The Default Assumptions we build into our Actuarial Budget Calculators (ABCs) are intended to be consistent with assumptions used by insurance companies in the pricing of inflation-indexed life annuities. Since fully inflation-indexed annuities are no longer issued by U.S. insurance companies, selecting these assumptions has become more of a theoretical exercise. However, we do have data on fixed income single premium life annuities and other sources to guide us to some degree.
In our post of April 11, 2020, we indicated that our Default Assumptions may no longer be conservative enough to price future essential expenses and your Floor Portfolio. Since annuity purchase interest rates have remained flat or decreased since last April, we have decided at this time to change the Default Assumptions to make them more conservative, as follows:
Default Assumption | Old Assumption | New Assumption |
Pre-retirement discount rate/investment return | 3.5% | 4% |
Post-retirement discount rate/investment return | 3.5% | 3% |
Rate of inflation/desired increases in future recurring expenses | 1.5% | 2% |
Lifetime planning period | 25% probability of survival from Actuaries Longevity Illustrator for non-smoker in excellent health | Same as old assumption |
We also indicated in our post of April 11, 2020 that interest/discount rates used to price life annuities may be lower for near-term payments than for longer term payments, indicative of yield-curve pricing. Older retirees may wish to take this into consideration when selecting an appropriate discount rate.
The Default Assumptions can be overridden in the Inputs section of the workbooks by:
- clicking on the applicable cell in the Choice of Default or Override column,
- clicking on the down arrow,
- selecting “Override” and
- entering the override assumption in the applicable cell of the Override Assumption column.
As discussed in our post of June 23, 2020, more aggressive than Default Assumption may be warranted for determining spending budgets for discretionary expenses funded by your Upside Portfolio, or you can simply use the “1% Upside Portfolio Bonus” approach discussed in that post as an approximation.
All things being equal, the new assumptions are expected to produce somewhat lower current spending budgets for retirees than the old assumptions.
