How Much Can I Afford to Spend in Retirement?: Actuarial Financial Planner FAQs

The Actuarial
Financial Planner (AFP) workbooks (for single retirees and retired
couples) are robust actuarial models integral to each of the three “M”
steps outlined below in our recommended process for keeping your
spending on track and consistent with your spending goals in retirement:Actuarial Approach–Three Key Planning StepsMeasure your Funded Status (Assets/Liabilities) at the beginning of each yearMonitor your Funded Status from year to year, andManage your spending, assets and risks in retirement as necessary We
have received questions about the AFPs over the years. In this post we
will once again attempt to briefly answer five of the most frequently
asked questions.How do I input data in the other
income/expected non-recurring expense rows of the spreadsheet to
determine present values of these items?Present values
of other income/expected non-recurring expenses are generally
determined by entering data into the following cells:Annual AmountDeferral PeriodPayment PeriodAnnual Rate of Increase% Upside (assets) or %Essential (Liabilities)Where
“annual amount” is the expected amount in today’s dollars increased by
inflation (or some other reasonable rate of increase) from the current
year until the expected year of first payment; the deferral period is
the period in which no payments are assumed; payment period is the
number of expected years of payment for this income item/expense after
the deferral period; annual rate of increase is the expected rate of
increase once payments are expected to commence, and % upside/%
essential is the users estimate of how risky this particular
asset/investment is or how essential this particular expense is.For
example, let’s assume a married household expects to remodel their
kitchen 10 years from now and the current cost of the remodeling project
is $25,000 in today’s dollars. Further assume that the couple has
determined that this project is 50% essential. Using the current default
assumption for inflation of 3% per annum, they would enter $33,598 as
the annual amount ($25,000 X [(1.03)**10]). This is the current cost in
today’s dollars increased by 3% per annum for 10 years. They would enter
10 as the deferral period, 1 as the payment period, 0% as the rate of
increase after the job is expected to be completed and 50% as their
estimate of how essential this project is.The present value of
this project (as calculated in the PV Calcs tab) under the default
assumptions is $17,899. Note that the discount rate used to determine
this present value is 6.5%, or 50% of the floor portfolio discount rate
of 5% and 50% of the upside portfolio discount rate of 8% per annum. Why are there two default expected rates of investment return/discount rates?Under
the Actuarial Approach, two separate buckets are assumed to be used to
fund household expenses: The floor portfolio, which is used to fund
essential expenses, and if assets are matched to spending liabilities
will consist of non-risky investments/assets. The current default
investment return/discount rate for the floor portfolio is 5% per annum.
The Upside portfolio is used to fund discretionary expenses. The
current default investment return/discount rate for the upside portfolio
is 8% per annum.Why should I input the percentage upside or percentage essential for some input items?As
discussed in the question above, we encourage users to consider using a
Liability Driven Investing (LDI) strategy where non-risky
investments/assets are matched with essential expenses. Some assets,
like Social Security are assumed to be 100% non-risky (or floor
portfolio) assets and some spending liabilities, like essential
expenses, are assumed to be 100% essential and also belong in the floor
portfolio. For other less obvious assets or expenses, we leave it up to
the user to determine how risky a certain asset/investment is or how
essential a certain expense item is.What if I
disagree with a default assumption or otherwise want to change an
assumption to stress test what the effect would be of an alternative
assumption on my Funded Status?The process for
overriding default assumptions is described in the spreadsheet. You must
use the specified process. Otherwise, you may mess up the spreadsheet
and you may have to download a new spreadsheet and start over again.What if the present value of my floor portfolio assets is less than the present value of my essential expense liabilities?As
discussed above, we encourage our readers to fully fund their floor
portfolio by matching the present value of their essential expenses with
the present value of their non-risky investments/assets. If your floor
portfolio is not fully funded, you can consider one of the following
actions:Transferring assets from the Upside Portfolio and investing them in non-risky investmentsReclassifying some of your essential expenses as discretionary, orIgnoring our suggestion completely or partiallyWe
are not investment or financial advisors. We are actuaries who believe
that the problem of decumulating assets in retirement is a classic
actuarial problem that can be solved by applying basic actuarial
principles, similar to the principles used to fund other financial
systems such as Social Security and pension plans.