What is Your “Sleep Well at Night” Funded Status?

In
this post, we discuss how you can use the Actuarial Approach and its
funded status metric to help you feel more confident about your spending
plan in retirement. It is a follow-up to our post of January 11, 2026.Bottom line:
Having a sufficiently high funded status can help you sleep better at
night. The question we address in this post is just how high does this
target funded status need to be for you—120%, 140% or higher?BackgroundYour
funded status (the present value of your total assets divided by the
present value of your total spending liabilities) is expected to remain
unchanged from year to year if all assumptions about future experience,
including your budgeted spending, are realized and unchanged. All things
being equal, future experience more favorable than assumed will
increase your funded status, and future experience less favorable than
assumed will decrease your funded status. Therefore, it is important to
input a reasonable spending budget (including future taxes and long-term
care costs) and use reasonable assumptions about the future when
developing your current funded status. We also recommend that you fund
your essential expenses with non-risky assets/investments, so that if
you do have to decrease spending in the future, it is highly likely that
such decreases will involve discretionary spending.While a
current funded status of 100% indicates that you currently have
sufficient assets to cover all your anticipated spending liabilities
under the current assumptions and spending budget items that you input,
these assumptions may turn out to be optimistic or your actual spending
in the future may exceed your spending budget for one reason or another.
Therefore, it is generally prudent to target an ongoing funded status
in excess of 100%. For the purpose of this post, we will call this
higher level your target funded status.Your tolerance for risk
determines how much in excess of 100% your target funded status needs to
be for you to sleep well at night or to determine when you might feel
comfortable increasing your spending budget. If your risk tolerance is
relatively low, for example, you may want your target funded status to
be sufficiently high so that even really bad future experience will not
force you to consider reducing your spending. If your risk tolerance is
somewhat higher, you may be ok with a target funded status that might
require you to reduce discretionary spending some time in the future in
the event of bad future experience.As discussed in our post of
January 11, 2026, the main risks you face in retirement come from events
that will either lower your expected assets or increase your expected
spending liabilities (i.e., decrease your Funded Status). These risks
include:Less favorable than assumed investment returnsHigher that assumed future inflation or cost increasesLower than assumed Social Security paymentsUninsured asset lossesUnanticipated spending, etc.Let’s
take a look at how you can stress test some of these risks so that you
can develop a sufficiently high target funded status that will enable
you to sleep well at night.Higher than assumed inflation or cost increasesYou
can stress-test this risk by inputting higher assumptions for future
rate increases in the Actuarial Financial Planner (AFP) and seeing how
such changes affect your funded status. If you do increase the rate of
assumed inflation for this test, this change will also increase the cola
assumption for your Social Security benefit, so that will mitigate the
negative impact of higher inflation to some degree.With 30-year
TIPs ladders currently providing a real rate of return of about 2.4%, we
feel that the approximately 2% real rate assumed as part of the set of
current default assumptions is already fairly conservative, so instead
of assuming higher rates of investment return and inflation, we suggest
stress testing certain expenses that you believe may increase at a rate
faster than general inflation, such as taxes, health costs, insurance
premiums, etc.We believe increasing a 100% funded status measure
determined under the current default assumptions by 10%-15% is probably
sufficient to address this risk for most users. If you are more
concerned about the impact of inflation on your spending plan, perhaps
you should look into increasing your investments in TIPs ladders (and/or
deferring commencement of your Social Security benefits, if possible).Lower than Expected Social SecurityThe
impact of assuming a 20% decrease in Social Security benefits seven
years from now is easily calculated in the AFP. The potential impact of
this risk will depend on the portion of your total assets you receive
from Social Security. For most users, we estimate that your funded
status will likely decrease by no more than 4%-8% in the unlikely event
that Social Security benefits are decreased across the board by 20% for
individuals already eligible for benefits. Of course, future cuts could
be more or less than 20%.Less favorable than assumed investment returnsAs
another hedge against higher than assumed inflation, it is important to
invest some of your assets in risky investments. Expected returns from
risky assets are higher than expected returns from non-risky assets over
time, but volatility is much greater. Over the past 80 years, there
have been three instances when the annual S&P 500 index decreased by
more than 35% over one year or more:1973-1974: -42%2008: -38%2000-2002: -40%So,
to stress-test for this risk, let’s assume that your 2026 risky assets
will decrease by 40% during 2026. Note that this is for stress-testing
purposes. It is not a prediction.The important take-away from this stress-test is this: The
larger the percentage of your total assets (including the present value
of Social Security benefits, pension benefits, life annuities, etc.)
that is invested in risky assets, the larger will be the beginning of
year funded status that will be needed to keep you above 100% at the end
of the year if equities decrease by 40% during the year. For
example, if the total present value of your assets is $3 million and
the total present value of your risky assets is $1 million (leaving $2
million in non-risky assets), then a 40% drop in your risky assets would
reduce your total assets by $400,000 and reduce your Funded Status by
13%. So, you would need to have a beginning of year funded status of at
least 115% (100%/.87) to have a Funded Status of 100% at the end of the
year under this “black swan” equity investment scenario.On the
other hand, if the total present value of your assets is $3 million and
the total present value of your risky assets is $2 million (leaving $1
million in non-risky assets), then a 40% drop in your risky assets would
reduce your total assets by $800,000 and reduce your beginning of year
funded status by 26%. So, in this case you would need to have a
beginning-of-year funded of at least 135% (100%/.74) to have a Funded
Status of 100% at the end of the year.If you don’t want to
increase your funding status target for the possibility of less
favorable than assumed investment performance, you can always reduce
your investments in equities or other risky assets. You can see what
will happen to your funded status if you invested all of your assets in
non-risky investments by changing the assumed investment return on risky
assets (current default of 10% per annum) to the assumed rate on
non-risky assets (current default of 5% per annum). The bad news is that
this change would reduce your funded status. The good news is that it
would likely significantly reduce your funding status target. Another
alternative would be to increase your tolerance for risk or hope that
future black swan equity experience will not re-occur in the future. Of
course, this latter action may not be consistent with your desire to
develop a “sleep well at night” funding status target.SummarySelecting
an appropriate funding standard target that will help you sleep well at
night will depend on your tolerance for risk and, for the most part,
the percentage of your total assets invested in equities or other risky
assets. We also recommend funding your essential expenses with non-risky
assets/investments to help you sleep better at night.If you have
a lifetime pension benefit in addition to your Social Security benefit
or you have a TIPS ladder and a relatively small investment in equities,
a funding status target around 120% might work well for you. If you
have a low tolerance for risk and a significant portion of your assets
invested in risky investments, you will likely need a higher funding
status target to help you sleep well at night in today’s economic
environment. We encourage you to use the Actuarial Financial Planer to
stress test your planning assumptions.If you are risk averse and
hold a fair amount of your assets in equities, it is not unreasonable
for you to have a target funded status near 150%. You want to be able to
withstand a black swan event in the equities market and other adverse
experience.Affect your guardrails. What you need to retire.