An Actuarial Process for Better Decisions in Retirement

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Incorporating actuarial methodology and the popular floor-and-upside approach to financial planning, I show how advisors can help their retired (or soon-to-be retired) clients make better financial decisions.

This article is a follow-up to my previous Advisor Perspectives articles, Think Like an Actuary to Become a Better Advisor and Better Budgeting with an Actuarial Approach, which encouraged financial advisors to use the actuarial approach to help clients determine how much they can afford to spend each year in retirement and to make other personal financial decisions. If you are unfamiliar with the actuarial approach, I suggest that you read one (or more) of my prior Advisor Perspectives articles or visit my website. I provide free education about the application of the same basic actuarial principles I used as a consulting pension actuary to help plan sponsors determine plan contributions to help individuals, couples and their financial advisors develop reasonable annual spending budgets. I also provide (free) Excel workbooks that may be downloaded for this purpose.

Inspiration for this article comes from the sage advice contained in two Forbes articles by Dirk Cotton, Negotiating the Fog of Retirement Uncertainty and Honey, What’s Our Retirement Plan? In those articles, Cotton discussed how much of one’s retirement resources might be allocated to what he refers to as “floor” and “upside” portfolios. According to Cotton, a floor portfolio is funded primarily by non-risky assets (i.e., Social Security, pensions, annuities and bond ladders) and is designed to provide a safe lifetime income to fund essential expenses, while the remaining assets (the “upside” portfolio) are funded primarily by risky assets to support future discretionary expenses.

Cotton stated, “The most important decision you will make in retirement planning is how much of your resources to allocate to the upside and floor portfolios.” He noted, “The correct balance will depend on how willing you are to risk losing your standard of living for the chance of having an even higher one.” His advice: “The less confident we are in our upside portfolio's ability to deliver on its promises, the more we should allocate to the safe floor portfolio. Finally, he concluded, “Many retirees and even some planners seem to be massively overconfident in upside-portfolio spending rules.”