Retirement Distribution Strategies

Transcription

1 Retirement Distribution Strategies What works and what doesn t under investment return and tax uncertainty Manish Malhotra, President & CEO, Income Income Discovery.

2 Takeaways Synergistic interaction among retirement income strategy components A framework to find these synergies Discover up to 20% higher post-tax retirement income at higher safety 2

3 Retirement Income Strategies Finding optimum among multiple strategies Social Security Bond Ladder Annuities Systematic Withdrawal Portfolio $ Annual Income 3

4 Current Approach Portfolio expected return and volatility not sufficient Probability of success -> sustainable withdrawals Reward: Retirement Income Prob. of success appropriate framing? 4

5 Presenting Risk Improve risk presentation by using learning from Behavioral Finance research First, a primer on Behavioral Finance 5

6 Fast Thinking Reaction to this picture Instantly see that she is angry; System 1 of the mind processed it Associative Memory 6

7 Slow Thinking 185 X 27 =? Takes effort Different part of your mind used, called System 2 conscious reasoning self Impressions and decisions are an interaction of System 1 & 2 7

8 WYSIATI What You See Is All There Is Will John be a good leader? He is intelligent and strong Answer: Yes. Associative Memory. Did you think about attributes of a good leader? 8

9 John Good Leader?.. He is intelligent, strong, corrupt and cruel Still Yes. He is corrupt, cruel, intelligent and strong No, not a good leader First Impression is the Last Impression. 9

10 75% Probability of Success What does client think? Associative Memory Triggered Appropriate risk presentation? 10

11 75% Probability of Success Good context of gambling and sports, very good Does client understand 25% chance of failure? No WYSIATI explains it Issue with both words, probability and success 11

12 Alternative Presentation Out of 1000 retirees, 750 were successful in generating the desired income 250 were not successful 12

13 System 1 Processing of Frequency Real people like them and their peers They imagine a room full of retirees; 250 unsuccessful segregated in a corner. Why call them a failure? 13

14 Partial Income Retirees Systematic Withdrawal Portfolio exhausts, creating shortfall 14

15 No Success or Failure Full Income or Partial Income 85% of desired income in shortfall years is not a complete failure 15

16 Story of individuals, not a statistic Risk: # of retirees out of 1000 that received partial income. 16

17 Shortfall $ Unfortunate Retiree 20th highest Cumulative Shortfall out of 1000 retirees Shortfall Years Systematic Withdrawal Portfolio Immediate Annuity Pension Bond Ladder Social Security Retirement Income By Source Over Time 17

18 Risk Unfortunate Retiree Case Years of full income for Unfortunate Retiree Again, Story of an Individual Percent of Income during Shortfall Years 18

19 Risk-Reward Framework Primary Reward: Retirement Income 1st Risk: Retirees with Full Income 2nd Risk: Years of Full Income for Unfortunate Retiree 3rd Risk: % of Income in Shortfall Years for Unfortunate Retiree Secondary Reward: Average Legacy 19

20 Distribution Strategies Social Security defer or take early Single Premium Immediate Annuity Withdrawal order across different accounts and purchase account for annuities 20

21 Brady Case Study 66 year old couple Total Assets: $800K Monthly Pension: $500 Social - $2.5K and $2K pm Low Return (µ 2% than history) and Moderate Inflation (2.5% µ and 2% σ) Capital Market Assumptions; Conservative inflation protected model portfolio. Same as in JFP paper. 21

22 Real Income Over Time $100K Higher Medical Expenses Discretionary spending reduces as they age; essential spending rises - 10% drop in total spending. $90K Discretionary Spending Essential Spending Early Middle Late 22

23 Strategy 1 Social $100K Systematic Withdrawal Portfolio (SWP) $90K Pension Social Security of $54K Real Income By Source Over Time 23

24 Strategy 2 Social Higher withdrawal from SWP for 4 years Pension $100K $90K Social Security increases to $71.2K lowering withdrawal from SWP over last 26 years Real Income By Source Over Time 24

25 Higher withdrawal from SWP for 4 yrs. Social Better 214 retirees with full income 3 years of full income 18% in shortfall 1.9 times Legacy Pension $100K Lower withdrawal from SWP over last 26 years $90K Social Security of Why? 15-20% lower withdrawal from SWP over 26 years 25

26 Annuity Mortality Credits Sam, Peter & John pool their assets together to provide income for all who survive Only Peter survives to claim benefit from the pooled assets After 20 years Annual Income Annual Income Sam Peter John Peter 26

27 Immediate Annuity $160K Purchase can it help? Inflation adjusted payout: $6,047 Level payout: $9,329 Which is better? Inflation adjustment is based on CPI-U index 27

28 Strategy 3 Inflation Adjusted Annuity Pension $100K Annuity payout of $6K $90K Social Security of $71.2K Real Income By Source Over Time 28

29 Strategy 4 Level Payout Annuity Purchasing power of nominal payout falls with inflation Pension $100K Annuity payout of $9.3K $90K Social Security of $71.2K Real Income By Source Over Time 29

30 Annuity Comparisons Level payout better than inflation adjusted 48 Full Income Retirees 4 Years of Full Income for Unfortunate Retiree 24% Average Legacy Inflation adjusted annuity based on negative real yields not attractive under moderate inflation Based on quotes as of Mar 15,

