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Assets to include in Safe Withdrawal studies
Old 07-07-2002, 07:26 AM   #1
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Assets to include in Safe Withdrawal studies

We read many studies about Safe Withdrawal strategies and the percentage of assets one might begin withdrawing at retirement. 4% of assets seems to be a common value many of these studies identify as a safe withdrawal rate.

My question is this. What ASSETS should be included in the base amount when looking at one's personal situation?

I have been using the following items for an asset base to forecast reasonable yearly budgets:

1) Taxable investment accounts
2) Tax deferred investment accounts
3) NPV of pension payments through age 83
4) estimate of NPV of social security payments through age 83 (using SSA estimate and 2.5% COLA)

Does it seems reasonable to use the NPV of pension and social security as part of the asset base to establish a realistic annual income stream for retirement withdrawal?

Red
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Re: Assets to include in Safe Withdrawal studies
Old 07-07-2002, 09:54 AM   #2
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Re: Assets to include in Safe Withdrawal studies

Yes. I think it's reasonable to include the present value of your pension and Social Security benefits in the safe withdrawal calculation, if you have faith they'll be there when you retire.

Personally, I exclude Social Security benefits from my own retirement planning since I'm only 46 years old. If I get something, fine. I'll treat it like lottery winnings.

If I was 60 years old, I might be more inclined to include Social Security in my planning.

intercst
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Re: Assets to include in Safe Withdrawal studies
Old 07-07-2002, 02:33 PM   #3
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Re: Assets to include in Safe Withdrawal studies

I calculate the NPV of my military retirement and other anticipated defined benefit retirement plans for the purpose of estimating my net worth and putting a value on those streams of income, but I do not include them directly in Safe Withdrawal Rate calculations. Instead, I subtract this income from my estimate of required income in retirement. I restrict entries into SWR calculators to actual investments (current and anticipated).

I do not like to include the NPV as an asset directly in the SWR calculation for two reasons: (1) the calculation of NPV is sensitive to my estimate of the discount rate and (2) the return on this 'asset' is known with certainty and I am unable to convert it to another asset class like the rest of my retirement portfolio.

If you treat the NPV as one or more fixed income investments with a certain return(s) then you can overcome these objections, but I do not see how this adds any value to the SWR calculation. It does, however, point out how one's effective asset allocation is much more conservative than it appears from looking at the investment portfolio alone.

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Prometheuss




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Re: Assets to include in Safe Withdrawal studies
Old 07-07-2002, 05:49 PM   #4
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Re: Assets to include in Safe Withdrawal studies

Quote:
Personally, I exclude Social Security benefits from my own retirement planning since I'm only 46 years old. If I get something, fine. I'll treat it like lottery winnings.

If I was 60 years old, I might be more inclined to include Social Security in my planning.

intercst
I can appreciate that one might have doubts whether Social Security will be there when it's time to start collecting. Personally I feel reasonably confident that I can begin collecting it in 11 years (I doubt any politician has the balls to do away with this expected benefit). But again, I could be wrong.

Since my NPV estimate for Social Security is approximately 12% of the total value, I'm willing to chance it.

Anyway, at this time in my life, these forecasts for withdrawal really only provide me with a value that I can use to ballpark my yearly budgets, and not get carried away in either direction (spending way too little or spending too much).

Hopefully we all know this is not an exact science and are mostly looking for warm and fuzzys!

Red
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Re: Assets to include in Safe Withdrawal studies
Old 07-07-2002, 06:09 PM   #5
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Re: Assets to include in Safe Withdrawal studies

Quote:
If you treat the NPV as one or more fixed income investments with a certain return(s) then you can overcome these objections, but I do not see how this adds any value to the SWR calculation. It does, however, point out how one's effective asset allocation is much more conservative than it appears from looking at the investment portfolio alone.

Prometheuss
I guess I have tended to look at my pension and future social security as a asset class similar to bonds. I used a discount rate of 5.5% to calculate the NPV. A I mentioned in my post to intercst, I'm mostly looking for warm and fuzzy values right now.

It's nice to hear that others in this forum think that it "could" be reasonable to consider the NPV of current and proposed income streams in the asset base of a safe withdrawal estimate.

I suppose that as the years unfold, I will be able to see that actual assets are deviating significantly from a plan or forecast and that I should start making appropriate corrections to expenditures.

