How Much Can I Afford to Spend in Retirement?: Actuaries Live for Mortality

In this weekend’s
Kitces.com Weekend Reading for Financial Planners (July 5-6), Adam Van
Deusen discusses three articles concerning the importance of selecting
reasonable lifetime planning period assumptions when decumulation
planning, as well as stress-testing these assumptions when measuring
longevity and mortality risks. He says,

“Ultimately, the key point
is that creating a plan based on how long a client will live is most
effective when both mortality and longevity risk factors are considered.
Actuarial science offers tools that can help advisors assess these
considerations so that they can adjust mortality assumptions and
longevity expectations as part of an ongoing process of monitoring and
updating a plan. And by making these adjustments collaboratively and
regularly, advisors can help clients develop a relevant and realistic
strategy to manage their mortality and longevity risks as they journey
into retirement!”

We
totally agree with Mr. Van Deusen, and in this post, we will highlight
the mortality/longevity related actuarial tools in our “Actuarial
Approach” website that can be of value to advisors and their clients.

Before
we jump into discussion of the Actuarial Approach and why advisors and
DIYers might want to use it, we want to thank Mr. Van Deusen for again
pointing out that “One of the most common (and valuable) services
financial advisors offer their clients is helping them determine how
much they can sustainably spend in retirement” (pretty much the name of
our website). In addition, Mr. Van Deusen reminds us that decumulation
planning is an ongoing process, not a one-and-done stochastic projection.

Assumed Lifetime Planning Periods in the Actuarial Financial Planners

The
default lifetime planning period (LPP) assumptions in the Actuarial
Financial Planners available in our website are based on the 2022
Actuaries Longevity Illustrator (ALI) Planning Horizon Chart; 25% chance
of survival for non-smokers in excellent health. Default “Either Alive”
and “Both Alive” LPPs (which are used in our Retired Couples
spreadsheet to develop present values for inputted lifetime expenses for
couples as discussed below) have been approximated based on simplified
algorithms.

The
25% probability of survival is more conservative than the 50%
probability of survival (more commonly referred to as the life
expectancy), and is generally 5 or 6 years longer than the 50%
probability of survival, so assumed ages at death are usually around 94
for males and 96 for females who are currently in their 60s.

The
LPP assumptions are based on inputted ages, so as users age from year to
year, these assumptions automatically change and generally the assumed
age at death will increase gradually as users age. 

The LPP
assumptions may be overridden by using the assumption override process
described in the model. This feature can be used to stress-test the LPP
assumptions (for example, by assuming one of the couples dies this year)
or by simply making them more or less conservative. Some of our
readers, for example, plan on living until 100. 

Recent research
has shown that individuals with higher levels of income have longer life
expectancies. To some extent, this research has already been built into
the ALI data, but again, the default assumptions can be overridden if
advisors believe this is appropriate for their higher income clients.

As
noted in the first article discussed by Mr. Van Deusen (and many
others), it is generally unwise to plan on living “only” to one’s life
expectancy. Our default LPP assumptions are consistent with this general
consensus and have been for years.

Present Value of Expense Determinations for Couples.

Both
members of a married couple will generally not die at the same time, so
realistic modeling of future expenses for a household should anticipate
periods of time after the passing of the first member of the couple to
die. The AFP for Retired Couples uses default assumptions (based on
information from the Actuaries Lifetime Illustrator) for periods when
both of the members are probably alive (Both Alive) and periods when
either of the members will probably be alive (Either Alive). These
periods are used in the spreadsheet, together with an input assumption
regarding the percentage decrease in the inputted expense upon the first
death within the couple (x%), to determine the present value of such
future recurring expense on a joint with (1- x%) continuation to the
last survivor basis. This approach is more accurate than simply assuming
that such expenses will continue at 100% until the last death within
the couple.

Investment Implications of Assuming Longer Lifetime Planning Periods

Advisors
and DIYers should note that assuming longer-than-life-expectancy
lifetime planning periods does not just affect expense liabilities. It
will also affect assets and investments that are payable for life. For
example, it may make deferring Social Security commencement age until 70
and purchase of a lifetime annuity contract to be more attractive. In
fact, it is not unusual for the modeling of such events to increase the
present value of a household’s assets, and thus increasing their Funded
Status. Generally, the longer one assumes they will live for planning
purposes, the greater the return will be on purchasing lifetime income
or deferring commencement of Social Security (until a maximum of age
70).

Summary

As noted by Mr. Van Deusen in
his Kitces.com post this weekend, actuarial tools can be quite useful in
helping retired households determine how much they can afford to spend
in retirement. We encourage advisors and DIYers to make full use of the
actuarial tools in our website.