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.
Several years ago, the American Academy of Actuaries (AAA) released an Issue Brief entitled Retiree Lifetime Income: Choices & Considerations. This Issue Brief “explores some of key decision areas and options available in making good choices [in or near retirement].” While the Issue Brief provides excellent non-quantitative guidance “intended to explain many considerations in retirement planning generally” it does not develop or recommend a model or models that may be used by households to produce the numerical results arguably needed to help them make better financial decisions. However, the general guidance set forth by the AAA can be important in establishing and testing key elements of a model that may be used in personal retirement planning.
In this post, we ask whether the AFP model available in our website is consistent with the general retirement planning guidance contained in the AAA retirement planning Issue Brief. In summary, we believe our model is very consistent with the AAA’s general retirement planning guidance and, while relatively simple, we believe it is more robust than general non-quantitative guidance and many other quantitative models we have seen.
AAA General Retirement Planning Guidance and Consistency with Actuarial Financial Planner
Issue Brief Section | General AAA Guidance (quoted from Issue Brief unless otherwise indicated) | Is Actuarial Financial Planner (AFP) Model consistent with this guidance? |
Introduction | Each individual has unique personal circumstances and needs. In addition, needs and circumstances are subject to change as one ages. | Yes. The AFP is based on individual household’s inputted needs and wants data and assumptions about the future that may be changed. It anticipates annual revaluation of household assets and spending liabilities. |
1 When to Retire | Working longer should enhance the chance of retiring with a greater lifetime income | Yes. Would simply need to estimate additional accumulated savings, Social Security benefit, etc. at later retirement age |
2. When to Claim Social Security Benefits | It is a widely held view that people in good health should consider delaying commencement of Social Security benefits to age 70 | Yes. Would simply need to estimate Social Security benefit at deferred commencement age and period of deferral. |
2. When to Claim Social Security Benefits | in order to exercise this option, individuals need to either have accumulated sufficient financial resources, perhaps through retirement benefits, to be able to support themselves until age 70 or continue to work earning an income. | Yes. Multiplying anticipated annual spending from other sources by years of deferral provides an estimate of potential financial resources that may be used during period of deferral |
3. Planning for an Unknown Length of Retirement | Everyone should, to the extent possible, plan for a retirement that may extend beyond his or her average life expectancy | Yes. AFP default assumptions assume 25% probability of survival for non-smoker in excellent health using Actuaries Longevity Illustrator |
4. How Much Retirement Income Is Needed | It is advisable that everyone planning for retirement should prepare a detailed analysis of future living expenses—fixed, discretionary, and emergency | Yes. These are input items in the AFP. Fixed expenses are referred to in AFP as “Essential Recurring” expenses |
4. How Much Retirement Income Is Needed | It is important to understand which expenses can be reduced if necessary and which cannot. | Yes. Essential vs. Discretionary spending is an important distinction in the AFP |
4. How Much Retirement Income Is Needed | This analysis can take the form of developing a retirement budget, which should include provision for future price inflation on consumer goods and services, and should reflect lifetime income needs based on projections of a range of life expectancies and expected investment returns. | Yes. AFP develops a current year spending budget (and future year’s expected spending budgets) and permits different levels of future price increases to be inputted for different types of expenses |
4. How Much Retirement Income Is Needed | A retirement budget should be formulated with consideration of all of one’s income sources | Yes. The AFP develops a spending budget by balancing all available household assets with all expected future household spending liabilities in retirement |
4. How Much Retirement Income Is Needed | Important to this process is recognition that different stages of retirement bring with them different expenses. Early in retirement, travel expenses might be greater, while medical and home care costs may be more significant in later stages. | Yes. This is accomplished in AFP by inputting expected recurring vs. non-recurring expenses |
5. How Leaving an Inheritance Factors into Retirement Planning | Common ways to leave an inheritance include maintaining life insurance, dying with a home that has little or no mortgage, and setting up a dedicated trust | Yes. Desired Estate is an input item in AFP |
7. Considerations for Utilizing an Income Annuity | If guaranteed income from Social Security and a pension (if available) do not cover future basic living expenses, an income annuity can make up the shortfall | Yes. This is the result of the comparison of present value of Essential Expenses vs. Floor Plan assets in the AFP Actuarial Balance Sheet |
9. Planning for Uninsured Medical Expenses | Medicare does not cover all medical expenses, and out-of-pocket medical expenses might be incurred. | Yes. Pre-Medicare and post-Medicare costs can be input with different expected future increases |
10. Planning for Long-Term Care | [Summary] Insure or self-insure | Yes. AFP includes an input item for uninsured LTC |
11. Using a Home to Provide Income | [Summary]Home equity loans, lines of credit, downsizing | Yes. AFP is flexible in terms of using home equity to pay for retirement expenses |
12. Having a Mortgage or Other Debt | Whether maintaining debt in retirement helps to enhance lifetime income levels will depend on the specifics of each retiree’s situation. | Yes. This issue is related to the present value of Floor Plan assets vs. the present value of Essential Expenses. Leveraged investing is discussed in our post of February 14, 2021 |
13. Plan Benefit Options: Lifetime Income or Lump Sum | There are advantages to lump-sum payments as well as some significant risks. | Yes. This issue is related to the present value of Floor Plan assets vs. the present value of Essential Expenses |
16. Managing a Retirement Portfolio | Managing investment risk within retirement accounts becomes more critical when approaching retirement age and continuing into retirement. | Yes. This issue is related to the present value of Floor Plan assets vs. the present value of Essential Expenses |
16. Managing a Retirement Portfolio | Those with a guaranteed income to cover living expenses in retirement can more readily take on more risk than those who are largely dependent on their investment portfolio to meet essential living expenses | Yes. The percentage of household assets that may be invested in non-risky vs. risky investments is an important output of the AFP |
Conclusion
General
non-mathematical retirement planning advice (like advice contained in
the above AAA Issue Brief and in Society of Actuaries Managing Retirement Decisions series)
frequently relies on opinions of “experts”, general rules of thumb or
research results that may not adequately reflect individual
circumstances. Frequently such educational material presents potential
advantages and disadvantages (trade-offs) of alternative decisions, and
often contains warnings to be sure to remember certain types of expenses
when retirement planning. As actuaries, we believe that good models
that are consistent with good non-quantitative advice can be better
education tools, particularly for mathematically-inclined individuals
who aren’t afraid to do a little number crunching to obtain more useful
financial information.
