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Old 01-21-2012, 09:56 AM   #21
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A good summary, somewhat related, by Wade Pfau...
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As a percentage of retirement date assets, what is the highest amount you can withdraw, while adjusting this amount for inflation in subsequent years, without running out of funds for a sufficiently long period of time?

This is a question plaguing retirees and near-retirees as lifespans and retirements lengthen, and as traditional defined-benefit pensions are falling by the wayside. Since William Bengen’s seminal investigation of the US historical data in his 1994 Journal of Financial Planning article, answers have tended to center around 4%, with perhaps 4-5% being a comfortable range for many retirees and planners.

For retirement planning research, I paid my dues by looking at three different methods (international data comparisons, speed of wealth depletion in the years since retirement, and impact of market valuation and yield measures at the retirement date) which each question whether recent retirees can still consider 4% to be safe over a 30-year horizon despite its historical success for retirements beginning up to 1980.

The question of safe withdrawal rates certainly does matter. My title is overly provocative. A 2011 Financial Planning Association survey described by Jonathan Guyton indicates that 75% of surveyed financial planners either always or frequently use systematic withdrawals with their clients. For them, the safe withdrawal rate is relevant. But my point is that safe withdrawal rates may be less important than I earlier thought.

That’s because for a lot of people involved in the retirement income debate, even when using a well-diversified portfolio of stocks and bonds (which is the recommendation in the safe withdrawal rate literature), the only safe withdrawal rate is 0%. We are deluding ourselves to think otherwise.

An alternative approach to retirement income planning that is gaining traction is the “guaranteed floor / upside potential” approach. With this approach, you first build a floor of very low-risk guaranteed income sources to serve your basic spending needs in retirement. The guaranteed income floor is built with Social Security and any other defined-benefit pensions, and through the use of your financial assets to do things such as building a ladder of TIPS or purchasing single-premium immediate annuities (SPIAs). GLWBs could also play a role here. Not all of these income sources are inflation adjusted, and you do need to make sure your floor is sufficiently protected from inflation, but this is the basic idea.

According to the Retirement Income Industry Association (disclosure: I am on their Academic Advisory Board), a fundamental goal of retirement planning is to “first build a floor, then expose to upside.” This is also the approach Moshe Milevsky has in mind when he recommends that you “pensionize your nest egg” and it is the way that Zvi Bodie suggests you can “risk less and prosper” in retirement.

Once you have a sufficient floor in place, you can focus on upside potential. With any remaining assets, you can invest and spend as you wish. Since this extra spending (such as for nice restaurants, extra vacations, etc.) is discretionary, it won’t be the end of the world if you must stop spending at some point. You still have your guaranteed income floor in place to meet your basic needs no matter what happens. With this sort of approach, withdrawal rates hardly matter. (Another note from the Jonathan Guyton article linked above: he suggests that retirees may not be as blasé as I’ve just made it appear about their abilities to fund even their ‘discretionary’ expenses).

“Safe withdrawal rates” and “guaranteed floor / upside potential” are really two competing approaches to retirement income planning. How can we reconcile them?

I think they can be reconciled by broadening some aspects of safe withdrawal rate studies. First, these studies ask the question about how much can be withdrawn over time from a risky portfolio, and so they do not directly incorporate other income sources such as Social Security, annuities, or pensions. Second, these studies focus on the probability of failure (also called shortfall risk, it is the probability of running out of wealth while still alive), without giving consideration about what is lost in terms of life satisfaction by using a lower withdrawal rate and spending less. The fact that with low withdrawal rates, people will typically leave behind a large pot of wealth (unless their retirement matches the worst-case scenario) is not something included in the analysis.

I have been part of a research effort with Michael Finke and Duncan Williams of Texas Tech University to incorporate the sustainable spending “safe withdrawal rate” framework into the “guaranteed floor / upside potential” framework. We look at safe withdrawal rates after adding other income sources from outside the retirement portfolio (such as Social Security and pensions). We also leave behind the safe withdrawal rate objective of worrying only about a low failure rate (low shortfall risk), and instead try to balance the competing tradeoffs between wanting to spend and enjoy more while one is still alive and healthy, against not wanting to run out of portfolio wealth while still alive (the guaranteed floor will always be in place though). We find that someone with flexibility about how much they can spend and with more outside sources of income may be willing to accept rather high failure rates as a part of balancing these competing tradeoffs.* Life is indeed a balancing act. Our study, “Spending Flexibility and Safe Withdrawal Rates,” can be downloaded now as a working paper, and it has been accepted for publication in an upcoming issue of Journal of Financial Planning.

Moshe Milevsky and Huaxiong Huong earlier produced a related work, and what we think of as “spending flexibility,” they call “longevity risk aversion.” Joseph Tomlinson will also have a paper exploring these sorts of concepts in an upcoming issue of Journal of Financial Planning.

I do have an article on safe withdrawal rates in the current January issue of Journal of Financial Planning. I generalize the framework for safe withdrawal rates to include any assets or assumptions, and it think it can really serve as a final word from me about traditional safe withdrawal rate studies (except, I still want to look at variable withdrawal rates).

