Check These Five Boxes to See if You Are Financially Ready to Retire

The Actuarial Financial Planner (AFP) is a useful tool to facilitate household decision-making in or near retirement. In this post we will discuss how the AFP (and possibly the Actuarial Budget Calculator for Single Retirees) can be used to determine if you are financially ready to retire. We include an example below to illustrate the process.

Ongoing vs. One-Time Financial Planning in Retirement

The Actuarial Financial Planner (AFP) advocated in this website is a relatively simple, deterministic actuarial model (i.e., it uses deterministic assumptions about the future to determine results).  By comparison, many financial advisors use more complicated Monte Carlo models which involve the use of one or more stochastic assumptions.  In this post, we will once again discuss why we believe the AFP is the more appropriate model for the purpose of ongoing (as opposed to one-time) financial planning in retirement.

This post is a follow-up to our post of December 25, 2022.  We start by providing background on deterministic vs. stochastic models and then discuss one of the main purposes of financial planning--periodically rebalancing household assets and spending liabilities to keep spending on track during retirement.  We conclude that the AFP better accomplishes this purpose than Monte Carlo models commonly used today.

Managing Risks in Retirement

Actuaries use models, dynamic processes and periodic risk assessments to measure and manage risks for financial systems. The same basic actuarial principles and processes used by actuaries for other financial systems can be applied to the problem of how much a retired household can afford to spend in retirement.

In his January 3, 2023 Advisor Perspectives article, fellow Fellow of the Society of Actuaries and friend, Pete Neuwirth, describes risks faced by retired households during “decumulation.” He concludes his article by saying:

“The fundamental nature of decumulation is different from accumulating sufficient assets to provide for a sustainable retirement. While the extensive body of investment and asset-allocation theory developed over the last 50 years is applicable, decumulation is more of a risk management problem where actuarial science should be brought to bear.

At its core, decumulation is an asset-liability and cashflow matching problem governed by random variables from unruly and difficult to determine probability distributions. It will take researchers in both the investment and actuarial professions to make progress.”

I agree. 

Updated Implied Discount Rates for Single Premium Life Annuities as of January, 9, 2023

In prior posts, we discussed possible assumptions used by life insurance company actuaries in pricing single premium immediate life annuities (SPIAs). In those posts, we provided implied discount rates consistent with quotes obtained from ImmediateAnnuities.com based on two different mortality assumptions (one based on life expectancy (50% probability of survival) and the other based on a 25% probability of survival, which is the basis we recommend in our website for planning purposes).

In this post, we will examine the implied interest rate assumptions built into quotes from ImmediateAnnuities.com as of January 9, 2023 and compare the quotes and the implied interest rates with the results of the similar exercise we performed as of November 25, 2022. You may wish to revisit our prior posts for more general discussion of annuity pricing assumptions.

The key takeaway from this post is that implied interest rates (rates of return) on SPIAs have decreased over the past several months. We have no idea, however, if they are going to decrease even more in future months (or even increase).

Automatic Funded Status Adjustments to Your Spending Budget

The Actuarial Approach advocated in this website is a dynamic spending approach that anticipates periodic determinations (or valuations) of the retired household funded status and, if necessary, adjustments in the household spending plan to maintain a desired funded status level. Contrast our recommended approach with static approaches (like the 4% Rule or static Monte Carlo models) that anticipate a one-and-done determination of future household spending with presumably a relatively high probability of success. 

In our last post, we provided an example of the actuarial approach for a couple (Bill and Betty), whose Actuarial Financial Planner (AFP) funded status decreased from 112% as of January 1, 2022 to 99% as of January 1, 2023. In that post, we left it up to Bill and Betty (and their personal tolerance for risk) to determine actions they might want to consider in light of this decrease. In this post, we propose an alternative automatic approach for Bill and Betty (and other households) to use to adjust their spending budget if their AFP funded status either becomes too low or too high now or in the future.

Retirees, it’s Time to Update Your Financial Plan

At the beginning of each new calendar year, we encourage our retired readers to perform an actuarial valuation of their household assets and spending liabilities to see whether changes should be made in the spending and investment components of their financial plans, especially if they haven’t done so recently. This year, we will use an example and the Actuarial Financial Planner (AFP) to illustrate the five easy steps we recommend for performing this annual actuarial valuation. 

2022 was a tough year for retirees. In addition to poorer-than-assumed investment return experience, we also experienced higher-than-assumed rates of price inflation. The combined effect on most retiree’s household balance sheets was to significantly reduce the size of household assets and Rainy-Day Funds (the balancing item between household assets and household spending liabilities). Going forward for 2023, retired households will need to decide what actions, if any, should they plan on to address these reductions.

Here We Go Again with the 4% Rule and “Safe” Withdrawal Rates

Last year Morningstar told us that the 4% Rule was really 3.3%. This year, based on revised assumptions about the future, they tell us that it is now 3.8% (The State of Retirement Income 2022). Of course, this new report has set off another flurry of discussions among financial advisors, financial academics and the retirement-focused media about:

• the 4% (or whatever %) Rule,
• Safe Withdrawal Rates and
• Spending under more-flexible spending strategies (dynamic vs. static spending strategies)

In this post, we will

• Discuss the results of the Morningstar 2022 Report,
• Briefly discuss the difference between static approaches like the 4% Rule and static Monte Carlo model projections and dynamic approaches like the Actuarial Financial Planner or dynamic Monte Carlo projections, and
• compare withdrawal rates developed in the 2022 Morningstar report with initial withdrawal rates developed from a simplified application of our Actuarial Financial Planner (AFP).

We conclude, once again, that the AFP is a much more robust planning tool than the 4% Rule or most Monte Carlo models.

Updated Implied Discount Rates for Single Premium Life Annuities as of November 25, 2022

In prior posts, we discussed possible assumptions used by life insurance company actuaries in pricing single premium immediate life annuities (SPIAs).  In those posts, we provided implied discount rates consistent with quotes obtained from ImmediateAnnuities.com based on two different mortality assumptions (one based on life expectancy (50% probability of survival) and the other based on a 25% probability of survival, which is the basis we recommend in our website for planning purposes).     

In this post, we will examine the implied interest rate assumptions built into quotes from ImmediateAnnuities.com as of November 25, 2022 and compare the quotes and the implied interest rates with the results of the similar exercise we performed as of July 25, 2022.  You may wish to revisit our prior posts for more general discussion of annuity pricing assumptions.

Managing Upcoming Holiday Expenses

Retirees, I don’t want to be the Grinch who stole your Christmas (or your holiday season), but if you haven’t done so already this year, you might want to estimate your end-of-year financial status by updating the data in your Actuarial Financial Planner (AFP). And, if your updated end-of-year Rainy-Day fund (the balancing item of your retirement assets and spending liabilities) is uncomfortably negative, you might want to think about reducing some of your discretionary expenses going forward, including your upcoming holiday spending. Alternatively, you might want to consider going back to work or finding other sources of income. In this post, I will provide some suggestions on how you can update your beginning of year AFP to year end.

Finding Financial Peace of Mind in Retirement—5 Easy Steps

In the recently released Stanford Center on Longevity report entitled, “Disconnected: Reality vs. Perception in retirement planning” which we briefly discussed in our post of October 7, 2022, the authors noted,

“While retirement planning is highly personal and dependent on many different factors, there is an almost universal desire for ‘peace of mind’ in retirement.”

Given this near universal desire, we thought it might be helpful to outline the five relatively straight-forward steps we think you should follow to help you find financial peace of mind in your retirement with the assistance of the Actuarial Financial Planner (AFP).