Tuesday, July 26, 2022

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.

From a retirement planning perspective for couples, it is important to quantify the financial impacts of the first death. As is the case with most aspects of retirement planning, overstatement of future expenses after the first death and/or understatement of future income streams can reduce current spending budgets (and vice versa).

In this post, we will discuss how the Actuarial Financial Planner (AFP) quantifies the financial impact of the first death within the couple. We note that many other planning models we have seen are not as robust with respect to this process as the AFP. 

Couples planning under the AFP

The AFP utilizes four Lifetime Planning Periods (LPPs) to quantify the present values of a household’s future streams of payments and future expenses:

  • LPP Person 1
  • LPP Person 2
  • LPP Both Alive, and
  • LPP Either Alive

Default assumptions for these LPPs are based on 25% probabilities of survival horizons from the Actuaries Longevity Illustrator (ALI) for males or female non-smokers in excellent health. These LPPs were recently updated to reflect revised mortality assumptions used in the 2022 OASDI Trustees report. As noted in the ALI Frequently Asked Questions (FAQs):

“This ALI enables you to see a much larger picture than a single life expectancy number. The tool estimates the likelihood that you will live for various lengths of time. Further, this analysis goes one step further and analyzes longevity for couples. That is, the ALI lets you consider longevity as it affects your retirement as a couple, not just as individual partners. The ALI ’s charts show the likelihood of the couple both living a given number of years as well as the likelihood that one of you will outlive the other. All of this information is crucial [emphasis added] towards planning a secure retirement.”

Some other budgeting approaches utilize one LPP for the retired household rather than four. Frequently, this one LPP is a fixed number of years like 30 or it is the longer of the expected lifetimes of the couple. The problem with using a single LPP approximation is that future income streams may be overstated and/or future expenses may be overstated. By using four LPPs, the AFP can stop income streams for each member of the household upon each member’s expected demise, and the AFP can reduce expected household expenses upon the first expected death within the couple.

See our post of November 17, 2017 for estimating the present value of survivor benefits anticipated after the first death within a couple.

Note that if you want to change the default LPP assumptions in the AFP, you can. For example, if you prefer to use a fixed number of years rather than the four default LPPs, you can override the default assumptions with a fixed number of years for each LPP period.

As discussed in our post of November 17, 2021, the ALI rounds LPPs to the nearest year and therefore, the ALI can produce a rounding error when solving the following equation:

LPP Both Alive = LPP Person 1 + LPP Person 2 - LPP Either Alive

We have recently corrected this potential rounding error by solving for LPP Both Alive using the other three LPPs rather than by using the LPP Both Alive from the ALI. This correction enables the AFP to more accurately calculate the present value of recurring expenses that are expected to decrease by x% upon the first death within the couple.

How much will household expenses decrease upon the first death?

As noted above, some household expenses will decrease upon the first death, some will remain unchanged and some may even increase. You can certainly examine your own expenses and decide for yourselves after discussing the matter with your spouse, but we believe a 33% reduction in household expenses upon the first death is probably a fairly reasonable planning assumption.

Summary

The AFP uses four LPPs to enable you to more accurately determine the financial impact of the first death within your married household. The assumptions are based on the 25% probability of survival planning horizons from the Actuaries Longevity Illustrator for non-smokers in excellent health. You can easily override these default assumptions if you prefer.

On a different subject, you might want to check out the Episode 24 podcast from Dr. Wade Pfau and his friends discussing the “Funded Ratio”, which as we discussed in our post of July 18, 2017, is very similar to our Actuarial Approach for comparing the present value of household assets to the present value of household spending liabilities. However, we are pretty sure that they only use one LPP for their married households J.