But the next generation of studies with a more comprehensive view toward withdrawal rates and retirement income is already on the way.

* This finding puts me in the rather odd position of having first recommended rather low withdrawal rates in earlier research, but now suggesting that much higher withdrawal rates (and chances for failure) may be acceptable in certain circumstances. If you are confused about this, Doug Nordman wrote a nice summary of these two competing viewpoints called, “Is the 4% withdrawal rate really safe?”

Update: just to clarify, when I talk about "safe withdrawal rates," I refer to the classical approach to safe withdrawal rates using a diversified portfolio of stocks and bonds. William Bengen and the Trinity study suggest stock allocations in the neighborhood of 50-75%. So it's a matter of how much can be safely withdrawn from a volatile portfolio. The "floor/upside" approach rejects this sort of view about the matter: volatile portfolios are inherently not safe.
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Old 01-21-2012, 12:02 PM   #22
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Thanks for the post. This has always made sense to me:

Quote:
With this approach, you first build a floor of very low-risk guaranteed income sources to serve your basic spending needs in retirement. The guaranteed income floor is built with Social Security and any other defined-benefit pensions, and through the use of your financial assets to do things such as building a ladder of TIPS or purchasing single-premium immediate annuities (SPIAs). ...

Once you have a sufficient floor in place, you can focus on upside potential. With any remaining assets, you can invest and spend as you wish. Since this extra spending (such as for nice restaurants, extra vacations, etc.) is discretionary, it won’t be the end of the world if you must stop spending at some point. You still have your guaranteed income floor in place to meet your basic needs no matter what happens. With this sort of approach, withdrawal rates hardly matter.
I've said that if you like, you can build the safe floor, then spend everything else on a round-the-world cruise if that's your dream. Even if you don't spend it all at once, knowing that you've got a bucket that can be spent solely on discretionary stuff kind of changes how you think about timing of purchases.

In our case, simply deferring SS to age 70 covers most of our basic spending. A fraction of a non-COLA pension covers the rest. That means that all of our financial assets are in the discretionary spending bucket.
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Old 01-21-2012, 01:20 PM   #23
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Thanks for the post. This has always made sense to me:



I've said that if you like, you can build the safe floor, then spend everything else on a round-the-world cruise if that's your dream. Even if you don't spend it all at once, knowing that you've got a bucket that can be spent solely on discretionary stuff kind of changes how you think about timing of purchases.

In our case, simply deferring SS to age 70 covers most of our basic spending. A fraction of a non-COLA pension covers the rest. That means that all of our financial assets are in the discretionary spending bucket.
From 55 ( planned ER age) until SS starts I plan to live off rent, a small annuity, CDs or I bonds and cash. Any gains from equities in taxable accounts will be gravy. Once a small pension and SS from US and UK start my entire income needs will be covered from stable sources. I'll still make distributions from my tax deferred accounts to roll over into a ROTH to reduce RMDs and also to simplify my taxes when I move back to the UK
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Old 01-22-2012, 07:34 AM   #24
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http://www.boomersblueprint.com/ is a book I recently read and found helpful.
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Old 01-22-2012, 09:45 AM   #25
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Pack-

Thx for the post. I first read Pfau on this forum in a thread from Nords, and it makes sense to me. Note that Nords gets a mention at the end.

This (floor with upside potential) is our most likely plan. We will use SS + small COLAd pension + SPIA (or another vehicle) to guarantee income for "essential" expenses, then an equity/bond AA at a SWR (using Clyatt's 95% rule) for remaining "discretionary" expenses.

However, we'll need to use withdrawals from our nest egg for several years until both the pension and SS have kick in. I've just run ORP for the first time to get guidance on where to take/move the funds from/to.
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Old 01-22-2012, 10:07 AM   #26
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Your Retirement Income Blueprint is a book I recently read and found helpful.
Looks good, though my enthusiasm was dampened once I realized it was written for Canadians. Their government programs are quite different as we all know. Hopefully it will still be largely applicable, I plan to check it out this week. Thanks!
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Old 01-22-2012, 06:06 PM   #27
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I primarily use a mix of Vanguard Target Retirement funds, Cd's & I bonds with an asset allocation of 31% stocks & the remainder in cash & bonds. Retirement will be July 2012. I have 2 years of needed assets in readily available CD's and I Bonds. I keep a 3rd year of assets in short term bonds. I plan to tap these funds only if the market is tanking. Otherwise I'll be drawing from the Target Retirement funds. About 3/4 of our assets are in Target Retirement 2005 which will be merged with Target Income Fund in February. Haven't quite figured out the actual process I'll use for withdrawing money.

