Thursday, April 13, 2017

Safe Withdrawal Rates—The Good News Bad News Story

This good news bad news story was inspired by Dr. David Blanchett’s recent article in the Journal of Financial Planning entitled, “The Impact of Guaranteed Income and Dynamic Withdrawals on Safe Initial Withdrawal Rates.”  Dr. Blanchett is head of retirement research at Morningstar Investment Management and is one of the leading retirement researchers in the country.

You want the good news first?  The good news is that Dr. Blanchett’s latest research shows that retirees:

  • with a larger percentage of their wealth invested in a specific type of guaranteed income, 
  • who are willing to commit to Dr. Blanchett’s complicated dynamic adjustments, 
  • who can achieve higher investment returns, or 
  • who are willing to live with lower probabilities of success
can use higher initial safe withdrawals rates when determining how much they can withdraw from their investment portfolio upon retirement (and subsequently increase this initial amount with inflation thereafter unless they also employ Dr. Blanchett’s dynamic rule adjustments).  We think that the good news in this research is that:
  • it is a mistake to view portfolio withdrawals in isolation from other sources of income (as is the common practice), and 
  • risks retirees face in retirement can be mitigated by investing in guaranteed lifetime income sources and using dynamic rather than static spending strategies.
The bad news in this story, however, is that Dr. Blanchett is even talking about utilizing safe withdrawal strategies with the implication that there are still financial planners out there who continue to use such strategies for their clients.  Since we here at How Much Can You Afford to Spend are not big fans of strategic withdrawal plans (SWPs) in general, and we are definitely not fans of the subset of SWPs known as Safe Withdrawal Rate approaches, we find the phrase “optimal safe withdrawal rates” to be an oxymoron.  Further discussion of why we are so negative about SWPs can be found in our posts of January 12, 2017 and October 27, 2016, and our website is littered with posts almost from its inception in 2010 of why we believe the 4% Rule and its safe withdrawal rate cousins are inferior to the Actuarial Approach.

A Few More Thoughts

As we have discussed in previous posts, in making SWPs work, researchers will generally pair the SWP with lifetime income streams that are paid in constant real dollars.  This is exactly the type of lifetime payment stream that Dr. Blanchett is referring to when he uses the term “guaranteed income.”  It is important to note that Dr. Blanchett would probably not reach the same conclusion if he defined “guaranteed income” as the far more common fixed dollar (constant nominal dollar) stream of payments, because, under this scenario, greater portfolio withdrawals would be needed in later years to provide total constant real dollar spending.  We caution financial advisors and retirees who may be misled by conclusions reached by Dr. Blanchett’s because of how he defines “guaranteed income.”

Dr. Blanchett goes to significant lengths in his article to point out that the methodology he uses in his analysis weights the probability of the retiree household surviving to each age rather than using “some arbitrary fixed period.”  We note, however, that Dr. Blanchett makes a number of significant assumptions in his calculations to simplify his calculations, so we find the implied precision of this one particular assumption to be grossly exaggerated.  And, we tend not to get as excited as Dr. Blanchett (and others) about assuming fixed lifetime planning periods.  We note that, in real life, whether one lives or dies is a binary process, and little pieces of us do not die each year.

While on the subject of implied precision, we will once again tackle the common misperception that, just because a researcher runs 10,000 scenarios using Monte Carlo modeling, that:

  • employs lots of assumptions about future experience, 
  • employs lots of simplifying assumptions about hypothetical retiree sources of income, and 
  • assumes retiree future spending will exactly follow certain sophisticated algorithms each year in the future,
the resulting spending solution will necessarily be more precise or more “optimal” than making best estimate deterministic assumptions about the future each year, and annually adjusting the spending strategy for deviations in actual experience and actual spending that will inevitably occur.  We caution financial advisors and others to be skeptical of optimal strategies that may be based on unrealistic modeling of retiree circumstances or of the future.

Finally, the Society of Actuaries 2012 IAM table(s) are the Individual Annuity Mortality tables, not the Immediate Annuity Mortality table, as stated in the article.


As discussed many times in this website, we think the safe withdrawal rate strategies are deficient in a number of areas, and attempts like Dr. Blanchett’s and others to modify them to make them work better are probably not worth the effort.  We know that you find this hard to believe, but we actually think a better answer lies with the Actuarial Approach we recommend.  And the really good news here is that the Excel workbooks that we provide to help you implement the Actuarial Approach are available for free and are just a click away.