"4% is too low." How much will you leave on the table?

[2B]

For the last 3 years of his life, my FIL financially "lived" almost entirely on his SS and military pension. Both were COLAd unlike a small pension/annuity he also had from his civilian career. His original pension may have been meaningful in 1985 (or so) when he retired but it was irrelevant in 2011. COLA is the key.

His "living" expenses were entirely what was paid to the nursing facility where he spent his final years. He had annual portfolio withdrawals of less than $10,000 not including his and his wife's funeral expenses.

 

[militaryman]

Hope to leave some on the table --

Proverbs 13:22a

A good person leaves an inheritance for their children’s children..

 

[RetireBy90]

70-some posts later, it's interesting how some of you think you'll end up poor... and a few of you think you'll end up penniless.

One advantage of annuitizing a portion of the portfolio is that you've hedged your longevity risk. Yeah, assuming the insurance company pays off. And assuming Social Security is still there. And assuming that a Greek butterfly flapping its wings doesn't cause hurricanes in Hawaii. And a bunch of other peripheral risk factors.

Thanks for the prose to explain this point. I composed several replies to point out that if you unnuitize a base level then you don't need to worry about going hungry or not being able to pay the rent and utilities. I never was happy with the way they turned out so never hit the submit key.

One other point - hopefully it will come out right here - to many the difference between a low SWR and 6% could be the difference between paying the bills and doing some of the things you always put off till RE, like a trip to Australia or a trip to X. Or it could mean a trip once a year to visit the grandkids. It isn't always a Beemer vs a 10yr old used car, and not always just a waste of $$.

Many of the folks set to retire in the next 20 or 30 years won't have enough at 3-4% draw to live out any dreams and some won't be able to retire at all, taking part time jobs to make ends meet. Many recent articles have profiled folks that took at hit from medical bills, loosing a job, or other setbacks that have them set to work till they die.

My main point is the security of a guarenteed income from annunity, cola'd pension, rental property, or otherwise. Thanks Nord for making that point.

 

[Gone4Good]

70-some posts later, it's interesting how some of you think you'll end up poor... and a few of you think you'll end up penniless.

So you'd think we'd have more support for annuitization and that the study would be more warmly received.

I imagine part of the negative reaction is driven by how the study is marketed rather than what it actually implies. It's certainly possible to use the ideas presented here in a very prudent, and even risk reducing, way. But the lead question of "How would you like to double your retirement spending" is probably the wrong hook for most of us here. It suggests, to me at least, an element of free-lunchism that doesn't really exist. We can spend down our future expected surplus only by increasing the liklihood that we'll spend some time living on the bare bones budget we designed for ourselves decades earlier, under more comfortable circumstances. That may be a worthwhile tradeoff, but it is still a tradeoff and one that often gets undersold in the marketing. That is especially true under current market conditions where those expected future surpluses could very well be smaller than many people hope, and backcast or Monte Carlo analysis suggest.

None of this invalidates the research or means it isn't usefull. It just suggests that maybe a more cautious approach is needed when constructing a retirement strategy intending to spend down future dollars we don't yet, and may never, have.

As with anything that sounds too good to be true, schemes to "Double your retirement spending NOW!" are best met with a healthy degree of skepticism.

 

[Running_Man]

In response to Nord's blog post above:

Again what is the cost of a cola-annuity for a couple? What I have seen is a 3.3% payout for a COLA limited to max 10% inflation increase in a given year, but I don't have much access to quotes which to me means the math does not work for this solution of increasing your retirement income when 4% withdrawal leaves too much on the table adn not enough income.

