Tuesday, March 4, 2014

Follow-Up to JP Morgan Post

Several individuals took me to task for criticizing JP Morgan's conclusion that "greater lifetime income through... pensions and/or lifetime annuities allows individuals to increase both their withdrawal rates and equity allocations."  While this may appear to be a "logical" conclusion, particularly for investment allocations, the math just doesn't support this conclusion as it applies to withdrawals rates.  Retirees who desire reasonably constant spendable income in retirement, should decrease, not increase, withdrawal rates from accumulated assets as the amount of their fixed immediate life annuity/pension income increases, all things being equal.

As an example, Let's go to the "Excluding Social Security 2.0" spreadsheet on this site.  If we enter $1,000,000 in accumulated savings, $0 immediate life annuity, 5% annual investment return, 3% per annum desired annual increases, 30 year payout period and $0 bequest, we get an initial withdrawal rate of 4.34%.  If we assume 3% inflation, the inflation-adjusted run out tab shows that annual withdrawals are expected to remain constant over the expected 30-year payout period.

However, if we input a fixed immediate payment of $20,000 per year, the initial annual withdrawal rate drops from 4.34% to 3.75% to keep total annual spendable income (withdrawals from accumulated savings plus annual annuity payment) constant in real dollar terms over the expected 30-year payout period.

Finally, if instead of $20,000 per year fixed annuity payment, we input $40,000, the initial annual withdrawal rate drops from 3.
75% to 3.15%.