Red
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Re: Assets to include in Safe Withdrawal studies
Old 07-07-2002, 11:08 PM   #6
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Re: Assets to include in Safe Withdrawal studies

Quote:

I guess I have tended to look at my pension and future social security as a asset class similar to bonds. *I used a discount rate of 5.5% to calculate the NPV. *A I mentioned in my post to intercst, I'm mostly looking for warm and fuzzy values right now.

It's nice to hear that others in this forum think that it "could" be reasonable to consider the NPV of current and proposed income streams in the asset base of a safe withdrawal estimate.

I suppose that as the years unfold, I will be able to see that actual assets are deviating significantly from a plan or forecast and that I should start making appropriate corrections to expenditures.

Red
Let me give you an example to make my post clearer. Suppose you calculate your initial required/desired retirement income/expenses at $50,000 per year and you have an inflation adjusted pension that pays $30,000 per year. You need (or hopefully just want) an additional $20,000 per year from other retirement income sources in the first year of retirement. If 4% is your safe withdrawal rate then you need 25 x $20,000 = $500,000 in your retirement portfolio. You can calculate the PV of the $30,000 per year, add it into your $500,000 portfolio and then treat the return as a bond or fixed income return, but why bother? If 4% is your SWR, the the value of the $30,000 per year is somewhere betwen that present value ($440,304 at 5.5% for 30 years) and 25 x $30,000 = $750,000 (and that is a wide range which is part of my point), but any way you slice it you still need to save and invest the same amount to achieve your goal. I would note, also, that your upside is much better with a portfolio of $1.25 million versus a portfolio of $500,000 and an inflation adjusted pension of $30,000 per year.

I agree that warm and fuzzy values are sufficient as you set your goals and put your saving and investing plan in place. I also agree that a present value calculation gives one a reasonable estimate of the value of a pension and 5.5% is a reasonable discount rate. I also agree that pension income is best considered as a bond or fixed income asset when considering topics like risk tollerence and asset allocation. I just think that my technique is easier when doing a SWR calculation.

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Prometheuss
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Re: Assets to include in Safe Withdrawal studies
Old 07-08-2002, 03:49 AM   #7
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Re: Assets to include in Safe Withdrawal studies

Quote:
I just think that my technique is easier when doing a SWR calculation.

Regards,
Prometheuss
In retrospect, I have to agree with you 100% that adding a NPV of pensions and other expected income streams really has no value in SWR studies. In fact, since my pension has no COLA, the effect will add more stress to my investment portfolio if I force that part of the pie to maintain the overall income stream for inflation.

On the implementation side, at this time, I am still limiting my yearly budget to the pension income + 3% of the preceeding year's investment portfolio value at year end.

For now, I still feel warm and fuzzy enough not to switch into panic mode!

Red
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Re: Assets to include in Safe Withdrawal studies
Old 07-09-2002, 09:10 AM   #8
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Re: Assets to include in Safe Withdrawal studies

For a "young" early retiree (let's say <50), wouldn't it be prudent to calculate survival rates on taxable savings up to the minimum required retirement age, and on the remaining taxable and tax-deferred savings thereafter? In many countries you cannot draw on your tax deffered savings until you reach a certain age (like 55 in the UK). So including these in survivability would not make sense as you could not draw income from them, n'est pas?
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Re: Assets to include in Safe Withdrawal studies
Old 07-09-2002, 12:19 PM   #9
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Re: Assets to include in Safe Withdrawal studies

Quote:
For a "young" early retiree (let's say <50), wouldn't it be prudent to calculate survival rates on taxable savings up to the minimum required retirement age, and on the remaining taxable and tax-deferred savings thereafter? In many countries you cannot draw on your tax deffered savings until you reach a certain age (like 55 in the UK). So including these in survivability would not make sense as you could not draw income from them, n'est pas?
FIREman,

After pondering your question about whether, in certain retirement scenerios, it would be prudent to separate taxable assets from tax-deferred, I come to the conclusion that perhaps we shouldn't treat the study of Safe Withdrawal Rates all that closely with the Withdrawal Strategy from an asset pool.

For each, survivability is an important aspect. But when it gets right down to deciding from which bucket and how much one could/should draw money for yearly expenses, there are probably just too many variables.

I would almost liken it to the old apples and oranges comparison. I supposed this is why I am finding the withdrawal phase such an interesting but difficult aspect of financial planning.