If the couple has 60K spending gap and invests in a COLA for 20K and 4% of their portfolio is not enough and a cola annuity only yields 3.3% to get 20K means 600K invested in the annuity. The couple if they had a million left had to start at 1.6 million which would have been 64K @ 4% but now to get that same level of money they would have to take 44K/1000 or 4.4% to be at the same level of income they were when they were withdrawing "too little" @ 4%. To have any meaningful increase in income puts them at increasing odds (each additional 1K per year will be additional .1% withdrawal from the portfolio) the "bare bones" budget" will become reality and I think that is not a terrific idea. But I think a form of this "research" will be embraced by financial planners, who the study was aimed at, as the way to both sell their sponsored insurance and convince unsophisticated retirees to withdraw more from their portfolio than is really suitable. For most of the people on this forum I don't think I'd see that happen.

 

[haha]

Hope to leave some on the table --

Proverbs 13:22a

A good person leaves an inheritance for their children’s children..

Thanks for this verse. Society would greatly gain if more people believed this, and if taxation did not harrass the process of trying to get to that goal.

Ha

 

[Independent]

I never really understand the feeling that we should increase our spending on silly things so as to not leave money on the table when we die. There is a simple way to spend every dollar of your fortune. It's called a will. I know I won't have any regrets dying with a small fortune that ends up doing tremendous good in the world. It's certainly not an outcome I worry about. Nor one I want to take extra risks to avoid.

Good point. I think that's one of the reasons many of us are comfortable being "too cautious". I don't list an explicit estate goal in my plan. BUT, I know that it won't bother me a lot if my kids or grandkids get a nice check after I die. If nothing else, I can think of it as a refund of the SS taxes they paid while I was retired.

 

[Midpack]

But the solution to this multi-variable problem is somewhere among the parameters of a bare-bones budget, an annuity to cover that budget, an ER portfolio (with a suitable asset allocation) to cover the rest, and a plan to reduce spending if the market has a down year. Consider it the design criteria for FIRECalc v2013-- simulating not only variation in market returns but variation in portfolio spending.

To the point quoted above, doesn't FIRECALC come close to allowing all these variables already? If for example you have $1M and you want to spend $40K/yr and need $30K/yr for bare bones would you not:

• Input on tab 1, spending $30,000 and portfolio of $1M - cost of a $10K/yr annuity using an actual current quote.
• Input on tab 2, pension income of $10,000 with inflation adjusted checked/unchecked matching the actual quote.
• Input on tab 4 (and this is where I suspect FIRECALC may come up short on options), choose Bernicke's Reality Retirement Plan or Percentage of Remaining Portfolio.
• And you can play with AA on tab 5 to some extent as well.

I've done some of this using various percentages of annuitization for the insights, assuming the results are correct...

 

[Gone4Good]

Again what is the cost of a cola-annuity for a couple? What I have seen is a 3.3% payout for a COLA limited to max 10% inflation increase in a given year, but I don't have much access to quotes which to me means the math does not work for this solution of increasing your retirement income when 4% withdrawal leaves too much on the table adn not enough income.

That is my intuition as well, although I haven't put pen to paper to try to figure it out. It seems the article assumes folks already have a COLA'd pension of some sort, like Nord's military constituents or someone with SS (which is basically everyone of a certain age).

Not addressed in the article is the cost of a COLA'd annuity for someone who wants to buy one. How big a hit the portfolio takes up front to buy this insurance is a pretty important consideration. And right now, that cost is pretty high. My strong suspicion is that payouts for early retirees might be quite a bit lower than 3.3%. At current TIPS yields, 3.3% basically gets you 30 years of payouts at relatively low inflation levels with nothing left over for the insurance company. My guess is that a 55 or 60 year old will be looking at payouts with a "two handle" in front. Trying to get to a 7% or 8% withdrawal rate when a big slug of the portfolio is throwing off less than 3% probably doesn't work.

 

[Animorph]

That is my intuition as well, although I haven't put pen to paper to try to figure it out. It seems the article assumes folks already have a COLA'd pension of some sort, like Nord's military constituents or someone with SS (which is basically everyone of a certain age).

