Withdrawal Strategies for your Re4rement Por8olio

Transcription

1 Withdrawal Strategies for your Re4rement Por8olio February 8, 2014 Fred Smith

2 Overview Most people spend more -me planning a two- week vaca-on than their re-rement. Bengen s Four Percent Rule Bucket strategies RMD drawdown method Semi- custom and full custom solu4ons Annui4es, Reverse mortgages Anonymous

3 Background to Bengen s Rule Ibbotson data from 1926 to 1993 Stocks 10.3% Intermediate Treasuries 5.1% Infla4on 3% Por8olio of 60% stocks/40% bonds Average return = 8.2% Real Return = 5.2% Withdrawal rate of 5% should be OK?

4 Bengen s Results Using Ibbotson s annual data and increasing the withdrawal rate by infla4on each year Ini4al withdrawal rate Por8olio longevity 3% pa > 50 years 4% pa 35 years 5% pa 20 years 6% pa 17 years Poor star4ng years: 1966, 1965, 1968, 1969, 1937

5 Bengen s Four Percent Rule Set up 50% - 75% of por8olio in equi4es with the balance in intermediate Treasuries Withdraw 4% of assets in first year Increase by infla4on for subsequent years Most por8olios should last > 50 years Worst case por8olio lasts 35 years

6 Varia4ons on Bengen s 4% Rule Bengen OK to use 4.5% if small cap stocks included 35% Large cap stocks 18% Small cap stocks 47% Intermediate Treasuries Blanchea et al: 3% is the new 4% Guyton et al: 5% - 6% OK with condi4onal rules

7 Guyton et al Decision Rules Guyton and Klinger (2006) Mul4- asset diversified por8olio, 40 year longevity Por8olio management rule Determines the source of each withdrawal Infla4on rule Caps maximum annual CPI increase at 6% Capital preserva4on and prosperity rules Act as +/- 20% guardrails around ini4al rate 5.2% - 6.2% ini4al rate OK with these rules

8 Limita4ons of Bengen s Rule Cash flow determined by ini4al por8olio value Sequence of returns risk When does safety- first trump current lifestyle? Unravels in periods of high infla4on Constant fixed real cash flow

9 Simple Bucket Model Bucket 1 Bucket 2 Purpose: Living expenses Growth Infla4on protec4on Timeframe: Short- term Long- term Assets: Cash, CDs Diversified por8olio MM funds, etc. Stocks, Bonds, etc.

10 Simple Bucket Strategy Every year Withdraw annual living expenses from Bucket 1 Transfer 4% - 6% from Bucket 2 to Bucket 1 May include: Interest and dividends Proceeds from rebalancing Proceeds from tax- loss harves4ng

11 Three Bucket Varia4on Bucket 1: Short- term (1 year) Cash, Checking/savings accounts Money market fund, T- bills, Short- term CDs, etc. Bucket 2: Intermediate term (2-5 years) CD ladder, short/intermediate- term bonds, etc. Bucket 3: Long- term (>10 years) Diversified long term por8olio

12 Funnel View * Long- term diversified por8olio (10 years) * * $ * * Intermediate- term por8olio * * $ * * Short- term account * * $ * * $ * * $ * $

13 Prac4cal Withdrawal Strategies Blanchea et al (2012), Benz (2013) Constant Dollar Fixed amount based on ini4al por8olio value Increased annually by infla4on Constant Percentage Fixed percentage of current por8olio value IRS Required Minimum Distribu4on Method Reciprocal of remaining life expectancy

14 Constant Percentage Strategy Typical mechanical approach Transfer say 5% pa of Bucket 3 to Bucket 2 Transfer say 25% pa of Bucket 2 to Bucket 1 Withdraw monthly living expenses from Bucket 1 Easy to implement May require selling from Bucket 3 in down market

15 RMD Method Sun and Webb (2012) Advantages Easy to follow Conserva4ve withdrawal rate Does not drive asset alloca4on Responds to market value Disadvantage Withdrawals not tailored to needs

16 RMD Values (IRS Pub 590) Unmarried or Married with Spouse < 10 years younger Age Years RMD Age Years RMD % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % %

17 RMD Withdrawal Paths

18 Equity Glide Path Tradi4onal glide path Age in fixed income, Balance in equi4es Declining equity glide path thru accumula4on and decumula4on Recent research: Phau and Kitces (2014) Bathtub shaped equity glide path Lowest at re4rement, 20%- 40%, most vulnerable Increasing thereaper, 60%- 80%, as we age

19 Seqng Up a Bucket Strategy Es4mate paycheck needs Living expenses less Social Security, pension, etc. Select a bucket management strategy Pick a sustainable withdrawal rate Create and fund buckets Buckets 1, 2 and 3 = 1yr, 2-4yrs and 10+ yrs? Document the plan Monitor progress annually

20 Issues with the Bucket Strategies Uneven cash flows require addi4onal tools Extensive travel early in re4rement Last mortgage payment in 2029 Increasing healthcare costs later in re4rement etc. etc. Low return from short- term buckets Dead money in today s environment

21 Uneven Cash Flows Semicustom re4rement planning tools Schwab, Vanguard, Fidelity, T Rowe Price, etc. Age, re4rement date(s), assets, liabili4es Full Custom Spreadsheet Balance sheet, Current income/expenses Recurring expenses, Non- recurring expenses Various scenarios

22 Balance Sheet Investment assets Taxable accounts, Tax deferred, Tax free (Roth) less liabili4es: margin loans, etc. equals Investment Net Worth Personal assets Home, furnishings, cars, etc. less liabili4es: mortgage, car loans, etc. equals Personal Net Worth Exclude for re4rement withdrawal plans

23 Current Annual Budget Income Salary, Pension, Social Security Investment income, etc. Expenses Housing, Mortgage, U4li4es, Insurance Food and Clothing, Vaca4ons Taxes, Investments, Transporta4on, UAF, etc.