One thing I've been pondering is when to draw qualified funds vs non-qualified funds. The following link advises drawing your IRA money 1st before drawing any non-taxable taxable monies such as your non-IRA savings.

https://retirerxcom.s3.amazonaws.com..._Booklet-1.pdf

A quote from page 6:
"As will be demonstrated in what follows, the correct timing for the use of the three categories of money by the average retirees is: use IRA money first, delay Social Security as long as possible, and position your non-qualified money correctly and use it last or to supplement your retirement income. "

The author "Dr. Shelby Smith, says that since SS benefits are taxed differently than other income, there are major tax benefits of delaying SS as long as possible and using up your IRA money 1st. He gives an example comparing 2 couples requiring 90K/yr and shows how the couple that delays taking SS enjoys major tax savings.

I've gone through the author's examples, plugging in my own figures and don't see an advantage for me but OTOH, my draw from SS will only be about 28K at age 70. Has anyone else considered this strategy?
Marc
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Old 01-23-2012, 11:57 AM   #28
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I've gone through the author's examples, plugging in my own figures and don't see an advantage for me but OTOH, my draw from SS will only be about 28K at age 70. Has anyone else considered this strategy?
Marc
I thought about taxation of SS benefits when I retired. The important thing to me was that the band limits ($32,000 and $12,000) are not indexed.

When I used modest rates of inflation, assuming both SS and non-SS income would keep up with inflation, I got a situation where 85% of our SS benefits would be taxable if we were spending our "desired" amount.

I played around with some scenarios, but didn't see any clear winner that stood up against the various unknowns.

We are moving trad IRA money to Roth IRA just to fill up a low initial tax bracket. But we'd be doing that regardless of how SS is taxed.

But, I'm a rookie in this discussion. I'd be happy to see other opinions.
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Old 02-12-2012, 03:29 PM   #29
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A good summary, somewhat related, by Wade Pfau...
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Pack-

Thx for the post. I first read Pfau on this forum in a thread from Nords, and it makes sense to me. Note that Nords gets a mention at the end.

This (floor with upside potential) is our most likely plan. We will use SS + small COLAd pension + SPIA (or another vehicle) to guarantee income for "essential" expenses, then an equity/bond AA at a SWR (using Clyatt's 95% rule) for remaining "discretionary" expenses.

However, we'll need to use withdrawals from our nest egg for several years until both the pension and SS have kick in. I've just run ORP for the first time to get guidance on where to take/move the funds from/to.
OK, since this post, I've read Otar's Myths and am now wondering who's correct: Pfau or Otar.

Clearly Pfau, along with others like Clyatt, support a "variable" spending plan. Pfau's includes the added feature of having the floor (essential expenses) covered by guaranteed income sources. However, if I understood Otar correctly, his analysis shows that no reasonable amount of variable spending reduction substantially increases portfolio survival probability.

What thoughts do you have on this? Have you read anything that compares/contrasts the two?
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Old 02-12-2012, 05:59 PM   #30
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Bob's financial page has links to most of the papers written on the subject. I also second Otar's book above. Another source is Bob Clyatt's Work Less, Live More.

Bob's Financial Website
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Old 02-12-2012, 06:00 PM   #31
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Our portfolio will probably be as interesting as can be for getting a best SWR answer. Roughly speaking, we will be at 1/3 Roth IRA, 1/3 IRA and 1/3 taxable equities. We will probably retire using pensions to fund us, within two years. That combined with an eventual social security draw will be enough to meet our basic needs.

With our basic needs met, I haven't convinced myself that any bonds are needed at current low rates. (I see probable losses with bonds if accounting for taxes and inflation.)

IRA RMDs will kick us up to a high tax bracket. For us, best plan is to spend IRAs, convert to Roth IRAs as we can, without upping our tax rates, then move to taxable equities, and lastly hitting the Roths IRA. We are close to the break point that pulling from taxable or IRAs could be a wash, depending on what happens to fund returns in the next few years.

With politicians rooting after more money, I'm expecting them to rob the bank, 'cause that's where the money is. We are the bank. Who knows if Roth's will withstand the assault.
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Old 02-12-2012, 07:21 PM   #32
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Unveiling the Retirement Myth by Jim C. Otar
+1 +1 +1 +1

No question worth the $5 for the pdf version!
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Old 02-12-2012, 09:19 PM   #33
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In retirement, I withdraw my SWR from both the TSP and taxable accounts in Vanguard. The money withdrawn from Vanguard is from my portfolio cash in Vanguard money market (where I have the dividends sent), and I don't have to sell anything for my withdrawals. Not so for the TSP, but I want to lower the balance there and take some of the tax hit before I get to age 70.5 and the mandatory withdrawals begin. Overall I spend less than my dividends.
Your last sentence bears thinking about.

At 70.5, we are required to take Minimum Required Distributions from IRAs according to a schedule set up by the IRS, which consists of an annual fraction = 1/your expected remaining years of life, according to actuarial tables (also by the IRS) times your balance on Dec 31 (if I recall correctly). (Same table as used for early distribution per 72T.) Vanguard will do this for you automatically but you have to tell them what you want.

I am sure that more than one here will be in the situation where their MRD is more than they typically spend. What to do with that excess?

Perhaps the simplest solution is to send it to a savings account at your bank and spend out of that. It builds an emergency fund at a time in life where it may become necessary.

Has this been discussed before? What are your thoughts?
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