Not addressed in the article is the cost of a COLA'd annuity for someone who wants to buy one. How big a hit the portfolio takes up front to buy this insurance is a pretty important consideration. And right now, that cost is pretty high. My strong suspicion is that payouts for early retirees might be quite a bit lower than 3.3%. At current TIPS yields, 3.3% basically gets you 30 years of payouts at relatively low inflation levels with nothing left over for the insurance company. My guess is that a 55 or 60 year old will be looking at payouts with a "two handle" in front. Trying to get to a 7% or 8% withdrawal rate when a big slug of the portfolio is throwing off less than 3% probably doesn't work.

One easy starting place would be starting Soc Sec at 70 instead of earlier. Many people have that option.

 

[Chuckanut]

From Wade Pfau's 4/11/2012 blog:

I think the real lesson from this exercise is that using a 4% withdrawal rate from a portfolio of risky assets is not as safe as the historical outcomes would lead us to believe.

Read the entire blog here: Pensions, Retirement Planning, and Economics Blog: Safe Withdrawal Rates and Retirement Date Market Conditions

 

[jdw_fire]

That is my intuition as well, although I haven't put pen to paper to try to figure it out. It seems the article assumes folks already have a COLA'd pension of some sort, like Nord's military constituents or someone with SS (which is basically everyone of a certain age).

Not addressed in the article is the cost of a COLA'd annuity for someone who wants to buy one. How big a hit the portfolio takes up front to buy this insurance is a pretty important consideration. And right now, that cost is pretty high. My strong suspicion is that payouts for early retirees might be quite a bit lower than 3.3%. At current TIPS yields, 3.3% basically gets you 30 years of payouts at relatively low inflation levels with nothing left over for the insurance company. My guess is that a 55 or 60 year old will be looking at payouts with a "two handle" in front. Trying to get to a 7% or 8% withdrawal rate when a big slug of the portfolio is throwing off less than 3% probably doesn't work.

ok, lets take a closer look at what conservative ERees are doing. from reading this board, people are talking about using a WR (hoping it is a SWR) of 2-3%. it has also been suggested here many times (i remember suggesting it prior to the crash) that a bare bones retirement budget be determined. so lets assume that our retiree has done both. now, just to help with the visualization, let me put some numbers to it (and to simplify the example, lets assume no pension/annuity/SS). lets assume that this retiree has decided that a 2% WR is safe (this example would be just as valid if she decides on 3%) and that she has a $2M portfolio. if she used the normal method of determining an annual WD simple math produces an annual spend of $40K/yr (real). now this retiree had also determined that her bare bones retirement spend amount is $20k/yr (real). however she would like to spend more in retirement so (and i suggested this earlier in another thread) my thought is that she splits her portfolio into 2 parts of $1M each and has them in 2 different brokerages. she invests part 1 reasonably conservatively and uses a 2% WR to get her bare bones amount of $20K/yr (real). this part looks alot like a COLAed annuity because the very low WR makes it extremely unlikely that part 1 will ever be depleted. however she decides (after reading the article we are commenting on) to use a 5% WR with part 2, which is invested reasonably (maybe 70/30, but exactly how this part is invested isn't the point). since part 2 is using a 5% WR it has a reasonable chance of surviving but is not as high as part 1. doing this has raised the total WD by 75%. granted, part 2 of her portfolio is at risk of running out but if it declines, she can adjust its WD without changing her bare bones portfolio/WD. by splitting her portfolio, she has created an annuity like entity (part 1 of her portfolio) for reducing longevity risk while still increasing her spending and leaving less in her estate when she dies.

now i am sure someone will say something like "that is the same thing as having a 3.5% WR" but i am suggesting that it is safer than a 3.5% WR because the 2 parts of the portfolio are treated differently and part 1 should never be depleted. this is a mindset change from the well discussed single WR approach and in essence creates an annuity for those people who don't want to buy 1 from an insurance company.

 

[obgyn65]

Very interesting thread. Good point below, Nords. These are two of the reasons why I have started to annuitize some of my savings. I do not intend to annuitize more than $200k-$300k (State limit) until I reach 62 though.

