Why are portfolio withdrawals lower than expected in a joint plan with cash flows that change when a spouse dies?

A joint plan with cash flows that change when one or the other spouse dies contains a special kind of mortality risk: the risk that one spouse will die before the plan ends and the non-portfolio income that the surviving spouse receives will go down - perhaps by a lot.

EXAMPLE 1: Single-Life Pension

Imagine that a household has a $1 million portfolio and that, if we included only the $1 million portfolio in the plan, this couple could take almost $3600/month from the portfolio.

But one spouse also has a $3000/month inflation-adjusted single-life pension.

Surprisingly, when we add this pension to the plan, instead of seeing $3000 (the pension) + $3600 (the withdrawals) = $6600, the plan proposes $6100, with only $3100 in monthly withdrawals.

Where did the $500/month in withdrawals go? In this case, withdrawals are lower in order to cover the mortality risk associated with the single-life pension. If the pension-earner dies, the surviving spouse will be left without that $3000/month income stream, so the software is telling the couple that about $500/month needs to be set aside to cover that risk and allow the surviving spouse not to have to absorb the full loss of that income stream.

Essentially, the plan doesn't "give full credit" for the pension because it very well may not be there throughout the plan. If the plan assumed it were there and allowed for $6600/month in spending, the couple would be taking on more risk than they think they are. This is one of the interesting cases where planning for a long life can actually lead a plan to be overly aggressive.

If this were a joint-life pension instead of a single-life pension, the plan would indeed have $3000 (the pension) + $3600 (the withdrawals) = $6600 in monthly income.

EXAMPLE 2: Social Security

Let's assume that, instead of a single-life pension, the same couple had a total of $5000/month in Social Security, where one spouse receives $3000/month and the other $2000/month. In this case, if either spouse dies, the surviving spouse would receive $3000/month, either as their own benefit or as a survivor benefit. So $2000/month would be lost on either death. Again, when we add these cash flows, we don't get the expected $5000 (Social Security) + $3600 (withdrawals) = $8600, but instead about $8000/month. Here we see a $600/month reduction in withdrawals is due to the mortality risk that both spouses carry due to the couple's total Social Security being adjusted if either spouse dies.

How Mortality Adjustments Work
In order to adjust for the chances that one or the other spouse does not survive until the end of the plan (and so the non-portfolio cash flows are not received in full through the end of the plan), when calculating spending capacity and other plan amounts, the software adjusts mortality-sensitive cash flows for the chances that each person is alive at the point in the plan.

For example, for the single-life pension example above, the plan doesn't assume that $3000/month will dependably arrive each month. Instead, it assumes that $3000 will arrive this month, but it adjusts this assumption for future months. For example, 10 years from now, given the pension-owner's age and sex, it gives the plan credit for only 88% of that amount ($2630), because there is an 88% chance that the pension-owner is still alive at that point.

For the Social Security example, the math is more complex, because the total mortality-adjusted Social Security is a combination of:

• The amount to be received if both spouses are alive (times the chances that both are still live), plus
• The amount received if only spouse A is alive (times the chances that only spouse A is alive), plus
• The amount received if only spouse B is alive (times the chances that only spouse B is alive).

But the result is the same - a plan that doesn't overstate future non-portfolio income and so avoids overstating currently available income.

How can I Remove Mortality Adjustments?

If you would like to remove mortality adjustments from a plan, simply set a non-portfolio cash flow to "End at second spouse's death" and ensure that the "Amount after death of X" values are the same:

This will produce a plan in which the full $3000/month is assumed to be available throughout the plan. If, in fact, this is a single-life pension, this will effectively produce a plan in which the surviving spouse will plan to take a $3000/month pay cut upon the death of the pension earner.

For Social Security, if you'd like to turn off mortality adjustments, you'll have to unselect "Calculate and Include Benefits" on the Social Security tab (and therefore turn off automatic Social Security calculations) and include these income streams instead in the "Other Income" section, being sure to choose "Social Security" as the Tax Treatment.

Inflation

All of the examples in this article include non-portfolio cash flows that are adjusted for inflation. If a plan contained cash flows that are not adjusted for inflation or had a fixed annual cost-of-living adjustment, the portfolio withdrawals would be (even) lower in order to offset inflation risk.

It is possible to have a plan that is affected by both inflation risk and mortality risk, and so to see portfolio withdrawals that are lower than expected due to both of these factors. Please see Why are portfolio withdrawals lower than expected in a plan with a non-portfolio income source that is not adjusted for inflation? for more on portfolio withdrawals and inflation risk.