At the beginning of each calendar year, we encourage our retired (or near-retired) readers to perform an actuarial valuation of their household assets and spending liabilities to see whether changes should be made to their financial plans. A household actuarial valuation involves calculating and comparing present values of household assets and household spending liabilities for the purpose of determining the household’s Funded Status. To do this, we suggest you follow the easy 5-step valuation process outlined below using our Actuarial Financial Planner (AFP) models.
2023 was a better year for retirees after a pretty tough 2022. Most of us experienced better-than-assumed investment return experience, rising interest rates and lower levels of price inflation. As a result, we increased the default assumptions used in the AFP to estimate future investment returns and decreased the default assumption for future inflation (as discussed in our post of November 16, 2023). The combined effect of more favorable experience during 2023 and changes in our default assumptions will generally increase household funded statuses as of January 1, 2024.
To help you with your actuarial valuation this year, we suggest that you review your entries in previous year’s valuations (which we hope you printed out, made notes on and filed away in a place you can find). Since the actuarial valuation process is a self-correcting process, we strongly encourage you to maintain a record of the progress of your funded status from year to year. This record will provide you with important trend information that will enable you to make better future financial decisions.
Easy 5-Step actuarial valuation process
As discussed in our post of August 23, 2023, here is a summary of our recommended annual actuarial valuation process (and a few hints):
Step 1: Make reasonable assumptions about the future. You can use our default assumptions, or you can override these assumptions by using the override function by clicking on the appropriate cell in column D, changing it to enable the override option and entering the override assumption in column F. Assumptions also need to be made for specific future increases in inputted assets or liabilities. Note that the default assumptions for lifetime planning periods are based on 25% probability of survival for non-smokers in excellent health from the Actuaries Longevity Illustrator. They assume passing will occur after the LPP and no “pieces” of a household member will die prior or after that time. Note that, unlike most other models you may see, separate investment return assumptions can be assumed for non-risky and risky investments.
Step 2A: Enter Asset information (Rows 7-17 for the Single Retiree workbook and Rows 8-28 for the Retired Couple workbook). Enter the percentage of these assets/investments considered to be risky asset investments (Upside) vs. non-risky investments (Floor). Increase last year’s Social Security benefits to reflect the cost-of-living increase starting in 2024.
Step 2B. Enter your planned spending in retirement (Rows 19-31 for the Single Retiree workbook and Rows 29-42 for the Retired Couple workbook). Be honest with yourself about your expected and unexpected recurring and non-recurring expenses for 2024 (or later years if they are expected to start later than 2024), as well as future expected annual increases to these expenses. Estimate the percentage of these expenses you believe to be “essential” vs. “discretionary.”
Hints:
- You might want to start with the same amounts you entered last year (or actual spending for last year if significantly different) and increase these relevant amounts with expected inflation for 2024.
- Hover your cursor over red triangles in the spreadsheet for specific cell hints
- Enter new data into data input cells. Don’t change cells that are not data input cells or you may overwrite the spreadsheet formulas.
- See our post of December 6, 2020 for discussion of possibly adjusting the present value of Social Security benefits to anticipate future reform reductions.
- See our post of December 8, 2023 for discussion of estimating Long-Term Care expense present values and how to calculate present values inside or outside the AFP to enter into unassigned PV cells.
- See our post of May 6, 2023 regarding taxes, especially if you expect your taxes will be significantly different from today’s taxes (i.e., once you commence Required Minium Distributions from your tax-deferred accounts).
- See our post of April 16, 2022 regarding planning for non-recurring expenses.
- Some expenses (for example future medical expenses) may be expected to increase at a rate faster than assumed inflation.
- Research has shown that real-dollar essential expense spending in retirement generally does not decrease over time, but discretionary expense spending does, so it may be reasonable to assume less than assumed inflation increases for some or all recurring discretionary spending.
Step 3A. Compare the present value of your planned essential expense spending with the present value of your non-risky asset/investments. As a result of this comparison, you may wish to consider changing your risky/non-risky asset investment mix to be consistent with the Safety-First Investment Strategy.
Step 3B. Compare the total present values of household assets and spending liabilities (balance sheet) to determine the household’s Funded Status (snapshot comparison) and the size of your Rainy-Day Fund (surplus). Maintain a history of your household Funded Status from year to year and note trends.
Step 4. When warranted, make changes to assets or liabilities (or both) to restore desired Funded Status (and/or to address possible cash flow issues). See our post of January 7, 2023 for our recommend algorithm for determining when plan changes should be implemented. Once you have “finalized” your inputs and produced an Actuarial Balance Sheet, the section below the Actuarial Balance Sheet will show you the components of your spending budget for 2024 that you have inputted. See the section below for discussion of actions that you may wish to consider this year.
Step 5. Periodically evaluate/stress test assumptions to see if they need to be changed or to assess risk and revisit the above steps at least annually to reflect changes in your spending plan, retirement assets or in the assumptions used to calculate present values.
Actions to Consider
Most likely, your Funded Status will increase comfortably above 100% as of January 1, 2024. You may still wish to consider some of the following actions as a result of this year’s valuation:
- Do nothing. You can let your Rainy-Day Fund grow to mitigate future risks
- Increase investments in non-risky assets to match the present value of household essential expenses if this is an issue
- Increase discretionary spending this year
- Strengthen the balance sheet by purchasing one or more life annuities,
- Use more conservative assumptions with respect to the future,
In order to help households decide which actions they should consider; it may be worthwhile this year to stress-test their plan by considering:
- What if future inflation is higher (or lower) than the default assumption of 3% per annum?
- What if other assumptions are not as favorable as assumed?
- What if their Social Security benefits are reduced as part of Social Security reform?
- What if one of the household members dies earlier (or later) than assumed?
These contingencies can all be fairly easily modeled in the AFP.
Summary
Retirement planning is definitely easier (and more fun) when investment returns exceed expectations, inflation is lower and your Rainy-Day Fund is growing (i.e., “fish are jumpin and the cotton is high” from the song “Summertime.”). Unless your 2023 spending far exceeded your 2023 spending budget, it is likely that your Funded Status grew from last year.
The first step in your ongoing planning process is to measure how you stand financially. That is, how your assets compare with your spending liabilities (your Funded Status) and how big your Rainy-Fund is. The AFP can help you employ the same general process used by actuaries for defined benefit pension plans and for Social Security. It’s time for you (and your spouse) to sit down and crunch your numbers to see where you stand at the beginning of 2024. And, once you determine where you stand, then you can consider the actions you should consider.
Happy New Year and Happy Planning!
