In this weekend’s Kitces.com Weekend Reading for Financial Planners (July 5-6), Adam Van Deusen discusses three articles concerning the importance of selecting reasonable lifetime planning period assumptions when decumulation planning, as well as stress-testing these assumptions when measuring longevity and mortality risks. He says,
“Ultimately, the key point is that creating a plan based on how long a client will live is most effective when both mortality and longevity risk factors are considered. Actuarial science offers tools that can help advisors assess these considerations so that they can adjust mortality assumptions and longevity expectations as part of an ongoing process of monitoring and updating a plan. And by making these adjustments collaboratively and regularly, advisors can help clients develop a relevant and realistic strategy to manage their mortality and longevity risks as they journey into retirement!”
We totally agree with Mr. Van Deusen, and in this post, we will highlight the mortality/longevity related actuarial tools in our “Actuarial Approach” website that can be of value to advisors and their clients.
Before we jump into discussion of the Actuarial Approach and why advisors and DIYers might want to use it, we want to thank Mr. Van Deusen for again pointing out that “One of the most common (and valuable) services financial advisors offer their clients is helping them determine how much they can sustainably spend in retirement” (pretty much the name of our website). In addition, Mr. Van Deusen reminds us that decumulation planning is an ongoing process, not a one-and-done stochastic projection.
Assumed Lifetime Planning Periods in the Actuarial Financial Planners
The default lifetime planning period (LPP) assumptions in the Actuarial Financial Planners available in our website are based on the 2022 Actuaries Longevity Illustrator (ALI) Planning Horizon Chart; 25% chance of survival for non-smokers in excellent health. Default “Either Alive” and “Both Alive” LPPs (which are used in our Retired Couples spreadsheet to develop present values for inputted lifetime expenses for couples as discussed below) have been approximated based on simplified algorithms.
The 25% probability of survival is more conservative than the 50% probability of survival (more commonly referred to as the life expectancy), and is generally 5 or 6 years longer than the 50% probability of survival, so assumed ages at death are usually around 94 for males and 96 for females who are currently in their 60s.
The LPP assumptions are based on inputted ages, so as users age from year to year, these assumptions automatically change and generally the assumed age at death will increase gradually as users age.
The LPP assumptions may be overridden by using the assumption override process described in the model. This feature can be used to stress-test the LPP assumptions (for example, by assuming one of the couples dies this year) or by simply making them more or less conservative. Some of our readers, for example, plan on living until 100.
Recent research has shown that individuals with higher levels of income have longer life expectancies. To some extent, this research has already been built into the ALI data, but again, the default assumptions can be overridden if advisors believe this is appropriate for their higher income clients.
As noted in the first article discussed by Mr. Van Deusen (and many others), it is generally unwise to plan on living “only” to one’s life expectancy. Our default LPP assumptions are consistent with this general consensus and have been for years.
Present Value of Expense Determinations for Couples.
Both members of a married couple will generally not die at the same time, so realistic modeling of future expenses for a household should anticipate periods of time after the passing of the first member of the couple to die. The AFP for Retired Couples uses default assumptions (based on information from the Actuaries Lifetime Illustrator) for periods when both of the members are probably alive (Both Alive) and periods when either of the members will probably be alive (Either Alive). These periods are used in the spreadsheet, together with an input assumption regarding the percentage decrease in the inputted expense upon the first death within the couple (x%), to determine the present value of such future recurring expense on a joint with (1- x%) continuation to the last survivor basis. This approach is more accurate than simply assuming that such expenses will continue at 100% until the last death within the couple.
Investment Implications of Assuming Longer Lifetime Planning Periods
Advisors and DIYers should note that assuming longer-than-life-expectancy lifetime planning periods does not just affect expense liabilities. It will also affect assets and investments that are payable for life. For example, it may make deferring Social Security commencement age until 70 and purchase of a lifetime annuity contract to be more attractive. In fact, it is not unusual for the modeling of such events to increase the present value of a household’s assets, and thus increasing their Funded Status. Generally, the longer one assumes they will live for planning purposes, the greater the return will be on purchasing lifetime income or deferring commencement of Social Security (until a maximum of age 70).
Summary
As noted by Mr. Van Deusen in his Kitces.com post this weekend, actuarial tools can be quite useful in helping retired households determine how much they can afford to spend in retirement. We encourage advisors and DIYers to make full use of the actuarial tools in our website.
