Why It’s Important to Monitor Your Funded Status from Year to Year

We encourage you to remember the following 3Ms when determining how much you can afford to spend in retirement:Measure your Funded Status periodically (we recommend at least annually at the beginning of each calendar year)Monitor your Funded Status from year to year, andMake changes when your Funded Status falls outside a reasonable corridor (guardrails)Some of our readers question why the second M is important. We will answer in this post.BackgroundYour
Funded Status is determined by dividing the present value of your
investments/sources of income (your Assets) by the present value of your
future expected expenses (your Liabilities), orFunded Status = A / LThe
assumptions used to determine your A and L include assumed investment
returns, assumed longevity, assumed inflation, assumed future rates of
increases in expenses, etc. If you spend your current year
spending budget determined using the Actuarial Financial Planner (AFP)
and all the assumptions used in the calculations are unchanged and
exactly realized in the future, your Funded Status will remain unchanged
from year to year. As discussed in our post of August 16, 2024,
it is highly unlikely that the future will happen exactly as assumed.
Increases (or decreases) in your assets relative to your spending
liabilities can occur from:Actual experience more (or less) favorable than assumedChanges in assumptions, orSpending more (or less) than budgetedThe
items above that increase your assets relative to your liabilities are
called “actuarial gains” while the items that increase your liabilities
relative to your assets are called “actuarial losses.” Actuarial gains
will increase your Funded Status while actuarial losses will decrease
your Funded Status.Why monitoring your Funded Status from year to year is importantPeriods
of consistent actuarial gains or losses where your Funded Status is
fairly consistently increasing, or decreasing, is an indication that
your assumptions about the future are either too conservative (or too
optimistic) an/or that you are under- (or over) spending your spending
budget.A perfect example of the importance of such a pattern
outside of Household retirement financing is Social Security financing.
When the system was last significantly amended (reformed) in 1983, the
system’s long-range funded status was 100%. Since that time, the
system’s funded status has fairly consistently deteriorated until it is
slightly less than 80% today, with the expectation of even greater
future deterioration. This is a clear indication that the assumptions
used to determine the system’s Funded Status are too optimistic.In
addition to indicating that assumptions may be too optimistic or too
conservative, the trend of a system’s funded status may also signal when
it is time to make changes in the system’s financing. For Social
Security, for example, this signal has been sounding loudly since the
1990s, but Congress has failed to act. Unlike Congress, individual
households can ill afford to wait decades to make changes to their
financial plans to bring them back into balance.