Here We Go Again with the 4% Rule and “Safe” Withdrawal Rates

Last year Morningstar told us that the 4% Rule was really 3.3%. This year, based on revised assumptions about the future, they tell us that it is now 3.8% (The State of Retirement Income 2022). Of course, this new report has set off another flurry of discussions among financial advisors, financial academics and the retirement-focused media about:

• the 4% (or whatever %) Rule,
• Safe Withdrawal Rates and
• Spending under more-flexible spending strategies (dynamic vs. static spending strategies)

In this post, we will

• Discuss the results of the Morningstar 2022 Report,
• Briefly discuss the difference between static approaches like the 4% Rule and static Monte Carlo model projections and dynamic approaches like the Actuarial Financial Planner or dynamic Monte Carlo projections, and
• compare withdrawal rates developed in the 2022 Morningstar report with initial withdrawal rates developed from a simplified application of our Actuarial Financial Planner (AFP).

We conclude, once again, that the AFP is a much more robust planning tool than the 4% Rule or most Monte Carlo models.

Updated Implied Discount Rates for Single Premium Life Annuities as of November 25, 2022

In prior posts, we discussed possible assumptions used by life insurance company actuaries in pricing single premium immediate life annuities (SPIAs).  In those posts, we provided implied discount rates consistent with quotes obtained from ImmediateAnnuities.com based on two different mortality assumptions (one based on life expectancy (50% probability of survival) and the other based on a 25% probability of survival, which is the basis we recommend in our website for planning purposes).     

In this post, we will examine the implied interest rate assumptions built into quotes from ImmediateAnnuities.com as of November 25, 2022 and compare the quotes and the implied interest rates with the results of the similar exercise we performed as of July 25, 2022.  You may wish to revisit our prior posts for more general discussion of annuity pricing assumptions.

Managing Upcoming Holiday Expenses

Retirees, I don’t want to be the Grinch who stole your Christmas (or your holiday season), but if you haven’t done so already this year, you might want to estimate your end-of-year financial status by updating the data in your Actuarial Financial Planner (AFP). And, if your updated end-of-year Rainy-Day fund (the balancing item of your retirement assets and spending liabilities) is uncomfortably negative, you might want to think about reducing some of your discretionary expenses going forward, including your upcoming holiday spending. Alternatively, you might want to consider going back to work or finding other sources of income. In this post, I will provide some suggestions on how you can update your beginning of year AFP to year end.

Finding Financial Peace of Mind in Retirement—5 Easy Steps

In the recently released Stanford Center on Longevity report entitled, “Disconnected: Reality vs. Perception in retirement planning” which we briefly discussed in our post of October 7, 2022, the authors noted,

“While retirement planning is highly personal and dependent on many different factors, there is an almost universal desire for ‘peace of mind’ in retirement.”

Given this near universal desire, we thought it might be helpful to outline the five relatively straight-forward steps we think you should follow to help you find financial peace of mind in your retirement with the assistance of the Actuarial Financial Planner (AFP). 

The Most Important Retirement Planning Decision for Baby Boomers

In this short post, we will once again repeat what we believe to be essential retirement planning guidance from our late friend, Dirk Cotton. In two of his early 2019 Retirement Café blogposts, Dirk said,

“The most important decision you will make in retirement planning is how much of your resources to allocate to the upside and floor portfolios” and “The correct balance [between the upside and floor portfolios] will depend on how willing you are to risk losing your standard of living for the chance of having an even higher one.”

Hey Retirees and Near Retirees: How is Your Current Retirement Plan Planning Process Working Out for You These Days?

In light of lower-than-expected investment returns and higher-than-expected inflation this year, retiree and near retiree households are facing difficult financial decisions. These decisions may include;

• Can I afford to retire when I had planned?
• Can my spouse retire at the same time as I?
• Should our plan assume higher rates of inflation, and if so, for how long?
• Should one of us continue to work or plan to work part-time for a while?
• Should one or both of us postpone commencing our Social Security benefits?
• Should we reduce or defer our planned discretionary spending?
• Should we change our investment strategy, and if so, how? Should we make it more or less risky?
• Should we take our pension plan distribution in the form of a lump sum?
• Should we somehow tap into our home equity to supplement our retirement spending?
• Have we budgeted enough for future long-term care, future healthcare, future household repairs, etc.?
• Should we somehow reflect a possible future reduction in our Social Security benefits in our current spending budget?

