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At retirement individuals relinquish a steady stream of employment earnings and enter a phase where they will rely upon the assets they have accumulated to finance the rest of their lives. Retirement spend down refers to the strategy a retiree follows to spend down, or decumulate, assets during retirement. Retirement planning aims to prepare individuals for retirement spend down because the alternative spend down approaches available to retirees depend heavily on decisions they make during their working years. Actuaries and financial planners are experts on this topic.
More than 10,000 Post-World War II baby boomers will retire every day between now and 2027.[1] This represents the majority of the more than 78 million Americans that comprise this generation – those born between 1946 and 1964. 74% of these people are expected to be alive in 2030, which highlights that most of them will live for many years beyond retirement.[2] The following statistics emphasize the importance of a well-planned retirement spend down strategy for these people:
Individuals each have their own retirement aspirations, but all retirees face longevity risk – the risk of outliving their assets. This can spell financial disaster. Avoiding this risk is therefore a baseline goal that any successful retirement spend down strategy addresses. Generally, longevity risk is greatest for low and middle income individuals.
The probabilities of a 65-year old living to various ages are:[6]
| Probability | Male | Female |
|---|---|---|
| 75% | 78 | 81 |
| 50% | 85 | 88 |
| 25% | 91 | 93 |
Longevity risk is largely underestimated. Most retirees do not expect to live beyond age 85, let alone into their 90s. A study of recently retired individuals asked them to rank the following risks in order of the level of concern they present:[7]
Longevity risk was ranked as the least concerning of these risks.
Individuals may receive retirement income from a variety of sources:
Each has unique risk, eligibility, tax, timing, form of payment, and distribution considerations that should be integrated into a retirement spend down strategy.
Traditional retirement spend down approaches generally take the form of a gap analysis. Essentially, these tools collect a variety of input variables from an individual and use them to project the likelihood that the individual will meet specified retirement goals. They model the shortfall or surplus between the individual’s retirement income and expected spending needs to identify whether the individual has adequate resources to retire at a particular age. Depending on their sophistication, they may be stochastic (often incorporating Monte Carlo simulation) or deterministic.
Standard input variables
Additional input variables that can enhance model sophistication
Output
There are three primary approaches utilized to estimate an individual’s spending needs in retirement:
Market volatility can have a significant impact on both a worker’s retirement preparedness and a retiree’s retirement spend down strategy. The global financial crisis of 2008–2009 provides an example. American workers lost an estimated $2 trillion in retirement savings during this time frame.[10] 54% of workers lost confidence in their ability to retire comfortably due the direct impact of the market turmoil on their retirement savings.[3]
Asset allocation contributed significantly to these issues. Basic investment principles recommend that individuals reduce their equity investment exposure as they approach retirement. Studies show, however, that 43% of 401(k) participants had equity exposure in excess of 70% at the beginning of 2008.[11]
Longevity risk becomes more of a concern for individuals when their retirement savings are depleted by asset losses. Following the market downturn of 2008-2009, 61% of working baby boomers are concerned about outliving their retirement assets.[12] Traditional spend down approaches generally recommend three ways they can attempt to address this risk:
Saving more and investing more aggressively are difficult strategies for many individuals to implement due to constraints imposed by current expenses or an aversion to increased risk. Most individuals also are averse to lowering their standard of living. The closer individuals are to retirement, the more drastic these measures must be for them to have a significant impact on the individuals’ retirement savings or spend down strategies.
Individuals tend to have significantly more control over their retirement ages than they do over their savings rates, asset returns, or expenses. As a result, postponing retirement can be an attractive option for individuals looking to enhance their retirement preparedness or recover from investment losses. The relative impact that delaying retirement can have on an individual's retirement spend down is dependent upon specific circumstances, but research has shown that delaying retirement from age 62 to age 66 can increase an average worker’s retirement income by 33%.[13]
Postponing retirement minimizes the probability of running out of retirement savings in several ways:
Studies show that nearly half of all workers expect to delay their retirement because they have accumulated fewer retirement assets than they had planned.[10] Much of this is attributable to the market downturn of 2008–2009. Various unforeseen circumstances cause nearly half of all workers to retire earlier than they intend.[3] In many cases, these individuals intend to work part-time during retirement. Again, however, statistics show that this is far less common than intentions would suggest.[3]
The appeal of retirement age flexibility is the focal point of an actuarial approach to retirement spend down that has spawned in response to the surge of baby boomers approaching retirement. The approach is based on a supply and demand model where supply and demand represent the following, which vary across different retirement ages:
Under this approach, individuals can specify a desired probability of retirement spend down success. Unlike traditional spend down approaches, retirement age is an output. It is identified by the intersection of the supply and demand curves. This framework allows individuals to quantify the impact of any adjustments to their financial circumstances on their optimal retirement age.
Most approaches to retirement spend down can be likened to individual asset/liability modeling. Regardless of the strategy employed, they seek to ensure that individuals’ assets available for retirement are sufficient to fund their post-retirement liabilities and expenses.