(Hint: The Actuarial Approach focuses on how much you can afford to spend each year, not how much of your invested assets you can safely withdraw each year)
As discussed in our post of October 28, 2020, there is no shortage of recent articles claiming that the 4% Rule or the IRS RMD approach, or the seemingly infinite number of modifications of these SWPs, is the best approach for you to use to develop your spending budget in retirement. Pardon our French, but we call “BS” on these articles. If your goal in retirement is to structure annual withdrawals from your invested assets so that they are relatively stable from year to year and unlikely to run out while you are alive, then an SWP approach may be just what you are looking for. However, if you are looking to structure your spending to meet your financial goals in retirement (including not running out of assets), you will want to check out the Actuarial Approach.
This post will illustrate the advantages of the Actuarial Approach by looking at two different hypothetical individuals, Bill and Jim. These two retired gentlemen are the same age, but they have significantly different spending goals and sources of income. Although they have about the same goal for annual recurring spending, the expected patterns of their future withdrawals from savings are significantly different. As a result, there is no SWP that will work well for both of them. Arguably, there is no SWP that will work well for either of them.
Data
Item | Bill | Jim |
Age | 65 | 65 |
Sex | Male | Male |
Accumulated Savings | $800,000 | $725,000 |
Social Security Benefit | $30,000 @ age 70 | $22,000 immediate |
Fixed Life Annuity | $10,000 @ age 85 | $20,000 immediate |
Future Home Downsize | $311,593 @ age 80 [PV of $200,000] | $0 |
Spending Goals
Item | Bill | Jim |
Approximate Annual Recurring Spending Needs in real dollars | $55,000 | $55,000 |
Non-Recurring Spending Goals | $40,000 for new car in 5 years. $10,000 per annum in real dollars for next 15 years. No planned bequest motives. | Long-term care of $70,000 per annum for 3 years at age 90. Bequest motive of approximately $200,000 in today’s dollars. |
Bill owns a home with about $400,000 of equity. His plan is to downsize his large family home when he reaches age 80, using about half the proceeds to fund his recurring spending and the other half to fund possible long-term care when/if needed. He wants to travel early in his retirement and he wants to buy at least one more new car while he can still drive. Jim is a renter with no real desire to travel and doesn’t want to own a car. He wants to leave a legacy to his children and doesn’t want to become a burden on them if he should require long-term care.
Actuarial Budget Calculator Results
Bill and Jim enter their data into the ABC for Single Retiree workbook. They use the default assumptions. Instead of entering present values for their desired non-recurring expenses, they enter information designed to produce about what they estimate for the present value they would have entered. For example, instead of entering $50,000 for the expected present value of unexpected expenses, they enter $2,000 per annum, increasing with inflation for the rest of their lives for expected non-recurring expense #1. They do this so that they can get a more accurate picture of future cash flows in the Runout tabs. Here are screenshots of their Input/Results tabs:
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| Bill (click to enlarge) |
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| Jim (click to enlarge) |
Feel free to enter Bill and Jim’s data into our recently updated ABC for Single Retirees to verify their results and view the information presented in the other tabs.
The workbooks show that Bill’s Recurring Spending Budget is expected to be about $55,000 for the rest of his life and Jim’s is expected to be about $56,000 under the Actuarial Approach if all assumptions are realized. If they used a standard SWP like the 4% Rule or the IRS RMD approach to “tap into their retirement savings” and added the result to their income from other sources, their recurring spending budgets would not be expected to be relatively constant in real dollars from year to year.
Anticipated Withdrawals from Accumulated Savings
The charts below are taken from Bill and Jim’s Inflation-adjusted Runout tabs, and show annual expected withdrawals from accumulated savings as a percentage of their projected beginning of year balances. Because of their different spending goals and income flows, these expected withdrawal percentages are significantly different for Bill and Jim.
Summary
SWPs used to develop withdrawal strategies from invested assets don’t coordinate with income from other sources and don’t address spending goals that involve non-recurring expenses. Therefore, there are many situations where using a SWP will produce a sub-optimal spending plan. Many financial advisors still employ SWPs for their clients. It is not clear to us why they continue to do this. We would like to think that it is not because they only care about managing your invested assets. If you use (or your financial advisor still uses) a SWP, we suggest that crunch your numbers using the Actuarial Approach to develop a sustainable spending plan that is more consistent with your spending goals in retirement.