So, how are retired and near-retired households making decisions like these?

Society of Actuaries/Financial Finesse Present a Dynamic Retirement Planning Calculator

The Society of Actuaries (SOA) recently released a retirement planning guide for older retirees entitled, “Late-in-Life Decisions Guide.” According to the Society’s website, the guide was written by Financial Finesse (a financial wellness consulting firm), but the guide itself states, “In collaboration with Financial Finesse, the SOA Aging and Retirement Strategic Research Program prepared this guide as a resource to help older retirees and those who assist them.” Irrespective of who was responsible for writing this guide, we found the retirement planning calculator prepared by Financial Finesse and included in the guide to be of interest. We will discuss the calculator in this post

We Call BS Again on Investment Allocation Rules of Thumb for Retirees

Most investment allocation rules of thumb ignore the existence of non-financial household assets such as Social Security, pension benefits and life annuities in the calculation of a portfolio’s target investment allocation. As a result, such allocations frequently fail to properly measure the amount of risk being assumed by the retired household in its overall retirement asset allocation.

The Two Basic Equations Underlying the Actuarial Financial Planner

In this post, we will once again set forth and discuss the two basic equations that form the foundation of the AFP. Application of household demographic and financial data and reasonable assumptions to these two equations turns the AFP into a relatively simple but very robust planning tool for financial planners with retired or near-retired clients and for retired or near-retired DIYers.

Yes, the AFP Even Does LDI

This post is a follow-up to our shameless Ginzu-Knife themed commercial for the Actuarial Financial Planner (AFP) in our post of July 21, 2022. Since that post, the AFP has received admittedly-indirect endorsements from two frequent financial writers. We describe these “endorsements” below.

How Should Purchasing an Annuity Affect Your Retirement Portfolio Investment Mix?

As discussed most recently in our post of July 27, 2022, annuity purchase rates for single premium immediate life annuities have become more favorable over the past five months. As a result, you may be considering purchase of a single premium life annuity in the near future to strengthen the Floor Portfolio you use to fund your Essential Expenses. In this post, we will once again discuss how changes in your

• Present value of Essential Expenses,
• Present value of Non-Financial Floor Portfolio assets, or
• Accumulated savings

can affect the optimal investment mix in your financial asset portfolio (accumulated savings) under the Safety-First investment strategy.

The Retirement Researcher Constructs a Household Balance Sheet Using Basic Actuarial and Economic Principles

In Episode 25 and Episode 26 of their “Retire With Style” podcasts, Dr. Wade Pfau and the Retirement Researcher team discuss the benefits of constructing a household balance sheet to measure the adequacy of household assets vs spending goal liabilities. They call the ratio of household liabilities to household assets “the Funded Ratio.” The information contained in the balance sheet, including the Funded Ratio, combined with results of their Retirement Income Style Awareness (RISA) Profile (discussed in our post of October 6, 2021) serves as the basis for their recommended household retirement plan.

Updated Implied Discount Rates for Single Premium Life Annuities as of July 25, 2022

In our post of April 2, 2022, we discussed possible assumptions used by life insurance company actuaries in pricing single premium immediate life annuities (SPIAs).  In that post, we provided implied discount rates consistent with quotes obtained from ImmediateAnnuities.com based on two different mortality assumptions (one based on life expectancy and the other based on a 25% probability of survival, which is the basis we recommend in our website for planning purposes).  In our post of May 18, 2022, we updated these implied interest rates consistent with SPIA quotes available on that date.   

In this post, we will examine the implied interest rate assumptions built into quotes from ImmediateAnnuities.com as of July 25, 2022 and compare the quotes and the implied interest rates with the results of the similar exercise we performed as of May 18.  You may wish to revisit our prior posts for more general discussion of annuity pricing assumptions.