One advantage of annuitizing a portion of the portfolio is that you've hedged your longevity risk. Yeah, assuming the insurance company pays off. And assuming Social Security is still there. (...)
Another advantage of annuitizing a portion of the portfolio is that you can choose a more aggressive asset allocation with the rest of the portfolio.

 

[Major Tom]

Very interesting thread. Good point below, Nords. These are two of the reasons why I have started to annuitize some of my savings. I do not intend to annuitize more than $200k-$300k (State limit) until I reach 62 though.

I'm a little confused Obgyn. I thought that your entire portfolio was invested in municipal bonds and CD's? Perhaps I'm remembering it incorrectly, but I recall many posts in which you stated that you were too risk averse to invest in equities and instead had all your money in fixed income. If this is the case, why would you want to annuitize part of your portfolio in order to take a more aggressive approach with the remainder?

I don't wish to sound combative. I am genuinely curious.

 

[obgyn65]

Thank you for your question, Major Tom. I apologize if my past posts have been confusing to you. I mentioned in the past since I joined this website that my entire portfolio included CDs, Munis and equivalent. This is true. However, very recently (see my recent posts from about a month ago http://www.early-retirement.org/forums/f28/plan-b-annuity-approach-60435.html and http://www.early-retirement.org/for...nnuitized-do-you-plan-to-annuitize-59590.html), I have started to annuitize some of my money. Deferred annuities only. I am in my late 40s now, the results in my Excel spreadsheet have a significantly improved SWR if I annuitize some of my savings (say 5-10%) until the age of 62. I do not consider annuities a "more aggressive approach" - to me, annuities are not an investment. They only buy peace of mind.

I'm a little confused Obgyn. I thought that your entire portfolio was invested in municipal bonds and CD's? Perhaps I'm remembering it incorrectly, but I recall many posts in which you stated that you were too risk averse to invest in equities and instead had all your money in fixed income. If this is the case, why would you want to annuitize part of your portfolio in order to take a more aggressive approach with the remainder?

I don't wish to sound combative. I am genuinely curious.

 

[clifp]

I think hand in hand with calculation of how much to annuitize is when to get the annuity.

Right now it looks like if you were 65 a $500K annuity would get you $22,300 with a light COLA. Combine this with waiting until 66/67 or preferable 70 for SS and you have a base income in the 45-50K range and you could easily go ahead with a 6% SWR.

Unfortunately doing this at 55 gets you only $14,700 with today's lousy interest rates.
Since this represents <3% SWR I guess I'd rather take my chances that I can just sustain a 3-3.5% investing on my own rather than turning over the money over to insurance company and hope they do a better job. This situation certainly can change in 10-15 years and I suspect that I'll be more likely to be less actively involved in investing.

Never the less from my prospective the best annuity out there right now is delaying SS until 70 so that is my plan A.

 

[obgyn65]

All good points, clifp. However, you may be talking about SPIAs or variable annuities. I am talking about deferred annuities. Giving $10k in premium to the insurance company (say Metlife, NYL, etc.) today in my late 40s means about $1k a month in payments when I reach 85. Can't beat this deal IMO (but again, I am not a finance person).

I think hand in hand with calculation of how much to annuitize is when to get the annuity.

Right now it looks like if you were 65 a $500K annuity would get you $22,300 with a light COLA. Combine this with waiting until 66/67 or preferable 70 for SS and you have a base income in the 45-50K range and you could easily go ahead with a 6% SWR.

Unfortunately doing this at 55 gets you only $14,700 with today's lousy interest rates.
Since this represents <3% SWR I guess I'd rather take my chances that I can just sustain a 3-3.5% investing on my own rather than turning over the money over to insurance company and hope they do a better job. This situation certainly can change in 10-15 years and I suspect that I'll be more likely to be less actively involved in investing.

Never the less from my prospective the best annuity out there right now is delaying SS until 70 so that is my plan A.

