Measuring and Managing Financial Risks in Retirement

In
prior posts, we’ve discussed the three M’s that constitute the
actuarial process for keeping your spending in retirement on track and
consistent with your spending goals:Measuring your Funded Status each yearMonitoring your Funded Status from year to year, andMaking changes in your assets or spending liabilities when your Funded Status falls outside a reasonable corridor (guardrails).In
this post, we will discuss two more M’s: Periodically Measuring and
Managing your financial risks. If you have completed Steps 1 and 2 above
as of January 1, 2026 and are contemplating increases in your spending
plan this year, we suggest that now may be a good time to measure and
possibly manage your financial risks before implementing your plan.
Stress testing your assumptions is a relatively easy process using the
Actuarial Financial Planner (AFP) to see what the results of changing
assumptions or inputted data has on your Funded Status. The last
three years were good years for equity returns. Despite
higher-than-expected essential expense costs, many retirees may be
looking at beginning-of-year 2026 Funded Statuses in excess of 140% and
may be contemplating increasing their spending for 2026 as a result. We
don’t necessarily want to pour cold water on reasonable spending
increases, but we do suggest that you take the time to kick the tires on
your plan to see how it will hold up under possible less-favorable-than
assumed future experience.Let’s take a look at some “stress-tests” you may wish to consider to assess your risks.Less favorable than assumed investment returnThe
S&P 500 Shiller Price to Earnings Ratio as of January 9 was 31.45
This compares with the historical mean for this measure of 17.2. Thus,
it is reasonable to assume that future equity returns may be lower than
historical averages. To stress-test less favorable than assumed
investment returns on equities, you can override and reduce the current
default 10% per annum assumption on risky assets and/or you can reduce
the value of your current equity holdings (by 50%?) to see what the
possible impact would be on your Funded Status.Possible risk
management tip: If the present value of your current non-risky
assets/investments don’t cover the present value of your essential
expenses, you might consider increasing your asset allocation to
non-risky assets/investments. You may also wish to consider maintaining a
higher Rainy-Day Fund for this risk.Higher than assumed future inflationWe
have no crystal ball with respect to future inflation. Government
deficits continue to increase, but the economy appears to be slowing
down. Climate change is likely to negatively affect the price of home
insurance and/or home prices. To stress-test for higher inflation, you
can override the current default inflation assumption of 3% per annum,
increase expected rates of increases on various expense items and/or
increase your current input estimates for selected expenses. If you rely
on your home equity to fund a significant portion of your retirement,
you may wish to stress-test the impact of losing some or all of your
home equity.Possible risk management tip: If you are looking to
manage inflation risk in expenses and are also looking to increase
investments in non-risky assets, you may wish to consider building a
TIPs ladder or, if possible, you can also defer commencement of your
Social Security benefits. Investment in equities has historically been a
good inflation management investment. You may also wish to maintain a
higher Rainy-Day Fund for this risk.Lower than assumed future Social Security benefitsAt
some point in the relatively near future, Social Security is going to
need an infusion of more income to keep paying promised benefits. In
lieu of saddling current workers with the entire burden of making the
system solvent, Congress may decide to reduce benefits for some current
and future beneficiaries. If no action is taken, current best-estimate
actuarial projections show an initial 20% decrease across the board for
beneficiaries as earlier as 2032. Of course, it is likely that Congress
will take action prior to the trust fund exhaustion date, but it is not
clear whether earlier action will result in potentially higher or lower
benefit reductions for certain beneficiaries.To stress test for
lower than assumed future Social Security benefits, you can input a
negative amount in an “other asset” cell with a deferred starting date
or you can simply reduce your current Social Security benefits to see
what the impact is on your Funded Status.Possible risk management
tip: You may wish to consider buying an annuity with a deferred
commencement date to cover the expected decrease in your benefits or you
may simply maintain a higher Rainy-Day Fund to address this risk.Unexpected expensesUnanticipated
housing repairs, uninsured property losses, family emergencies, etc.
may occur in 2026 or future years. The AFP enables you to input a
reserve for unexpected non-recurring expenses. You can increase this
amount or simply maintain a higher Rainy-Day Fund/Funded status for
these unexpected expenses.Longer than expected lifetime planning periodsYou
should plan to live longer than your life expectancy. As discussed in
the previous post, you may wish to use the 3-step process we discussed
to change the LPPs used in your Funded Status calculations and/or stress
test longer periods.Death/DivorceIt is a
relatively easy (but perhaps depressing) process to stress test your
plan for earlier than expected death of one of the members of the
household or divorce. This may make sense if one of the members of the
household has more lifetime income assets than the other.ConclusionDespite
experiencing significant levels of price inflation, many retirees are
better off financially than they were several years ago and may be
considering increases in their spending plan as a result. We don’t want
to be “Debby Downers”, here, and we certainly don’t know what the future
will be, but you may wish to stress-test some of your assumptions
before committing to those spending increases. When testing, you will
want to see what the effect of certain changes could have on your Funded
Status.