Couples Planning in Retirement—How Much Will Household Expenses Decrease After the First Death?

We know that you probably don’t want to think about death or dying. But chances are fairly small that both you and your spouse will die at the same time. Therefore, if you are financial planning as a couple, your retirement plan should anticipate that one of you will predecease the other. And, while it is possible that some household expenses will remain about the same (or even increase), it is not unreasonable to assume that total household expenses will decrease after the first death within the couple. Of course, it is also possible that household sources of income will also decrease with the first death.

Financial Planning in (or Near) Retirement Made Super Easy

What if I told you that there is a simple, but very robust one-tab Excel workbook that you can download that will take you about 15 minutes to complete each year and will provide you with data points that will enable you to determine important planning information for your entire period of retirement, such as:

• How much you can afford to spend each year (spending budget)
• How much to invest in risky vs. non-risky assets (investment strategy)
• Whether you should consider going back to work on a full or part-time basis
• Whether you should consider deferring your (or your spouse’s) Social Security benefit, and
• Whether (and by how much) you should consider changing your spending budget or investment strategy in response to favorable or unfavorable experience (such as higher-than-expected inflation or poor investment performance)

Do You Want Your Spending Budget in Retirement to be More (or Less) Conservative?

Long-time readers of our blog know that we aren’t big fans of Monte Carlo models generally used by financial advisors for financial planning. These models typically use historical investment return assumptions (or other assumptions that may not be clearly communicated to the clients) in simulations to produce what financial advisors claim to be probabilities of being able to spend $X per year in retirement. Of course, these probabilities are only as good as the assumptions used in the simulations and can change significantly as actual experience emerges (such as the actual investment returns experienced this year). You may wish to revisit our post of January 29, 2021 to read a discussion of the significant limitations of Monte Carlo models typically used today. 

We’ve Changed the Default Economic Assumptions in the Actuarial Financial Planners

Because interest rates on government-issued securities have increased significantly since the beginning of the year and implied investment returns on immediate annuities have also increased, we have decided to increase the default assumptions used in the AFPs for future:

• Investment returns on Floor Portfolio assets to 4.5%,
• Investment returns for Upside Portfolio assets to 7.5% and
• Annual rates of inflation to 3.5%.

The Actuarial Financial Planner—Helping You Design a Plan to Weather Tumultuous Periods and Achieve Your Financial Goals

The title of this post was shamelessly borrowed from the Kitces.com post of June 17, 2022, in which Adam Van Deusen said,

“The key point is that advisors can not only serve as empathetic listeners during periods of market stress, but also serve as a reassuring force to remind clients how their plan was designed to weather tumultuous periods and help them achieve their goals.” 

While we are not financial advisors and we don’t have clients, we do believe that our Actuarial Financial Planner (AFP) can be a very effective tool for helping users develop a plan specifically designed to weather tumultuous investment periods and to help them achieve their financial goals in retirement.

Retirement Researchers Discuss Retirement Planning Approaches

For those of you who like to listen to retirement-finance-focused podcasts, we recommend you try the Wealth, Managed podcast of September 24, 2021 featuring Drs. Finke, Blanchett and Pfau, entitled “Approaches to Retirement Income Planning.” In this podcast, these preeminent retirement researchers discuss some of the cons of probabilistic approaches commonly used today by financial advisors utilizing the 4% Rule and Monte Carlo modeling and some of the pros of the Safety-First approach utilizing what Dr. Pfau calls the Funded Ratio. You may recognize the Funded Ratio as the Actuarial Approach described in this website and the Safety-First approach as the approach built into our Actuarial Financial Planner. 

