How other/variable expenses work and how they can add risk

An Income Lab plan does not require any expenses. (Instead, it can just build a plan using the household's resources to figure out how much they can spend.) However, most complete plans will include at least some baseline and/or other/variable expenses.

While baseline expenses do not affect the plan's retirement paycheck or spending capacity, other/variable expenses do! And so, it's important not to overload a plan with large amounts of other/variable expenses. If you do, risk can go up and the plan can start to look very strange. 

For example, let's imagine a plan with no other/variable expenses has $14,000 in monthly spending capacity. But then the advisor layers in $13,000/month of other/variable expenses. If these are inflation adjusted and run through the full plan, this will change very little about the overall spending capacity (just replacing uncategorized spending with itemized spending goals). In a way, it will look like you're just specifying how a lot of that $14,000/month will be spent. But that's not really true! Adding these other/variable expenses has actually changed the plan quite a bit. That's because other/variable expenses as treated as high-priority "gotta have it" expenses. In other words, the plan will try really really hard to hit those expenses, adjusting only the non-itemized “other spending” or excess spending capacity in the plan. In this case, there's only around $1,000 of spending that could be adjusted, because the plan is trying to hit those other/variable expenses. You can see how much of the retirement paycheck/spending capacity is not other/variable expenses by going to the “Income” dashboard for a plan, going to the view tool menu in the upper right of the screen (it looks like a radio equalizer), and toggling off the “Variable Expenses” toggle.

It's important to understand that turning off this toggle does not remove the other/variable expenses from the plan. Instead, it just removes those expenses from the total retirement paycheck shown on the dashboard. For example, if $2,000 of a $14,000 retirement paycheck was earmarked for a mortgage payment that ends in 5 years, it would be nice to be able to show that to clients either as $14,000 (including paying the mortgage) or as $12,000 (excluding the mortgage, and thus the more steady long-term amount that will be available in the plan.

Returning to our extreme plan that was overloaded with other/variable expenses, what will that mean for the plan? It could mean the guardrails could be extreme. For example, for this plan the upper guardrail went from a reasonable position (5-10% above the current balance) to tens of millions of dollars above the current balance. Why? Because it was going to take that big gain to reach a point where hitting those "gotta have it" other/variable expenses AND being able to spend more would be possible. Until then, it is all the plan could do just to hold on and hit those specified other/variable expenses. In other words, because so many other/variable expenses are in the plan, the plan is left with a very small pressure-relief valve: not much can be adjusted.

So, what to do in this case? Usually, shifting expenses to baseline will work. It's fine to want a detailed and itemized budget (some clients will like that; some won't), but it's important to prioritize. Only very important, notable, sizable, and high-priority spending should be included as other/variable expenses. Another time when an expense should be categorized as other/variable (rather than baseline) is when it is temporary or lumpy. If an expense is steady from now until the end of the plan, or if it just follows a normal income/spending path (such as the “age-based” or “retirement smile” path), you can safely leave it as a baseline expense. (Note that baseline expenses follow a plan's Income Path. So, if you are using the “Ag-Based” path, a baseline expense will follow a “smile” pattern.)