24 Recurring Expenses Recurring expenses Everything except.. Non- recurring expenses Investments Income Taxes Mortgage Vaca4ons and hobbies Health care, etc., etc.

25 Master Spreadsheet Year, Age thru 100, Spouse s age Income: Salary, Pension, Social Security Investment income, etc. Expenses: Recurring: U4li4es, Food, Clothing, etc. Non- recurring: Taxes, Mortgage, etc. Por8olio balance Ini4al Investment net worth + Income - Expenses

26 Sample: John and Jane Doe John and Jane are each age 60 Own their own home, Current value $1M Mortgage $500K, last payment in 2029 Total investment net worth $1.7M John earns $120K pa, plans to re4re at age 70 Jane earns $90K pa, plans to re4re at age 66 Hope to travel extensively aper re4rement Both in good health, good family history

27 A Re4rement Scenario for the Does

28 Explore What- If Scenarios Re4ring at various ages Social Security claiming strategies Claim early, full re4rement age, or late File and suspend File a restricted claim for spousal benefits only Viability of major vaca4on plans Health care issues, Long term care, etc. Various scenarios at

29 What If I Can t Stretch It To Age 100? Possible solu4ons to longevity challenge Save more during working years; work longer Minimize withdrawals; Seek higher returns Buy insurance; Transfer the risk for a fee Cost of risk + Overhead cost + Profit Best for low probability of risk, high financial cost Advantage Law of large numbers

30 Consider an Annuity Single premium immediate annuity (SPIA) Supplement income for life Living expenses less Social Security benefits, etc. Use balance of por8olio for discre4onary spending Most appropriate for middle income people

31 Longevity Insurance Single premium deferred annuity (SPDA) e.g. Purchase at age 65, defer income to age 85 Cost is lower, i.e. returns are higher Insurance company has use of $ for many years Many purchasers will never collect payments Collect payments for fewer years Longevity insurance is not underwriaen Use adverse selec4on to your advantage

32 FHA Reverse Mortgage for Seniors Home Equity Conversion Mortgage (HECM) Requirements Be 62 years of age or older Own property outright or have significant equity Occupy property as principal residence Con4nue to pay property taxes, insurance, etc. Not be delinquent on any federal debt Must undergo counseling, financial assessment

33 How Much Can I Borrow? Maximum loan Lesser of appraised value or $625,500 Adjusted for age of the youngest borrower and the interest rate Form of loan Lump sum or monthly payments Line of credit (non- cancellable) Repayment due on sale, or death of owner

34 Costs for a HECM Interest, accumulates on loan Mortgage insurance premiums Ini4al: 0.5% or 2.5% of loan Annual: 1.25% of loan balance Closing costs Appraisal, 4tle search, inspec4ons, taxes, etc. Origina4on fee: 1% to 2% capped at $6,000 Servicing fees: Capped at $30 to $35 per month

35 Benefits of a HECM Allows significantly smaller cash bucket Reduces opportunity cost of dead money Provides flexibility in LT investment bucket Reduces need to sell assets in bear markets Increases life expectancy of por8olio Can provide living expenses if re4rement por8olio is exhausted

36 Summary Bengen s 4% rule and varia4ons Bucket strategies RMD method Custom spreadsheet Annui4es Reverse mortgages

37 References William P. Bengen, Determining Withdrawal Rates Using Historical Data, Journal of Financial Planning, October 1994 Phillip I. Cooley, Carl M. Hubbard and Daniel T. Walz, Re4rement Savings: Choosing a Withdrawal Rate That Is Sustainable, AAII Journal, February 1998 Jonathan T. Guyton and William J. Klinger, Decision Rules and Maximum Ini4al Withdrawal Rates, Journal of Financial Planning, March 2006 William P. Bengen, How Much Is Enough?, Financial Advisor Magazine, May 2012 David Blanchea, Marciej Kowara and Peng Chen, Op4mal Withdrawal Strategy for Re4rement Income Por8olios, Morningstar, September 2012 Chris4ne Benz, Using the Bucket Approach With Your Re4rement Por8olio, AAII Journal, October 2013 Wei Sun and Anthony Webb, Re4rement Withdrawals: Can You Base Them on RMDs?, AAII Journal, December 2012 Wade D. Pfau and Michael E. Kitces, Reducing Re4rement Risk with a Rising Equity Glide Path, Journal of Financial Planning, January 2014 David M. Cordell and Thomas P. Langdon, Hedging Longevity Risk for Worry- Free Re4rement, Journal of Financial Planning, May 2013 John Salter, Shaun Pfeiffer and Harold Evensky, Standby Reverse Mortgages: A Risk Management Tool for Re4rement Distribu4ons, Journal of Financial Planning, August 2011

38 Website References Re4rement Income Calculators Annui4es Same websites as above, plus Reverse Mortgages: hap://portal.hud.gov hap://reversemortgageques4onsandconcepts.com