Here is the link to their podcast:

Wealth, Managed with Michael Finke and David Blanchett: Ep. 21: Approaches to Retirement Income Planning on Apple Podcasts

Planning on Social Security, Part II

The Social Security trustees recently released their 2022 OASDI Trustees Report detailing the financial status of the program. The news this year was actually a little better than last year’s. Based on the trustees’ intermediate assumptions,

• The trust fund depletion date (TFD) in this year’s report is 2035, compared with 2034 in last year’s report,
• The program’s 75-year actuarial deficit is only 3.42% of taxable payroll compared with 3.54% last year, and
• The default option if Congress does not enact program changes prior to TFD is an across the board 20% decrease in program benefits in 2035 compared with a 21% decrease in program benefits in 2034.

In this post, we will once again raise the question that very few of our readers (or many baby boomers for that matter) care to actually think about--How should one plan for possible future decreases in Social Security benefits in light of the program’s financial situation? 

Is Rebalancing a Good Strategy for Retirees?

This post is a follow-up to our post of February 9, 2022, “Reflecting Non-Financial Assets in Your Asset Allocation Strategy” and our February 21, 2022 Advisor Perspectives article, “Including Non-Financial Assets in a Client’s Allocation.” The question addressed in this post is whether periodically rebalancing portfolio assets to maintain a specific percentage allocation between risky and non-risky investments (i.e., 60% equity/ 40% fixed income) is a good strategy for meeting one’s spending goals in retirement.

Planning Your Discretionary Spending

In our post of May 9, 2022, we questioned whether it was perhaps too early to consider reducing 2022 discretionary spending in light of unfavorable 2022 stock market performance to date. In that post, we suggested several alternatives to reducing already-budgeted discretionary spending for 2022, including:

• Deciding to wait until next year to worry about investment losses incurred during 2022,
• Dipping into one’s Rainy-Day fund to cover the losses,
• Taking a part-time job to cover the losses, or
• Smoothing the losses over several years

In this post, we will discuss a slightly different alternative to reducing current discretionary spending—keeping current year recurring discretionary spending unchanged but effectively reducing future planned recurring discretionary spending by assuming smaller annual future rates of increases in such expenses. While this approach technically still involves reducing discretionary spending, it may be more palatable to retirees who believe their discretionary spending will probably decrease as they age.

The Household (Actuarial) Balance Sheet—the Foundational Retirement Planning Principle

In their recent post of May 18, 2022, Michael Kitces and Kitces.com are once again trying to convince us all that their “Risk-Based Guardrails (RBG) Model” is a better tool for retirement planning than the typical monte carlo models used by most financial advisors. In their post, they argue that while the “gamification power” of monte Carlo modeling can change household behavior, “the rules of the game can become more clear and easier for clients to follow when we make this shift” [to a RBG model.]

We last discussed the Kitces RBG Model in our post of November 28, 2021. In that post, we indicated that while we agreed that moving to the RBG model was a step in the right direction, we believed that their model is both more complicated and less robust than our Actuarial Financial Planner (AFP) model, and we provided a functionality comparison of the two models. We will not repeat that functionality comparison here, but if you are interested, you can reread our post of November 28, 2021. 

Rather than toot our own horn again in this post, we are going to let one of today’s preeminent retirement thought-leaders indirectly do it for us.

Updated Implied Discount Rates for Single Premium Life Annuities

In our post of April 2, 2022, we discussed possible assumptions used by life insurance company actuaries in pricing single premium immediate life annuities (SPIAs). In that post, we provided implied discount rates consistent with quotes obtained from ImmediateAnnuities.com and two different mortality assumptions (one based on life expectancy and the other based on a 25% probability of survival, which is the basis we recommend in our website for planning purposes).

Is it Too Early to Start Thinking About Reducing Your Discretionary Spending?

The S&P 500 closed just under 4,000 today and is down approximately 16% year to date. The default assumption for returns on risky investments in our Actuarial Financial Planner (AFP) workbooks is 6%, so to date, we are looking at actuarial losses in the neighborhood of 20% on Upside Portfolio assets invested in equities for 2022. Of course, the equity markets may bounce back tomorrow, next week or next month, and these losses may be completely eliminated by year end. 

