How Conservative is Your Decumulation Plan?

If
the assumptions used in your retirement decumulation plan (including
the important assumptions that the assets you plan to receive, and the
expenses you expect to incur in the future) are exactly realized, your
Funded Status should remain approximately the same from year to year. If
your (or your financial advisor’s) assumptions are too conservative,
future experience will be more favorable than assumed, and your Funded
Status will increase over time. Conversely, if your assumptions are too
aggressive, future experience will be less favorable than assumed and
your Funded Status will decrease over time.Most retirees prefer
to be somewhat more conservative than aggressive in the funding of their
retirement liabilities. They prefer the possibility of future spending
increases to future spending decreases, even if such spending decreases
involve discretionary expenses that presumably are not as critical as
essential expenses. On the other hand, most retirees don’t want to be
overly conservative and prefer to enjoy increased spending early in
retirement if at all possible. This conflict of preferences and the
uncertainty of the future make retirement planning difficult. Some
financial advisors attempt to address this issue by administering risk
tolerance questionnaires and by asking clients to select between
spending strategies that have varying “probabilities of success” or
“probabilities of future changes.”In this post, we will attempt
to quantify how conservative certain sets of assumptions are when using
the Actuarial Financial Planner (AFP) with different Funding Status
targets. We will do this by using an example hypothetical individual and
comparing calculated withdrawal rates for this individual with
withdrawal rates under the 4% Rule.ExampleJohn
is a recently retired 64-year-old with a current annual Social Security
benefit of $25,000 and accumulated savings of $1,000,000. He has
determined his recurring essential expenses to be $50,000 per annum. He
will solve for his annual recurring discretionary expenses by running
the AFP under alternative sets of assumptions about the future and
solving for a Funded Status of either 100% or 120%. This will determine
his spending budget for the year and the amount that should be withdrawn
from his accumulated savings together with his Social Security benefit
to provide his spending budget. The amount he expects to withdraw from
accumulated savings is then expressed as a percentage of his accumulated
savings and compared with 4% or 4.7%, percentage withdrawal rates under
the 4% Rule.To make the withdrawal rates in this example
consistent with withdrawal rates under the 4% rule, we have made the
example very simple in terms of expenses. We have assumed no
non-recurring expenses, including no LTC expenses.John starts
with the current default assumptions: 5% discount rate for essential
expenses, 8% discount rate for discretionary expenses, 3% annual rate of
inflation and a lifetime planning period of 30 years. John’s age of 64
was selected for this post to produce the 30-year LPP under the default
assumptions which is consistent with the assumed lifetime under the 4%
Rule.With a Funded Status target of 100%, John’s recurring
spending budget under the default assumptions is $25,908, his total
spending budget for the year is $75,908 and the amount to be withdrawn
from his savings would be $50,908, or 5.09% of his accumulated savings.The
table below shows different withdrawal rates for John for different
sets of assumptions and different Funding Status target percentages.John’s Withdrawal Rates Under Different Assumptions and Funding TargetsAssumptionsWithdrawal Rate Funding Status Target: 100%Withdrawal Rate Funding Status Target: 120%5%/8%/3%/305.09%3.49%5%/5%/3%/304.34%3.20%8%/8%/3%/306.10%4.67%   5%/8%/3%/255.83%4.16%5%/5%/3%/254.99%3.74%8%/8%/3%/256.67%5.14%The
percentages in the first row were developed using the default
assumptions in the AFP for Funding Status targets of 100% and 120%. The
percentages in the second row were developed assuming the same 5%
discount rate is used for both essential and discretionary expenses and
results would be expected to be similar to those produced by approach
advocated by Dr. Wade Pfau, as discussed in our post of August 31, 2025.
The percentages in the third row were developed assuming the same 8%
discount rate is used for both essential and discretionary expenses and
results would be expected to be similar to results produced by some
financial advisors who make no distinction between expected returns on
non-risky and risky assets.The bottom three rows show results
under the same set of assumptions as the top three rows with the
exception that 25 years is used for the lifetime planning period rather
than 30 years.It should be noted that these calculations are relatively easy to perform using the AFP and its assumption override function.The
withdrawal rate under the 4% Rule fluctuates from time to time. For
many years it was 4% (hence the name), but now Mr. Bengen has declared
it to be 4.7%. In any event, the 4% Rule is thought to be a fairly
conservative approach, which is why we used it for comparison with the
results produced by the AFP. Under the default assumptions, the
AFP withdrawal rate results for John are slightly less conservative than
under the 4% Rule for a Funding Target of 100% and more conservative
than under the 4% Rule for a Funding Target of 120%. Other assumption
sets can be more or less conservative than under the default
assumptions. For example, we would have no problem if users wanted to
assume a 10% rate of return (7% real) rather than the default assumption
of 8% per annum on risky assets used to fund discretionary expenses.Note
that while we are using the 4% Rule withdrawal rates to determine the
level of conservatism built into the AFP model and the default
assumptions, we are not encouraging users to use the 4% Rule or any
other systematic withdrawal rate approach to determine their spending
budgets unless adjustments like separate reserves for non-recurring
expenses are also made.SummaryThere are
lots of levers in the AFP to make spending budgets more or less
conservative, including changing assumptions about the future and
funding status targets. Ifyour risk tolerance is relatively high,you prefer increased spending early in retirement, andyou aren’t overly troubled by the thought of decreasing discretionary spending in the future,you
may wish to use more aggressive assumptions and lower funding targets.
If not, you can stick with the default assumptions, knowing that if
these assumptions are indeed too conservative, your spending will likely
increase in the future (assuming your assets are not unexpectedly
reduced and you have accurately captured all your future expenses,
including future taxes, medical expenses and long-term care expenses,
etc.).