This post is a follow-up to my post of June 11, 2023, where I outlined the general actuarial process that we recommend for ongoing planning in retirement and my Advisor Perspectives article of July 3, 2023, where I illustrated how this same process is applied to Social Security. Several readers questioned why I illustrated the application of the general actuarial process using Social Security since, according to them, it clearly hasn’t worked very well for our primary U.S. retirement system. In this post, I will respectfully disagree with those readers and point out that not only is this proven actuarial process exceptionally robust, but it has actually worked quite well for Social Security and other financial systems. Notwithstanding, there is, an important lesson involving Steps 4 and 5 of the process that we can learn from Social Security when planning our own retirements.
Critical Planning Lesson
The lesson we can learn from Social Security is this:
Ignore negative trends in your Funded Status at your own risk, particularly if your Funded Status is less than 100%. Delaying actions to address a plan with a Funded Status less than 100% and decreasing over time will generally require larger changes later to restore the plan’s Funded Status to 100%.
If you don’t know what your household Funded Status is or you haven’t yet calculated it, then you haven’t been paying attention to the many posts on our website for the past six months which have encouraged you to use our Actuarial Financial Planner (AFP) to calculate your Funded Status (the ratio of the present value of your assets to the present value of your spending liabilities) and use it as part of your ongoing financial planning. In addition to our post of June 11, 2023, some recent posts covering this topic include:
January 7, 2023—Automatic Funded Status Adjustments to Your Spending Budget
March 12, 2023—Focus on Your Spending Budget and Your Funded Status, Not on Withdrawals from Your Accumulated Savings
March 25, 2023—What’s Your Funded Status? and
Aoril 16, 2023—Plan on Future Adjustments to Your Retirement Plan
How has the general actuarial process worked for Social Security?
As we all know, Social Security is looking at significant tax increases, benefit decreases or some combination of the two in the relatively near future in order to restore the system’s funded status to 100% (or restore the system’s long-range actuarial balance) and address the forecasted trust fund exhaustion. Is this the fault of the process used to finance the system? No. In fact, the process has worked quite well since 1983 to warn our policymakers that the program was out of balance and this imbalance problem was getting worse over time. And the process continues to sound the alarm to this day with increasing intensity almost every year.
As discussed in my Advisor Perspectives article, consistent with Step 4 of the general actuarial process, Social Security actuaries have, in Actuarial Note 2023.8, documented the trend of Social Security’s funded status deterioration since 1983, the last time the system was in long-range actuarial balance.
Unfortunately, our policymakers have ignored these Funded Status deterioration alarms. And it is not as if this problem was hidden in the OASDI Trustees’ reports. For example, the 1996 OASDI Trustees Report, the Trustees said:
“Although the combined trust funds are well financed over the next 10 years, the OASDI program is not in close actuarial balance over the full 75-year projection period and therefore does not meet the long-term solvency test. The estimated actuarial balance is a deficit of 2.19 percent of taxable payroll over the next 75 years, based on the intermediate assumptions. The combined OASI and DI Trust Funds would become exhausted in 2029 without corrective legislation. At that time, annual tax revenues of the combined trust funds would be less than expenditures by 3.87 percent of taxable earnings and would be sufficient to cover only 77 percent of annual expenditures.”
and
“In view of the lack of close actuarial balance in the OASDI program over the next 75 years, we again urge that the long-range deficits of both the OASI and DI Trust Funds be addressed in a timely way….It is important to address both the OASI and DI problems soon to allow time for phasing in any necessary changes and for workers to adjust their retirement plans to take account of those changes. We believe there is ample time to discuss and evaluate alternative solutions with deliberation and care. The size of the long-range deficit is such that long-range balance could be restored within the framework of the present program. Nonetheless, the magnitude of any required changes will be smaller the sooner they are enacted.”
Similar statements were also made in the 1994 and 1995 reports and many subsequent years reports.
The report from 1996 is now 27 years old, and no actions have been taken since then by our policymakers to address the increasingly deteriorating actuarial balance.
Now Social Security’s actuarial deficit is much larger than it was in 1996 and expected to increase each year even if all assumptions are realized. This means that corrective actions today to restore the program’s actuarial balance must be larger than anticipated 27 years ago. Should we point the finger of blame for this problem at:
- The actuarial process or assumptions used to measure the system’s funded status? No
- Our country’s demographics as the American Academy of Actuaries suggests? No
- The Social Security actuaries or OASDI Trustees? No
- Our policymakers? Yes
Application of the Actuarial Process to Ongoing Household Financial Planning
Like Social Security, there is no legal or other requirement for households to periodically place their financial systems back into actuarial balance once their Funded Status falls below 100%. For Social Security, this responsibility rests with our policymakers and for households it rests entirely with the household. Note that this is not the case with pension plan systems or other financial systems, many of which are subject to legal or other requirements to automatically maintain system solvency. This why we have recommended in our post of January 22, 2023 an automatic approach for adjusting household spending (or household assets) when the household funded status falls below 95%.
We believe that the actuarial process is the best approach available for keeping household financial systems in balance during retirement and for ongoing planning. We acknowledge that there are models out there that are more sophisticated than the AFP and may be more useful for one-time planning decisions, but these models are generally not designed for ongoing planning. If you or your financial advisor initially used such a model (such as a Monte Carlo model), we suggest that you match the results of that model with the results of the AFP, determine your Funded Status, monitor that Funded Status over time and generally follow the general actuarial process outlined in this website to keep your plan sustainable over time.
Summary
We encourage you to annually compare your household assets with your household spending liabilities to determine your Funded Status. We also encourage you to monitor your Funded Status over time and make adjustments to your spending or your assets when appropriate. As we have learned from Social Security, ignoring deterioration of your Funded Status when it falls below 100% may result in larger required changes later rather than smaller changes now.