Lump Sum Option vs. Life Annuity from a Pension Plan

As indicated in our post of February 18, 2015, we generally recommend that individuals elect to receive a lifetime income form of payment from a pension plan when offered a choice between a lump-sum and a life annuity. Yes, we have heard from readers who believe we are wrong, and they tell us that they have done quite well, thank you, investing their lump sum distribution in the current bull market. We received similar comments from individuals who disagreed with our recommendation relative to borrowing and investing proceeds in a low-interest rate environment in our post of February 18, 2015. What can we say? Sometimes people take risks and are rewarded for doing so.

Calm Your Financial Fears with the Actuarial Financial Planner (AFP)

Actuarial science offers proven approaches and processes for assessing and mitigating financial risks. The Actuarial Financial Planner (AFP) advocated in this website utilizes basic actuarial and financial economics principles to help retirees:

• Quantify household spending liabilities
• Develop a sustainable spending budget process
• Develop a liability-driven investment (LDI) process for allocating household assets between risky and non-risky investments, and
• Establish a strong foundation for retirement planning.

And while we can’t guarantee that you will never have to reduce your future spending budget in retirement if you use the AFP annually and fully fund your Floor Portfolio with non-risky assets, we believe that you will be able to sleep better at night knowing your essential spending in retirement is relatively safe. 

After some background discussion, we will discuss four ways the AFP can help you mitigate financial risks in retirement.

Planning For Non-Recurring Expenses in Retirement

As we have said many times in this blog, if you want a reasonable spending budget in retirement (or if you want a better idea of whether you can afford to retire) it is important to estimate your expected non-recurring expenses in retirement separately from your expected recurring expenses. For example, see our post of February, 7, 2019, “If You Aren’t Separately Budgeting for Non-Recurring Expenses, You Probably Don’t Have a Robust Retirement Spending Budget.” 

Actuarial Financial Planner Consistent with General Personal Retirement Planning Guidance Issued by the American Academy of Actuaries

As professional number-crunchers, actuaries generally use and develop models designed to produce useful information to help clients and others make financial decisions. These models typically consist of:

• Input (data and assumptions),
• Calculations that transform the inputs into outputs, and
• Results that translate outputs into useful financial information

The Actuarial Financial Planner available in this website is a simple model that we designed to help retirees and near retirees make better financial decisions. It is a deterministic model (with no random variable assumption inputs) much like the actuarial models generally used by actuaries to determine pension plan contribution and expense requirements or Social Security’s funded status. 

Discount Rate Assumptions Used to Price Life Annuities

Thanks to our friend, Will Selden, for asking what discount rates are currently being used by insurance companies to price life annuities in his March 28, 2022 blog post SWAG on Annuity Discount Rate. Based on his analysis, Will notes that current annuity pricing appears to be based on higher interest rate assumptions than in the past few years. This is not terribly surprising as interest rates in general have increased since the Federal Reserve signaled that it would raise the Federal Funds interest rate and would probably continue to do so into 2023. For example, the 10-year constant maturity Treasury rate has increased by almost 70 basis points during the month of March. All things being equal, higher assumed interest rates translate to higher monthly life annuity benefit amounts per dollar of premium. 

Thinking About Retiring Early?

The primary purpose of this website is to help the retirees and near retirees who happen to stumble across this blog site make better financial decisions. We attempt to do this by providing relatively simple tools (spreadsheets) and processes which utilize basic actuarial and financial economics principles. These tools and processes, which are available for free, can be used by DIYers or by financial advisors to quantify the effects of various options available to retired or near-retired households with respect to their spending and investing. The authors of this blog are retired actuaries. Neither of us receives any direct or indirect compensation from visits to this website or from any activity associated with this blog.

Planning on Temporary Higher Levels of Inflation

This is a follow-up to our post of January 30, 2022 on stress-testing your retirement plan for rising interest rates/inflation. In this post, we will provide you with a work-around for the Actuarial Financial Planner for Retirees (AFP) default inflation assumption if you believe that today’s increased rates of inflation relative to interest rates will be temporary and will revert back to “more normal rates” in the future. 

Will Kitces.com Guarantee the 4% Rule?

