withdrawalstrategies...
TRANSCRIPT
Overview
Most people spend more -me planning a two-‐week vaca-on than their re-rement.
Anonymous
• Bengen’s Four Percent Rule • Bucket strategies • RMD drawdown method • Semi-‐custom and full custom solu4ons • Annui4es, Reverse mortgages
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 ?
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
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
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
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
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
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.
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
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
Funnel View
* Long-‐term diversified por8olio (10 years) * * $ *
* Intermediate-‐term por8olio * * $ *
* Short-‐term account * * $ *
* $ * * $ *
$
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
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
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
RMD Values (IRS Pub 590) Unmarried or Married with Spouse < 10 years younger
Age Years RMD Age Years RMD 70 27.4 3.6% 86 14.1 7.1% 71 26.5 3.8% 87 13.4 7.5% 72 25.6 3.9% 88 12.7 7.9% 73 24.7 4.0% 89 12.0 8.3% 74 23.8 4.2% 90 11.4 8.8% 75 22.9 4.4% 91 10.8 9.3% 76 22.0 4.5% 92 10.2 9.8% 77 21.2 4.7% 93 9.6 10.4% 78 20.3 4.9% 94 9.1 11.0% 79 19.5 5.1% 95 8.6 11.6% 80 18.7 5.3% 96 8.1 12.3% 81 17.9 5.6% 97 7.6 13.2% 82 17.1 5.8% 98 7.1 14.1% 83 16.3 6.1% 99 6.7 14.9% 84 15.5 6.5% 100 6.3 15.9% 85 14.8 6.8%
RMD Withdrawal Paths
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
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
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
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
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
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.
Recurring Expenses
• Recurring expenses Everything except …..
• Non-‐recurring expenses Investments Income Taxes Mortgage Vaca4ons and hobbies Health care, etc., etc.
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
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
A Re4rement Scenario for the Does
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 www.siliconvalleyaaii.org
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
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
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
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
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
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
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
Summary
• Bengen’s 4% rule and varia4ons • Bucket strategies • RMD method • Custom spreadsheet • Annui4es • Reverse mortgages
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
Website References • Re4rement Income Calculators
www.schwab.com www.vanguard.com www.fidelity.com www.troweprice.com www.marketwatch.com
• Annui4es Same websites as above, plus www.immediateannui4es.com www.annuityquickquote.com
• Reverse Mortgages: hap://portal.hud.gov
hap://reversemortgageques4onsandconcepts.com