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.
In this post, we will unsurprisingly promote the basic Actuarial Approach and the Actuarial Financial Planner workbook advocated in this website as the preferred way to develop such a robust plan.
Typical Financial Advisor Models vs. the Actuarial Financial Planner
Using Monte Carlo models, many financial advisors calculate probabilities of being able to spend specified levels of constant annual real dollar amounts in retirement. On the other end of the budget development spectrum, Strategic Withdrawal Plans (SWPs) are primarily designed to spread withdrawals from accumulated savings over retirement in a systematic manner. When combined with other non-linear sources of income, these SWP approaches may or may not produce linear annual income levels (or spending budgets) from year to year. Since neither of these approaches anticipates non-recurring spending, it is quite likely that they will fail to meet your real-world spending goals.
By comparison, the Actuarial Approach advocated in this website anticipates that some of your spending may be non-recurring. For example, you may:
- Incur extra medical costs prior to becoming Medicare eligible,
- Plan to pay off your home mortgage five years into your retirement,
- Plan significant travels until you reach age 80,
- Plan to improve your kitchen,
- Buy a vacation home or a boat (or both),
- Buy a new car,
- Assist children or grandchildren with education costs,
- Incur long-term care costs, etc.
This ability to distinguish between recurring and non-recurring expenses, in addition to matching non-risky assets with essential expenses, makes the Actuarial Financial Planner a more robust planning tool than most Monte Carlo or SWP approaches frequently used by financial advisors, in our opinion.
Actuarial Financial Planner (AFP)
Developing a current year spending budget using the AFP is an iterative process. Desired recurring and non-recurring expenses and future increases for these expenses are entered in the Input section of the Input & Results tab. The present values of these future expenses are then shown in the Actuarial Balance Sheet and the current year’s spending budget based on inputted planned expenses is shown below the Actuarial Balance Sheet. If the present value of your total assets significantly exceeds or is significantly less than the present value of your inputted expenses (evidenced by a positive or negative Rainy-Day Fund), you can increase or decrease inputted planned expenses to obtain a more acceptable Rainy-Day Fund amount. Once you obtain an acceptable Rainy-Day Fund amount and you are comfortable with the matching of your non-risky assets with your essential expenses, the final amounts inputted for recurring and non-recurring expenses will constitute your current year spending budget. As discussed above, you are not required to spend your current year spending budget.
In light of recent greater than expected returns on equities and spending restrictions imposed by the pandemic, you may find that your current year spending budget developed using the Actuarial Financial Planner is greater than annual amounts you have been recently spending. If that is the case, you may wish to consider consciously increasing your spending for the near future rather than simply watching your Rainy-Day Fund accumulate.
Conclusion
Don’t let fear of future possible expenses ruin your retirement. Budget for these expenses carefully so that you feel that you are not being overly conservative or overly aggressive. Careful budgeting includes selecting reasonably assumptions for future expected increases in recurring and non-recurring expenses.
We suggest you consider the following spending corollary to Benjamin Franklin’s famous saying, “If you fail to plan, you plan to fail” -- “If you are not spending enough in retirement, plan to spend more.”
In our household, we like to use the phrase, “its in the budget” when promoting the purchase of a certain item. If you budget carefully and recognize that certain future discretionary expenses may need to be reduced if risky investments go south, you may be able to purchase an item or two that will significantly enhance your retirement.