Red
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Re: Assets to include in Safe Withdrawal studies
Old 07-09-2002, 07:20 PM   #10
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Re: Assets to include in Safe Withdrawal studies

JB posted this strategy elsewhere:

To make your retirement portfolio last, follow this strategy devised by financial planner Frank Armstrong.

1. Divide your assets into three parts: cash, bonds, and stocks.

2. Keep one year's worth of living expenses in cash. That's the money you'll be living off of, so a money-market account will be fine. You want a year's worth of expenses because you don't want to dip into investments when they're down. You don't want to put much more in the cash pile, though--you could miss out on some of the gains you'd get from investing.

3. Put between five and seven years' worth of living expenses in a short-term bond fund. This is the key to the strategy: Seven years would have carried you through the longest stock-market declines in U.S. history. This should allow you to survive a down market without selling your stock funds.

4. The rest of your portfolio stays in stock funds. If you're an aggressive investor, that's fine, but be sure that growth isn't the only theme in your portfolio. Your growth bets should enhance your core investments, not replace them.

Setting the Plan in Motion

For convenience, have your funds pay dividends or capital gains distributions into your money-market account. That means that you won't have to sell as many shares to refill your money market account yourself, which will limit additional capital-gains taxes. At the end of each year, transfer whatever amount you need to keep a year's worth of living expenses in the money-market account. Where will the cash come from? That depends on how your bond and stock funds performed in the previous year.

Scenario One: Bonds and stocks are both up for the year. In this case, reduce your bond position so that it once again covers seven year's worth of expenses before you tap into your stock funds. Your stock funds are the fuel for your portfolio, so the less you have to draw on them, the better.

Scenario Two: Stocks up, bonds down. Replenish your money-market account by using the gains from your stock funds first. Don't dip below their profits for the year, though, because that would cut into your principal. If your stock gains aren't sufficient, make it up by selling bond funds. Fill your bond stake again with future stock gains.

Scenario Three: Stocks and bonds are both down. The golden rule of this strategy is to never sell stocks when they're down. Draw on the bond funds instead--that's why you have seven years' worth of living expenses in them. Restore your bond stake by selling stock funds the next year they gain ground. Remember not to sell off more than you made, though.

Scenario Four: Stocks down, bonds up (the case in 2001). As I mentioned in the third scenario, the golden rule of this strategy is to never sell stocks when they're down. Draw on the bond funds and restore your bond stake by selling stock funds the next year they gain ground. When you restore your bond stake, remember not to sell off more than you made in stocks, though."

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Re: Assets to include in Safe Withdrawal studies
Old 07-10-2002, 01:19 AM   #11
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Re: Assets to include in Safe Withdrawal studies

RedOscar,

Yes, it is difficult. The whole picture includes tax penalties, capital gains and dividend taxes. There is one other thing I would add, however.

When we are in our middle years (35-55) and especially with children, we are more likely to spend more than in our "Golden Years". As gummy has said, you spend more early on when you can make the effort to go on that diving holiday or exploring other countries (or paying for Nikes). So the picture also includes a wish, no, a requirement, to spend more early on. For me, that is a prime reason to separate tax-deferred from taxable savings. My flexiblility is that I can draw on them at age 50, if necessary, or I can wait if my taxables are still in good shape. By including tax-deferred into the SWR calculation, I am deluding myself that this is an asset I can draw on, if necessary. On the other hand, if things were that bad, I probably wouldn't care about the tax implications.
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Re: Assets to include in Safe Withdrawal studies
Old 07-10-2002, 01:22 AM   #12
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Re: Assets to include in Safe Withdrawal studies

Prometheuss,

Super plan! Anybody tried this in a backtest?

FIREman

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Re: Assets to include in Safe Withdrawal studies
Old 07-10-2002, 02:29 AM   #13
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Re: Assets to include in Safe Withdrawal studies

Quote:
By including tax-deferred into the SWR calculation, I am deluding myself that this is an asset I can draw on, if necessary. On the other hand, if things were that bad, I probably wouldn't care about the tax implications.
It just goes to show that taking the RE route is not always an easy thing, full of unknowns and pitfalls. Since my tax-deffered assets are less than 30% of the total asset base, I have generally felt confortable that I can manage spending of the taxable stuff until MRD comes along.

My main interest is making sure I don't spend too much in the early years, only to realize 10 or 20 years from now that I have a serious problem on my hands.

Still feeling warm and fuzzy!

Red
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