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.