In our last post, we tried to encourage retirees afraid of (or behaviorally resistant to) spending their wealth to consider increasing their spending whenever their Funded Status exceeded a specific threshold percentage. In this post, we will take another shot at increasing your spending comfort level assuming safely increasing spending during retirement is consistent with your spending goals.
The “spend-less” Funding Status guardrail we recommend is 95%, and the “spend-more” guardrail we previously recommended in our post of January 7, 2023 for considering increased spending was 120%. The 150% (or 140%) Funded Status spend-more threshold used in the example in our previous post was considerably higher than our recommended 120% “spend-more” guardrail. We did this primarily to illustrate the process that could be used to transfer assets from one’s “upside portfolio” bucket to a “surplus bucket” whenever the Funded Status exceeded the specified threshold. We have absolutely no problem if you want to use a higher threshold than 120% as your spend-more guardrail, especially if you may be afraid of having to decrease your spending in the future.
However, in this post, we are going to look at just how conservative the 120% Funded Status spend-more guardrail is by stress-testing it for a hypothetical couple.
Stress testing the 120% spend-more guardrail
The household Funded Status is expected to remain about the same from year-to-year if
- Future investment return, inflation and longevity assumptions are realized
- Household spending and income is the same as assumed, and
- Investment return assumptions, inflation assumptions and longevity assumptions remain unchanged
Let’s assume that our hypothetical couple uses the default assumptions in the Actuarial Financial Planner and produces the following Actuarial Balance Sheet as of January 1, 2025:
Assets | Liabilities | ||
Floor Portfolio | $1,150,074 | PV Essential Expenses | $1,145,266 |
Upside Portfolio | $638,390 | PV Discretionary Expenses | $345,212 |
Total PV Assets | $1,788,464 | Total PV Spending Liabilities | $1,490,387 |
Funded Status | 120% |
How much of a negative return on their Upside Portfolio assets would they have to suffer to trigger a spending reduction based on the 95% spend-less guardrail? See our post of April 2, 2024 for further discussion of the simple algebra required to solve this question. By solving the basic algebraic equation below for “X”, we determine that it would take a return on the Upside Portfolio assets of -58% or worse to trigger a spending reduction, all things being equal.
[X ($638,390) + $1,150,074] / $1,490,387 = .95
X =.42, or a -58% return.
By comparison, the worst S&P returns over the past 30 years were the periods 2000-2002 and 2008 when returns were about -37%. Thus, if our hypothetical couple started 2025 with a Funded Status of 120% and experienced a -37% return on their Upside Portfolio assets, they could expect to have an end- of-year Funded Status of about 104%, determined as follows:
[.63 ($638,390) + $1,150,074] / $1,490,387 = 1.04
Now let’s assume that price inflation for the next 4 years is worse than it has been in any four-year period over the past four years, which just happens to be the last four years. Over the last four years, inflation, measured by Social Security cost-of-living increases, has averaged about 5% per year. If we assume inflation of 6% per year for the next four years, then dropping back to our default assumption of 3% per annum, the effect on our hypothetical retired couple would be to decrease their funded status by about 3%. Therefore, if we subject our hypothetical 120% Funded Status to the worst equity investment period and the worst four-year inflation period over the past 30 years, we are still slightly above 100%.
Is it possible for a 120% Funded Status to fall below the spend-less guardrail of 95%? Sure, anything is possible. Our hypothetical household can experience:
- Even larger investment losses,
- Even higher levels of inflation for longer periods
- Unanticipated reductions in income
- Higher than budgeted spending, including unanticipated family support, uninsured property loss replacement, larger-than-expected medical or long-term care expenses, unanticipated legal expenses, etc.
So, clearly the 120% spend-more guardrail is not “bullet-proof”, but it is fairly robust, and the consequence of falling below 95% doesn’t mean that you are bankrupt. It means that you might be required to temporarily or permanently reduce some discretionary spending.
The solution? Probably the best solution is to stress-test your own plan to develop your own spend-more guardrail. Absent doing that, instead of using a Funded Status of 120%, you can use a more conservative 130%, 140% or even 150% as your personal spend-more guardrail. It all depends on your personal tolerance for risk.
Summary
Our website is called; How Much Can I Afford to Spend in Retirement. We aren’t going to tell you how much you should be spending in retirement. If you want to build a large legacy for your heirs, that is fine with us. If you are worried about not spending enough during retirement, however, you can use our tools and the Funding Status metric to help you decide when it may be time to open up your purse strings and spend more on things important to you.
