RFI User Guide: Set-Asides


RFI Set-Asides


When you define a scenario involving a deferred annuity in RFI (see RFI Fundamentals for guidance on setting up a basic scenario), the system assumes (by default) that all financial assets are depleted at the end of the annuity deferment period. For retirees who are uncomfortable with the idea of using up all their liquid assets at a relatively early phase of retirement, RFI allows you to specify a "set-aside".  (Read more about the importance of set-asides in Another Desirable Feature of a Retirement Plan: a Set-Aside.)

The amount of the set-aside is treated as a separate account that earns a return equal to the "rate that materializes" for the scenario, and is not available for use in computing the optimal purchase price of the annuity.

The example below first shows the definition of 3 scenarios which are identical except for the amount of the set-aside; Scenario 1 has no set-aside, Scenario 2 has a $200,000 set-aside, and Scenario 3 has a $400,000 set-aside (the total financial assets on all cases is $1,000,000.

When all 3 scenarios are calculated we get the monthly spendable fund chart below.  Notice that Scenario 1 has the highest spendable funds; this is because the entire $1,000,000 in financial assets is available for purchase of the 10 year deferred annuity and drawdowns during the deferment period.


The chart below shows financial asset balances for the 3 scenarios. One again notice that on Scenario 1 the financial asset balance goes to zero at the end of 10 years; RFI has allocated the entire $1,000,000 to the purchase of the annuity plus funds necessary to provide spendable funds during the deferment period.  On Scenarios 2 and 3, the initial value of the set-aside continues to grow leaving a balance in the retiree's estate.

In the 3 scenarios defined above, we used 6% for both the "Assumed Rate of Return" and the "Rate that Materializes".  It is interesting to use the concepts in Downside Risk Analysis to see what happens in a "bad case" scenario where the rate that materializes is less than the assumed rate; in this example we change the Rate that Materializes in all 3 scenarios to  3%.  Recalculating all 3 scenarios we get the following spendable funds chart:

Notice that on all 3 scenarios there are insufficient financial assets (due to the reduced rate of return) to continue the constantly increasing spendable funds pattern during the 10 year annuity deferment period. Hence, RFI automatically reduces the spendable funds each year to reflect the reduced financial asset balances.

However, RFI also has an option to draw from the set-aside balance in order to make up the shortfall caused by a bad case return scenario. To illustrate how this works, lets simplify our scenario definition to include two similar scenarios; the only difference between the two is that Scenario has the box checked in the "Financial Asset Set-Aside" column, as follows:

Checking this box tells RFI to use the set-aside (which grows at the "Rate that Materializes") to make up any shortfall that results from the "bad" rate scenario.  When calculated, these two scenarios look like the following chart:

The green line in Scenario 2 (with the box checked) has a constant annual increase in spendable funds because RFI computes the amount of the shortfall (i.e. in Scenario 1) and draws from the set-aside to make up the difference. If the box is checked RFI will continue to draw from the set-aside balance until it is either depleted or the annuity deferment period is over.

Note that you can always see projected asset balances by viewing the second chart in RFI; you can also view more details by using the interactive chart capability of RFI (as described in RFI Fundamentals) as shown below:


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