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.
In our post of January 30, 2022, we said
“In the 2021 OASDI Trustees report (Table V.B.2), the Social Security actuaries and Trustees assume in their intermediate assumptions that rates of returns on the [non-risky] special Treasuries in which Social Security assets are invested will be less than assumed rates of inflation for the next 5 years, but then real rates of return are assumed to ultimately increase to 2.3% in years 2035 and later. By comparison, our default assumptions assume a constant real rate of return on non-risky investments over the household lifetime planning period of 1% per annum [3% investment return and 2% inflation]
While we believe that a 1% real rate of investment return on non-risky investments is reasonably conservative when combined with 25% probabilities of survival, you should feel free to select more conservative assumptions (or future reductions in Social Security benefits) if you are so inclined.”
While more conservative retired readers may wish to reflect higher current rates of inflation when determining the cost of their Floor Portfolios, they may believe (like the Social Security Actuaries) that reflecting such higher inflation rates over the entirety of their remaining lifetime planning periods is too conservative. The table below provides an approximate work-around for reflecting the current high rates of inflation for a temporary period. It shows the override inflation assumption (instead of the default assumption of 2% per annum) that is mathematically equivalent to various temporary increases in inflation for retirees with different remaining lifetime planning periods.
Additional annual inflation estimates shown in the table include 3% (for a total of 5% per annum) and 5% (for a total of 7%) for the next 5 years and for the next 10 years. As shown in this table, the impact of these temporary inflation increases is more significant for longer temporary periods and for households with lower remaining lifetime planning periods.
Actuarial Financial Planner--Override Inflation Assumptions Under Various Additional Annual Inflation Estimates and Lifetime Planning Periods (vs. 2% default inflation assumption)
Additional Annual Inflation/Lifetime Planning Period | 40 Years | 30 Years | 20 Years | 10 Years |
3% for 5 years | 2.4% | 2.5% | 2.7% | 3.5% |
5% for 5 years | 2.6% | 2.8% | 3.2% | 4.5% |
3% for 10 years | 2.7% | 3.0% | 3.5% | 5.0% |
5% for 10 years | 3.2% | 3.6% | 4.5% | 7.0% |
To input the desired inflation-override assumption into the AFP, simply click on the Default/Override box for the inflation assumption in Column D and select “Override.” Then enter the override assumption from the table above (or the assumption you otherwise desire) in Column F. This action will change the amounts shown in the Actuarial Balance Sheet by increasing the present values of essential and discretionary expenses. This, in turn, may cause you to consider changes to your financial plan to rebalance your assets and your liabilities under the override assumption.
