Subsequent to release of our previous post, we received a suggestion from one of our readers that we show Bill and Jim’s spending graphically, since pictures can frequently communicate better than words. We agreed. Therefore, this post will illustrate Bill and Jim’s expected future spending under the Actuarial Approach if all assumptions made in the calculations are realized and will compare the results with spending expected under the 4% Rule under the same assumptions about the future. Amounts are shown in today’s dollars.
In addition to assuming the default assumptions are exactly realized each year in the future, both gentlemen are assumed to spend their total spending budgets, determined under either the Actuarial Approach or the 4% Rule each year.
The spending lines shown below illustrate the old spending adage, “you can spend it now or you (or your heirs) can spend it later. The present value today of future spending steams under either approach is equal to the current present value of their assets (accumulated savings plus PV of their streams of payments). For Bill, this amount is $1,351,816 and for Jim, this amount is $1,653,203.
Bill’s Spending
While the 4% Rule is not specific about how Bill’s proceeds from his home sale should be spent in situations like this, we assumed that Bill would spend 8% of the sale proceeds ($231,518 in today’s dollars) in the year of sale and increase that amount by inflation in subsequent years.
Here is Bill’s spending graph
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The blue flat line shows Bill’s anticipated recurring expense spending under the Actuarial Approach, and the red line shows his total spending, including non-recurring spending items that Bill included in his spending goals. The large jump in year 5 is the amount reserved by Bill ($36,229 in today’s dollars) for purchase of a new car. The bulk of the remaining difference between the red and blue lines is the amount Bill reserved for future travel expenses.
The green line shows spending under the 4% Rule. For the first five years, Bill would not be able to afford his recurring expense spending goal of $55,000 under this approach, but spending is expected to be somewhat higher than his recurring expense spending goal once he starts to collect his Social Security. Once he downsizes his home at 80, converts the proceeds to annual income and starts receiving deferred annuity benefits at 85, his spending becomes significantly higher than his recurring expense spending goal, and it may even be difficult for him to spend these amounts in his later years.
Jim’s Spending
Here is Jim’s spending graph
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Once again, the blue flat line show’s Jim’s recurring expense spending under the Actuarial Approach and the red line shows total spending, including non-recurring expense amounts consistent with Jim’s spending goals. The green line shows Jim’s spending under the 4% Rule.
While Jim can spend more under the 4% Rule for the first 25 years of his lifetime planning period, he won’t be able to afford to fund his goals of having sufficient amounts set aside for Long-Term Care or for his bequest motive goals.
Summary
Even if Bill and Jim
use the 4% Rule to develop their spending budgets, they can still
accomplish their spending goals. Bill can do this by borrowing against
future assets. Jim can do this by saving income in excess of his
recurring spending goal for the future. Of course, an easier approach
for both would simply be to use the Actuarial Approach.
