In discussing strategies to evaluate the financial health of a retirement plan, Wade Pfau cautioned against using a higher interest rate assumption to inflate the funded ratio, as it could lead to a lower likelihood of success. Pfau mentioned the importance of increasing assets or reducing retirement liabilities to improve the funded ratio, suggesting adjustments to expenses or legacy goals.
Pfau explained that a funded ratio of 100% or above signifies a well-prepared retirement plan, while a ratio below 100% offers room for improvement through various actions. The funded ratio concept mirrors the evaluation methods of government and corporate pension plans in ensuring adequate coverage for pension benefits.
Pfau recommended a conservative rate of return for calculating the funded ratio and outlined a three-step framework for assessing retirement readiness. This strategy involves determining financial goals related to longevity, lifestyle, legacy, and liquidity, followed by evaluating available retirement assets and estimating future expenses to fund retirement objectives effectively.
Pfau emphasized the importance of setting realistic assumptions and monitoring the funded ratio regularly to align with financial goals. He advised adapting spending based on fluctuations in the funded ratio caused by market conditions, suggesting adjustments to maintain financial stability during retirement.
In estimating retirement expenses, Pfau highlighted the significance of understanding pre-retirement costs and categorizing retirement assets into reliable income sources, investment portfolios, and reserves for unexpected expenses. While acknowledging common rules of thumb, Pfau cautioned against solely relying on them and encouraged a personalized budget-based approach for effective retirement planning.
Addressing risks associated with retirement, Pfau stressed the need to manage longevity risk by planning for a longer lifespan and considering strategies like delaying Social Security benefits and utilizing risk-pooling products. He also discussed the variations in spending patterns during different stages of retirement, emphasizing the importance of adjusting expenses to match income levels and increase the chances of a successful retirement.