The Actuaries Longevity Illustrator (ALI) has recently been updated to reflect mortality changes made in the 2021 Trustees’ Report for Social Security. We have therefore also updated our actuarial workbooks to reflect these changes. Like prior year changes, the changes in this year’s version were not major (no more than one year increases or decreases in lifetime planning horizons from the prior year) even though the 2021 Trustees report reflected the increased pandemic mortality experience in 2020.
Of some interest, male lifetime planning horizons have generally stayed the same this year or decreased by one year, while female planning horizons have generally stayed the same or increased by one year. For example, at the 25% probability of survival for non-smokers in excellent health, the planning horizons for age-65 males and females (often-used as example retirement ages) changed from 29 years and 31 years (a two-year difference) last year to 28 years and 31 years (a three-year difference) this year. Because the ALI rounds planning horizons to the nearest year (more on this below), it is not easy to measure the exact impact of the changes from last year.
In this post, we will:
- briefly describe the ALI and why we believe it is an important and useful tool for retirement planning,
- discuss recent recognition of the ALI from respected retirement academics, and
- point out one relatively minor limitation of the ALI applicable to couples planning that we would like to see addressed to make ALI an even better retirement planning tool.
For those who find discussion of the ALI a little too geeky, feel free to skip to the conclusion below.
Actuaries Longevity Illustrator
As noted in the welcome page of the ALI:
“With information you provide based on a few questions about your health, smoking habits and demographic characteristics, the ALI will produce tables and graphs showing the likelihood that you (and your spouse/partner, if applicable) may live to certain ages. In addition, the ALI provides information on the number of future years that you might expect to live, as opposed to living to certain ages. The tables and graphs can be used to help you understand your potential retiree financial longevity risk.”
The answer to the first FAQ of the ALI (Why should I consider using something other than life expectancy for financial planning?) says:
“This ALI enables you to see a much larger picture than a single life expectancy number. The tool estimates the likelihood that you will live for various lengths of time. Further, this analysis goes one step further and analyzes longevity for couples. That is, the ALI lets you consider longevity as it affects your retirement as a couple, not just as individual partners. The ALI ’s charts show the likelihood of the couple both living a given number of years as well as the likelihood that one of you will outlive the other. All of this information is crucial [emphasis added] towards planning a secure retirement.”
We agree with these statements (particularly the last sentence above), which is why, for the past four years, our Actuarial Budget Calculator (ABC) workbooks have used 25% probability planning horizons for non-smoker males and females in excellent health from ALI as default lifetime planning period assumptions in spending budget determinations.
Recent Recognition of ALI by Respected Retirement Academics
As noted in our post of September 5, 2020 we referred to a Morningstar report authored by Dr. David Blanchett entitled Estimating the End of Retirement in which Dr. Blanchett refers to the Actuaries Longevity Illustrator and we concluded in our post that the research conducted by Dr. Blanchett regarding lifetime planning periods were quite consistent with the default LPP assumptions used in our workbooks.
More recently, Dr. Wade Pfau refers to using the 25% probabilities (and even the 10% probabilities) from the ALI in his Financial Advisor article of November 1, 2021, which is an excerpt from his new book, “Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success”. With respect to using the 10% probability of survival vs. the 25% probability that we recommend as a default option, we note that using 10% probability of survival may not make much of a difference in an individual’s or couple’s spending budget provided the household has significant Floor Portfolio assets as discussed in our post of September 27, 2021.
We note that in addition to suggesting that some families may wish to plan using 10% probabilities of survival, Dr. Pfau also suggests in his article that couples may wish to select a “planning age” that is the planning horizon for the last of the couple to survive (Either Alive). And while we have no problem selecting a planning horizon that anticipates survival until the last of the couple is expected to pass, we do believe that more reasonable planning will anticipate some percentage reduction in recurring expenses upon the first death within a couple.
