The Actuarial Approach recommended in this website involves periodically (generally annually) comparing the present value of a retired household’s assets with the present value of its anticipated household spending liabilities to develop its Funded Status as of a valuation date (generally the beginning of the current year). The present value of assets used in this comparison is the current market value of accumulated savings plus discounted values of future lump sum payments or streams of payments from other income sources. The present value of household spending liabilities is the discounted value of future lump sum expenses or streams of expenses. To help retired households allocate their assets between risky (Upside Portfolio) and non-risky (Floor Portfolio) investments, separate rates (investment return assumptions) are used to discount future essential expenses/non-risky asset sources and future discretionary expenses/risky asset sources.
If relevant information is entered into the Input tab of the Actuarial Financial Planners (AFP), the necessary present values used in the Funded Status calculation are calculated in the AFP model, and results are shown in the PVCalcs tab and are summarized in the Actuarial Balance Sheet. Alternatively, present values may be calculated outside the AFP model and separately entered into relevant “other PV” asset or liability cells. We provide a separate Present Value Calculator spreadsheet to facilitate present value calculations not directly calculated in the AFP for this purpose.
In order to avoid the classic Garbage-In, Garbage-out problem when using the AFP, care needs to be taken to accurately input asset and expense items into the model (only in the input section) and to avoid double counting of asset information or understating future expenses. Also, changes in the AFP spreadsheet should not be made in any cell other than the appropriate input cell in the Input section of the Input/Results tab. Hint on this: Don’t input or change values in cells that utilize formulas to develop values. If you do, you may ruin the spreadsheet and then you may need to download and enable a new spreadsheet and start over.
Recently, we have received several inquiries about how to use the AFP to estimate the present values of long-term care expenses (a liability) and survivor benefits expected to be received after the first death within a couple (an asset). In this post we will discuss how to do this and include an example. We will also discuss what to do if there are an insufficient number of cells in the AFP to perform these or other PV calculations. Readers may wish to re-visit our post of April 16, 2022 for discussion of determining present values of non-recurring expenses, including Long-Term Care expenses, and our post of November 21, 2017 for discussion of how to develop present values of survivor benefits.
Example Calculations
Survivor Benefits
Roger is 74 years old and his spouse, Susan, is 66. Roger has a Social Security benefit of $28,000 per annum that he is currently receiving, and Susan’s Social Security benefit is $14,000 per annum that she expects to start this year. Roger also has two fixed dollar pension benefits currently paying him $5,000 and $8,000 per annum with 100% of his benefit to continue to Susan if she survives him. Roger’s expected lifetime planning period (LPP) using the AFP default assumptions is 19 years and Susan’s is 30 years. Therefore, under the default planning assumptions, Roger is expected to pass 11 years before Susan.
Roger separately develops the present values of his and Susan’s Social Security benefits payable over their respective LPPs by entering their current benefits in cells 9E and 19E of the AFP for Retired Couples. The present value of Roger’s Social Security benefit payable over his remaining lifetime under the default assumptions is $449,935. Roger wants to also include in household assets the present value of Susan’s higher Social Security benefit that she is expected to receive after his death (which he determines will be $14,000 in today’s dollars). In cell E 27 (other income #1), he enters $24,549 ($14,000 increased by 19 years of assumed 3% cost of living increases). In the remaining cells in row 27, he enters the amounts for the Soc. Sec. Survivor item shown below. Going to cell I 6 of the PVCalcs tab, he sees that the present value of Susan’s Social Security survivor benefits is $97,246 based on the input amounts below and default assumptions.
Because he has at least three “other income” sources of income (He may want to downsize his house in the future and he has life insurance), he decides to zero out the Other Income #1 cell after calculating the Social Security survival present value, separately calculate the present values of the survivor benefits for his two fixed pensions, add all three survivor present values together and insert the sum in cell D 26 (PV Other Sources of Income)
Item Name | Annual Amount | Deferral Period | Payment Period | Annual Rate of Increase | % Upside (Assets)/ % Essential (Liabilities) | Present Value |
Soc. Sec. Survivor | $24,549 | 19 | 11 | 3% | 0% | $97,246 |
Pension #1 Survivor | $5,000 | 19 | 11 | 0% | 0% | $17,257 |
Pension #2 Survivor | $8,000 | 19 | 11 | 0% | 0% | $27,612 |
Long-Term Care Costs
Estimating the present value of expected long-term care costs is a very tricky proposition. Just a few of the factors to consider include:
- Whether or not you have long-term care insurance
- Whether or not you will have children or others who may be available (or who will want) to take care of you
- Expected costs of long-term care in the future
- Your gender and life expectancy
- Whether you will want semi-private or private rooms during long-term care
- The general costs of long-term care in your region, and
- Whether you anticipate using home equity values to fund these costs
As indicated in our April 16,2022 post, you may access the Genworth Cost of Care Survey to find average costs of various long-term care services in your state.
Roger and Susan decide to include an estimate of the present value of their long-term care costs in their spending liabilities (as opposed to assuming it will be paid with their home equity). They decide it is more likely that Susan will need long-term care near the end of her lifetime rather than Roger and, as recommended in our Overview assumption recommendations, they plan to fund 60% of two years of assisted living and one year of nursing home care for the final three years of Susan’s life. As discussed in previous posts, the 60% factor results from assuming recurring expenses in the final three years of life while in long-term care will be significantly reduced.
They determine that the average annual current cost where they live is about $50,000 for assisted living care and $100,000 for nursing home care (or an average annual cost during the 3-year period of care of about $67,000 in today’s dollars). They also assume that these expenses will increase in the future by assumed inflation plus 1% each year (4% per year), so they enter $115,911 (.6 X $67,000 X 1.04**27) as the annual amount to be paid in cell E 38 of the AFP (Expected Non-Recurring Expense #1) starting 27 years from now. The other entries and resulting present value shown in cell I 28 in the PV Calcs tab is shown below.
Item Name | Annual Amount | Deferral Period | Payment Period | Annual Rate of Increase | % Upside (Assets)/ % Essential (Liabilities) | Present Value |
Long-Term Care | $115,911 | 27 | 3 | 4% | 100% | $92,255 |
Roger and Susan decide to reserve more than $92,255 to fund expected long-term care costs as Roger may need some care before he passes, and they simply want to be more conservative with respect to this possible expense. Since Roger has another expense to input in row 38 of the spreadsheet, he zeros out the above calculation and inputs the amount they decided to reserve for long-term care expenses in cell D 36 of the Input/Results tab.
When he “finalizes” his spreadsheet, Roger prints it out and makes notes on it so that he can remember how he developed this year’s numbers (including those above) when it comes time to perform next year’s asset/liability valuation. Roger understands that most of the numbers will change next year.
Have fun playing with your AFP, everyone!
