would have increased by $406 ($10,300 / 25.3820), where 25.3820 is PV of Future Years with Desired Future Recurring Spending Budget Increases in cell M18.
It should be noted that this level of flexibility is not available in many other spending budget approaches, as these other approaches generally do not distinguish between recurring and non-recurring expenses.
Summary
Courtesy
of Covid-19, many of us experienced a bad news/good news type of story
this year. The bad news was that we had to cancel our 2020 travel plans
(among other things). The potential good news is that we probably
spent less than our 2020 budget, and as a result, we will likely see an
“actuarial gain” when we perform our January 1, 2021 valuations. If
you experience actuarial gains from various sources during 2020, you
will have options available to you with respect to how you recognize
these gains in your spending. We suggest you use your best judgement
to determine how these gains should translate to 2021 spending increases
vs. future year spending increases. You may also need to decide
whether such increases should involve your non-recurring or recurring
expense budgets.