In this post, we will discuss a recent Kitces.com post defending the 4% Rule, and we will compare this widely-used rule of thumb with the Actuarial Financial Planner (AFP) approach for a hypothetical single retiree. We believe the example illustrates that many retirees can better meet their spending goals and better manage their investment risk by using the AFP approach rather than the 4% Rule.

Planning on Future Decreases in Discretionary Spending? OK With Us.

In this post we will revisit the planning implications of research that finds that household spending may decrease in real dollars as retired households age. This week we became aware of research in the U.K. that, like several other research reports we have discussed, shows that spending in retirement does decrease in real dollars, on average. Unlike other research, however, this research measured the sources of spending decreases in retirement and concluded:

• Much of the decline in consumption is explained by falls in spending on “non-essential items” such as recreation, eating out and holidays.
• Spending on essential items remains relatively flat during retirement, which means essential items account for an increasing proportion of the overall household budget. Indeed, by age 80+, over 50% of expenditure is on essential goods and services.
• There does not appear to be a post-retirement spending boom on leisure and holidays. In fact, from age 50 onwards, spending on most non-essential items begins a slow decline.

We believe the conclusions of this research are consistent with the thoughts we expressed on the planning implications of possible spending decreases in retirement in our post of December 11, 2021 where we said,

Reflecting Non-Financial Assets in Your Asset Allocation Strategy

Unless you are almost totally reliant on Social Security and/or your pension benefits, one of the most important decisions you will need to make in (or near) retirement is how to allocate your Accumulated Savings among risky investments, such as equities, and less-risky investments, such as bonds or annuities.  

Stress-Testing Your Retirement Plan for Rising Interest Rates/Inflation, Part II

One of the three basic principles of the Actuarial Approach to personal financial planning is periodically stress-testing of significant assumptions made in your plan to assess the risks that these assumptions may not be realized in the future and to determine if you want, or need, to take actions that may mitigate these risks. In this post, which is a follow-up to our post of March 16, 2021, we once again look at the importance of future inflation and resulting future expected increases in expenses in retirement.

Not Spending Enough in Retirement? Plan to Spend More

Many researchers have concluded that retirees frequently underspend their available assets in retirement. And while we are not pushing you to spend more than you want, we don’t want you to underspend if that is not part of your plan. In our post of June 19, 2021, we discussed how failure to spend assets during retirement (underliving wealth) can prevent you from achieving your financial goals. In our post of June 23, 2021, we noted that “the many uncertainties involved in retirement planning can and do lead to anxiety, stress and sub-optimal decisions,” and we suggested facing financial fears in retirement by developing a robust plan to mitigate and/or address future contingencies.

Hey Retirees; What Percentage of Your Retirement Assets Should be Invested in Stocks?

In his recent Advisor Perspectives article entitled, “Is It Still Worth Investing in Stocks?” Fellow actuary Joe Tomlinson outlines the potential positives and negatives for retired households of investing in stocks in today’s low-interest rate, high-stock valuation environment. He concludes that there are tradeoffs associated with taking stock market risk, and different households will “put different weights on the positives and negatives.” We suggest you read Mr. Tomlinson’s excellent article.

What Will Retirees (and their Financial Advisors) Do Now That The 4% Rule is Dead?

We have never been big fans of the 4% Rule. One of the major reasons we started this blog in 2009 was because we didn’t particularly care for the 4% Rule, and we thought we could help people make better financial decisions by suggesting a more dynamic (flexible) spending strategy based on fundamental actuarial principles. In 2014 alone, we posted four separate posts trying to convince our readers to ditch the static 4% Rule and adopt the dynamic Actuarial Approach that we recommend.

It’s Time to Perform Your January 1, 2022 Actuarial Valuation

Congratulations. You made it through 2021!

In our ongoing effort to turn you all into actuaries, this post will recommend that you perform an “actuarial valuation” based on your personal and financial data as of January 1, 2022. An annual actuarial valuation is part of our 7-step Recommended Financial Planning Process. As part of this process, we will also encourage you to prepare a brief “actuarial report” to document your thought-process and any planning decisions you make for this year.