31 Social Security and Annuity Does level payout Annuity help if Social Security was taken at 66? No. Compared to buying the annuity causes 21 Full Income Retirees 30% Avg. Legacy 31

32 Why Annuity doesn t help with SS@66? $100K Systematic Withdrawal Portfolio (SWP) Pension Social Security of $54K $90K Portfolio avg. flow rate is $37K / $800K = 4.6% Immediate Annuity with 3.9% avg. flow rate Immediate Annuity with 5.8% initial payout under 3% inflation expectation has avg. flow rate of 3.9% 32

33 Why Annuity doesn t help with SS@66? Risk 4.6% Flow 3.9% 33

34 How Annuity helps with $100K Pension $90K Portfolio avg. flow rate is $29.3K / $800K = 3.7% Social Security of $71.2K Immediate Annuity has 3.9% avg. flow rate Fixed Annuity with 5.8% initial payout under 3% inflation expectation has avg. flow rate of 3.9% 34

35 Why Annuity helps with Risk 3.7% Flow 3.9% 35

36 Key Learning Not the isolated impact of the component of a strategy But, their cumulative impact Rules are not general Need to optimize for each client; DON T rely on intuition 36

37 Tax Sensitive Analysis Tax sensitive analysis valuable for a higher net worth client - Full tax brackets and standard deductions - Rules for taxable portion of Social Security 37

38 HNW Brady s Taxable Joint Account: $1 million 65% average cost basis Peter s IRA: $1.25 million and Lisa s IRA: $800K Both 15% post-tax basis Roth IRA: $200K 38

39 Tax Sensitive Strategies Strategy A - Withdrawal Order: Taxable, IRA, Roth - Purchase $800K of immediate annuity in Peter s IRA Strategy B - Withdrawal Order: Taxable, Roth, IRA - Purchase $800K of annuity in Taxable 39

40 Tax Strategies Comparison Strategy A is better Taxable-IRA-Roth; Annuity in IRA 66 1 Full Income Retirees Year of Full Income for Unfortunate 6% point Partial Income 8% Avg. Legacy 40

41 Strategy B Cash Flow 1. If Annuity bought in Taxable Account, it runs out in 1.5 years 41

42 Strategy B Cash Flow 2. Roth hasn t had time to grow, it can give income only for 2.5 years 42

43 Strategy B Cash Flow 3. Full taxable withdrawals from IRA in the later phases exhaust it faster 43

44 Strategy A Cash Flow 1. Taxable Account has assets to sustain longer as annuity is bought in IRA 44

45 Strategy A Cash Flow 2. Then, IRAs kick in 45

46 Strategy A Cash Flow 3. Roth has time to grow tax free and fund 7+ years of withdrawal 46

47 Summary Synergistic interaction among retirement income strategy components A framework to find these synergies Discover up to 20% higher post-tax retirement income at higher safety 47

48 Appendix 48

49 Contract Value Variable Annuity with Guarantees GMIB contracts also allow min guaranteed growth Of Benefit Base Benefit Base Past Value Contract Value Time 49

50 Strategy 5 - Variable Annuity GLWB Immediate lifetime income at 4.5% of benefit base GLWB rider at 0.95% fee and 0.3% MEA fees Moderate inflation protected allocation 160K purchase with Social Security@70 50

51 Risk increases VA GLWB helps? 36 Full Income Retirees 3 Years of Income for Unfortunate Retiree 5% points guaranteed income for Unfortunate Retiree 8% in Avg. Legacy 51

52 Strategy 6 - Variable Annuity GMIB Growth phase with 1.75 times guaranteed income base after 10 years Rider fees 1.5%; MEA Fees 1.3% Payout rate: 4.75% of Income Base Moderate Inflation Protected Model 160K purchase with Social Security@70 52

53 Risk increases GMIB helps? - 84 Full Income Retirees - 7 Years of Income for Unfortunate Retiree - guaranteed income for Unfortunate Retiree - 43% in Avg. Legacy 53

54 Current VAs why risk? For Retirees that barely got full income: Fees and poor returns combination doesn t let Income Base step-up. Without Income Base, VA behaves like an immediate annuity, but with payout payout means in risk as more retirees can t get full income 54

55 Older VAs with Guarantees 6% compounded return for 10 years 200% guaranteed income MEA Fees 0.85%, Rider fees 1.1% Payout rate at 6% when clients are 76 years old This VA reduces risk 55

56 VA under Better Returns Percentile 25th Percentile $4,082 50th Percentile $5,246 Last year s GLWB Benefit in today s dollars 75th Percentile $7,399 81% higher than 25 th Percentile 56

57 Current VAs Use? Not very appropriate for essential expenses But a good strategy for discretionary expenses that can be locked Client frees rest of the portfolio to be structured for inheritance 57

58 Certain Cash Flow Using Bond Ladder Cash flow not sensitive to interest rate movements if bonds held-to-maturity Principal Maturity Semi-annual coupons 58

59 TIPS Ladder Fill-in for Social Security Using Ladder $100K $90K Pension Social Security Real Income By Source Over Time 59

60 TIPS Ladder Performance Psychological comfort of safe cash flow But because of negative real rates 25 Full Income Retirees 1 Year of Full Income for Unfortunate Retiree stability of cash flows 20% Avg. Legacy Bond quotes as of 25 March