There is a relatively simple basic actuarial equation that can be used (and we do use it in our ABC workbooks for couples) to adjust a couple’s planning horizon to reflect a X% reduction in recurring expenses after the first death within the couple. The equation is:
Couple planning horizon adjusted for an X% decrease in expenses on first death =
[ (1 – X%) X (LPP 1 + LPP 2)] minus [ ((2 X (1- X%)) -1] X LPP Both Alive
Where LPP1 is the lifetime planning horizon for person 1, LPP2 is the lifetime planning horizon for person 2 and LPP Both Alive is the lifetime planning horizon where both of the couple is expected to be alive.
For example, let’s assume person 1 is an age 65 male and person 2 is an age 65 female, and we are looking at 25% probabilities of survival for non-smokers in excellent health. ALI tells us that
- LPP 1 is 28
- LPP2 is 31
- LPP Both Alive is 24, and
- LPP Either Alive is 33
Instead of using a planning period equal to LPP Either Alive of 33 years as suggested by Dr. Pfau to be conservative, the couple determines that it is more reasonable to assume that household expenses will decrease by 33% upon the first death within the couple instead of remaining the same. Applying the equation above, they would develop an effective planning period of 31.4 years.
[.67 X (28 + 31)] minus (.34 X 24) = 31.4 years
This adjusted planning period is about 95% of the Either Alive planning period of 33 years, but as we will see in the next section, without whole-year rounding used by the ALI, the adjusted planning period in this example would be closer to 30.7 years or about 93% of the Either Alive planning period. Utilizing this adjustment, some couples may find that they may not need to be quite as conservative as suggested in Dr. Pfau’s article.
We agree with Dr. Pfau in his discussion about “front-loading” vs. “back-loading” of spending in retirement and how this decision involves evaluating a trade-off. As we have said many times in our posts, you can either spend it now or you (or your heirs) can spend it later. In his article, he discusses this trade-off by saying:
“This is the trade-off: either live a more robust lifestyle today by accepting a shorter planning horizon or protect your lifestyle in a longer future by spending less today. People must determine how little spending they are willing to accept today so they won’t have to deplete their assets to live a longer life.”
In the end, we are all responsible for deciding how much spending risk we are willing to take. We believe the ALI can help us make these decisions.
We are encouraged that retirement academics are discovering the benefits of using the ALI in retirement planning and hope this awareness of its benefits will spread to financial advisors and others.
ALI Rounding Issues
While we think ALI is a good, solid tool, it does have one minor flaw, in our opinion: ALI rounds lifetime planning periods to the nearest year. This rounding convention produces inconsistencies in the LPPs used for couples planning. For example, the LPP for the period when either member of the couple is alive (LPP Either Alive) should be equal to
LPP 1 + LPP 2 – LPP Both Alive (which sharp eyed readers will note is the result of inputting a 0% reduction for X in the equation above.)
But, because of the use of whole year rounding in ALI, this equation does not work. Taking our numerical example for the male and female above, the equation becomes:
28 + 31 – 24 = 35, which does not equal the LPP for Either Alive shown in ALI of 33.
In order to make the equation work, for example, the LPP for Both Alive would have to be 26. Had we used a LPP Both Alive of 26 instead of 24 for the example above, we would have developed an adjusted planning period of 30.7 years rather than 31.4 years. And while this is not a huge difference for this couple, it illustrates a problem that we think can be fairly easily addressed.
We would like to see this rounding issue fixed by rounding planning years to the nearest tenth rather than to the nearest year.
We also think it would be helpful to ALI users to include the simple equation discussed above for couples who want to model an X% reduction in expenses upon the first death within the couple rather than using the more conservative LPP Either Alive number of years for planning purposes.
Conclusion
We are pleased to see that retirement academics are recognizing the usefulness of the ALI for planning purposes. We hope that more individuals and their financial advisors will reach the same conclusion. While the tool is already very robust, we would like to see the rounding issue described above addressed so that individuals and financial advisors can adjust lifetime planning periods for couples to reflect lower expected expenses after the first death within a couple.
