We, here at How Much Can I Afford to Spend in Retirement, advocate the use of basic actuarial and financial economics principles to help our users make better retirement-related financial decisions. We don’t claim to address every possible decision you may need to make before or after you retire. For example, we don’t address the tax ramifications of withdrawals from after-tax vs. pre-tax accounts (or any specific tax strategies for that matter) or how much you should spend on insurance products vs. self-insuring your risks.
In addition to helping you develop an annual spending budget before or after retirement, our goal is to provide you with “data points” that can be used to assist you in making other retirement-related decisions, including:
- timing of your retirement
- timing of your Social Security benefit commencement,
- allocation of your assets between risky vs. less-risky investments,
- spending on discretionary expenses, and
- whether to take a part-time job in retirement.
In this post, we briefly discuss these decisions and how our tools (the Actuarial Budget Calculator [ABC] workbooks and Recommended Financial Planning Process [RFPP]) can be used to help you make them.
Decision # 1 – How Much Can I Afford to Spend This Year?
Since this is the name of our blog, it is only natural for us to start with this one as one of the most important ongoing decisions to be made by a retired household—the annual spending budget. The recommended process to produce “data points” to enable you to make this decision involves using our ABC workbooks and the RFPP. The use of this recommended process and ABC workbooks generally applies to all the decisions discussed in this post.
Process:
Enter your data, assets, non-recurring expenses and assumptions (we suggest starting with the default assumptions) into the Input section, on the left of the Input & Results Tab of ABC for Retired Single or Couples, as appropriate. Enter all your assets and your non-recurring spending liabilities. If you or your spouse plan to work part-time, enter estimated income and period of part-time employment in the appropriate employment income cells. The screen shot below shows data for a hypothetical couple.
 |
| (click to enlarge) |
The Results section, on the right of the Input & Results tab, will show the Present Value (PV) of Assets (including benefit streams and lump sum amounts), the present value of your non-recurring expenses and the “maximum” current year recurring expense budget based on the inputted assumptions and inputted non-recurring expenses.
Check the items in the PV Calcs tab for reasonableness. For example, make sure that annual payment amounts are entered as annual payments are not inadvertently entered as monthly payments.
 |
| (click to enlarge) |
Once you have completed the Input & Results tab and checked the PV Calcs tab for reasonableness, go to the Asset Reserves by Expense Type tab. This tab is shown above for our hypothetical couple. The same investment return/discount rate used in the Input & Results tab is used in this tab. The Present Value of Assets developed in the Input & Results tab is carried forward to the top of this tab.
Enter your annual estimated Essential Expenses and Discretionary Expenses and expected annual increases in the shaded cells. Also enter “Percentage Essential” in column E for present values of non-recurring expenses that were calculated in the PV Calcs tab. You may need to consult the PV Calcs tab to determine the essential percentage of some of your expected non-recurring expenses. Column I of the Asset Reserves by Expense tab shows the remaining present value of your assets after reflecting the present value of each inputted expense.
The three important cells in the Asset Reserves by Expense Type tab are:
- H (22) Additional Unallocated Results,
- G (26) Present Value of Essential Expenses, and
- H (26) Present Value of Discretionary Expenses.
If H (22) Additional Unallocated Results is negative, this is an indication that the present value of your assets can’t currently support your future estimated expenses under the assumptions inputted for this tab. If this is the case, you can:
- reduce inputted current year expenses (recurring or non-recurring and generally discretionary),
- reduce inputted rates of expected annual increases in your recurring expenses
- use more aggressive investment return/lifetime planning period assumptions to develop the present values of future expected discretionary expenses, essential expenses (not recommended) or both, or
- increase the present value of your assets to produce a non-negative number for this cell H (22). This may be accomplished by deferring commencement of Social Security benefits, purchasing a lifetime annuity, or engaging in part-time or full-time employment.
Repeat this process every year to reflect differences between actual and assumed experience and keep your spending plan on track.
Decision #2 – Timing of Retirement
Use the same ABC and process described above to provide data points for this decision of when to retire. In terms of measuring the financial feasibility of whether you can afford to retire, the larger the unallocated amount shown in H (22), the more financially feasible will be your retirement. You may also not be financially ready to retire if you have to significantly reduce your discretionary expenses in order to have a positive value in cell H (22).
Decision #3 – When to Commence Social Security
To measure the impact on the present value of your assets of deferring commencement of your or your spouse’s Social Security benefit, simply enter your (or your spouses) projected Social Security benefit (together with assumed cost of living increases at the inputted rate of inflation) at the later commencement age and the number of years of deferral.
Decision #4 – Allocation of Assets Between Risky vs. Less-Risky Investments
We advocate considering building a Floor Portfolio of less-risky investments to fund your future estimated essential expenses. Therefore, the process for this decision is the same as outlined in Decision #1 and involves many possible decisions, including whether or not to purchase an annuity or take a lifetime annuity form of payment from a pension plan vs. a lump sum.
Once you have determined the present value of your essential expenses, compare it to the present value of your less-risky assets (such as Social Security, pensions, annuities, cash and individual bonds that may be calculated in the PV Calcs tab) to determine whether you should increase or decrease such assets to cover the present value of your essential expenses. Increasing the present value of your less-risky investments involves combinations of the following actions, for example:
- Deferring Social Security benefit commencement
- Selecting life annuity forms of payment from defined benefit or defined contribution plans
- Purchasing lifetime income annuities
- Investing in cash, individual bonds or bond ladders
The remainder of your assets may be invested in more risky assets in your Upside Portfolio used to fund your discretionary expenses.
Decision #5 – Spending on Discretionary Expenses
As discussed in our post of November 12, 2019, you may wish to be more aggressive in determining your spending from your Upside Portfolio on discretionary expenses, as in theory, these expenses can be reduced in the future if necessary, and you probably expect to earn higher returns over your retirement on these more-risky investments. Therefore, instead of using the same default assumptions used to determine your annual essential expense spending (as is shown in the Asset Reserves by Expense Type tab if you use the default assumptions), you may decide to either front-load your discretionary expense spending or otherwise use more aggressive assumptions to spread these assets over your retirement.
Summary
As discussed in our post of April 5, 2021, there are many decisions involved with aligning your retirement plan with your spending goals, your tolerance for risk and other preferences you may have. While we don’t claim that our relatively simple tools will enable you to make every possible retirement-related decision you may need to make, we do believe that these tools can provide important data points to help you make many better decisions.