 

[clifp]

All good points, clifp. However, you may be talking about SPIAs or variable annuities. I am talking about deferred annuities. Giving $10k in premium to the insurance company (say Metlife, NYL, etc.) today in my late 40s means about $1k a month in payments when I reach 85. Can't beat this deal IMO (but again, I am not a finance person).

You are correct I was referring to SPIAs. Interestingly enough I was reading a recent article about longevity insurance and thinking about them as alternative to an SPIA. (I am not sure that there is a difference between a deferred annuity and longevity insurance can anyone explain the pro and cons.)

At the end of the day we are all trying to solve the same problem how do you keep from running out of money in your old age while not depriving yourself too much today.

One approach is to establish a minimum income as Wade and Nords suggest. Another is to establish a maximum length of time my portfolio needs to last is by getting a deferred annuity. A 55 year old with a deferred annuity that kicks in after age 85 knows that his portfolio needs to last no more than 30 years. If you want to be ultra conservative you can purchase 30 year ladder of TIPs bonds and get withdrawal rate of ~3.75% (3.33% is by spending the capital) the hitch is that at age 85 you are out of money, but not income.

The practical advantage of a deferred annuity for me is at 85, I realize there is a good chance my mental facility are diminished, so I'll vulnerable to attacks by financial sharks. But they won't be able to touch my annuity.

 

[Gone4Good]

now i am sure someone will say something like "that is the same thing as having a 3.5% WR" but i am suggesting that it is safer than a 3.5% WR because the 2 parts of the portfolio are treated differently and part 1 should never be depleted. this is a mindset change from the well discussed single WR approach and in essence creates an annuity for those people who don't want to buy 1 from an insurance company.

We agree that this isn't identical to a 3.5% WR from a more aggressively constructed portfolio, but neither is it identical to the 2% WR scheme we started with.

What we've done is taken someone who is drawing a very conservative $40K and raised their draw to $70K by increasing the likelihood they'll have to cut their spending to $20K. Whether this is an improvement is highly subjective. I kind of think it's not, but I'm also certain that others will come to different conclusions. Like I said earlier, identifying and understanding the tradeoffs are very important. There are no free lunches.

And while we're talking about tradeoffs, your plan has one even relative to the typical 3.5% WR from a single portfolio. What happens in a split portfolio with different equity allocations is that the equity allocation of our combined portfolio changes as asset prices change. As equity prices rise, the combined portfolio gets more agressive and as equity prices fall it gets more conservative. That is opposite how most of us would ideally choose to invest, and probably has negative implications for risk and return relative to a rebalanced single portfolio. So while it is true that your approach buys a measure of safety relative to the traditional approach, it does so at a cost. To understand whether the benefits are worth the price, we have to understand both.

 

[Midpack]

I think hand in hand with calculation of how much to annuitize is when to get the annuity.

Right now it looks like if you were 65 a $500K annuity would get you $22,300 with a light COLA. Combine this with waiting until 66/67 or preferable 70 for SS and you have a base income in the 45-50K range and you could easily go ahead with a 6% SWR.

Unfortunately doing this at 55 gets you only $14,700 with today's lousy interest rates.
Since this represents <3% SWR I guess I'd rather take my chances that I can just sustain a 3-3.5% investing on my own rather than turning over the money over to insurance company and hope they do a better job. This situation certainly can change in 10-15 years and I suspect that I'll be more likely to be less actively involved in investing.

Never the less from my prospective the best annuity out there right now is delaying SS until 70 so that is my plan A.

+1. Annuitization can be a good strategy, but now is not the time to do it if you can avoid it. However, some people can't push the decision off, too close to annuitization hurdle or equivalent...

 

[Gone4Good]

The practical advantage of a deferred annuity for me is at 85, I realize there is a good chance my mental facility are diminished, so I'll vulnerable to attacks by financial sharks. But they won't be able to touch my annuity.

Sound advice.

One of the risks we often overlook while constructing complicated portfolios with non-correlated assets strategically siloed in multiple buckets from which we draw down according to variable spending algorithms is that many of us will someday lack the capacity to manage all of this effectively.