Retirement Income Source Diversification

http://howmuchcaniaffordtospendinretirement.webs.com/Retirement_Income_Source_Diversification_09222013.pdf

As indicated in previous posts, It is not unreasonable to manage risks in retirement by diversifying sources of retirement income.  This could involve maximizing Social Security benefits (by deferring commencement), utilizing some life insurance company annuity products (or defined benefit plan annuity income) and utilizing a rationale spend-down strategy for managed assets.  This article compares three diversified options with the 100% Annuity option and the 100% Self-Managed option.

Gotbaum Tells Council Lump-Sum Cash-Outs Are Like Cigarettes: Legal but Bad for You

Pension Rights Center
http://www.pensionrights.org/sites/default/files/docs/news/130903_bna_pension_benefits_reporter_-_gotbaum_tells_council_lump_cashouts_are_like_cigarettes_legal_but_bad_for_you_-_k2_nstein_quoted_banner_version.pdf

In this article, the head of a federal government agency implies that most people aren't very smart when given a choice between an annuity and a lump sum in a defined benefit plan.   He indicates that since 1997, more than two out of three people have taken the lump-sum option instead of an annuity when given a choice.
 
Therefore he concludes that more government regulation is needed to prevent you from making the "bad" lump sum choice.
 
This thinking appears to be shared by representatives of the Department of Labor who continue their push to make it more difficult for people to take "bad" lump sums from defined contribution plans.
 
Never mind that recent research from Felix Reichling and Kent Smetters questions the supposed superiority of the annuity choice.  And never mind that recent research from Frank Sr., Mitchell and Pfau (see previous post) suggests that it may make financial sense to rollover the lump sum to an IRA and purchase an annuity at a later date.  And never mind that rolling over the lump sum to an IRA, buying a longevity annuity with a portion of the proceeds and self-managing the remainder of the assets may help you better manage risks in retirement by diversifying your sources of retirement income.
 
Bottom line--Don't worry.  When it comes to your retirement, your federal government knows what is best for you.

Life Expected Income Breakeven Comparison Between SPIAs and Managed Portfolios

by Larry Frank Sr., John B. Mitchell and Wade Pfau 
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2317857 

A tip of my hat to Messrs. Frank Sr., Mitchell and Pfau for publishing this fine (and very thorough) paper.  The authors use a sophisticated Monte Carlo simulation approach to conclude that many retirees may find it financially beneficial to delay purchase of a single premium life annuity until a later age and self-manage their retirement assets until such age.

"The paper provides insight and guidance for the retiree decision making between whether to annuitize or manage their retirement savings."  While the authors' analysis examined this decision on an "either or" basis, it would be interesting to see their analysis for partial SPIA annuitization/partial self-management strategies (which could affect investment allocation decisions) or strategies that involve purchase of single premium deferred annuities (sometimes referred to as longevity annuities).

If you have read even a few of my prior blog posts, you will know that I am not a big fan of "set and forget" Safe Withdrawal Rates determined using Monte Carlo simulations.  As indicated in the authors' paper, the authors advocate a dynamic approach, described as follows:

"The newer camp is more dynamic with annually recalculated, serially connected, simulations to arrive at a Prudent Withdrawal Rate (PWR) that is sustainable given current conditions. Client annual reviews include annual updates to the simulation data to reflect 1) period life table changes and changes in personal health, 2) current portfolio value, 3) latest market data series, and 4) current year feasible spending needs. The dynamic school provides an ongoing method to address how often and by what method "revisiting" the PWR and making corrections to it recognizing that markets affect the safety of withdrawals and that time allows the PWR to increase."

Thus, while the authors use Monte Carlo simulations, they are using an approach that is similar to the actuarial approach advocated in this website.  In discussions with Mr. Frank Sr., he even refers to his approach as an "actuarial" approach.  Since it is so similar, he makes it very difficult for me to find fault with it.

This paper is a practical application of the previous work done by Messrs.  Frank Sr., Mitchell and Blanchett in three papers that describe in more detail their dynamic approach.  Links to these excellent papers may be found in Mr. Frank Sr.'s website and blog "Better Financial Education.com"

Renaming The Outcomes Of A Monte Carlo Retirement Projection

(Nerd's Eye View, August 14, 2013)
http://www.kitces.com/blog/archives/537-Renaming-The-Outcomes-Of-A-Monte-Carlo-Retirement-Projection.html#extended
 
When explaining outcomes of a Monte Carlo retirement projection for a safe withdrawal rate strategy, Mr. Kitces suggests replacing the phrase "probability of failure" with "probability of a mid-course correction" and replacing "probability of success" with "probability of accumulating excess assets."  He implies that this "framing" will help facilitate good decisions.
  
Does renaming the outcomes of such a projection, as advocated by Mr. Kitces, improve the safe withdrawal rate strategy or is he just putting lipstick on a pig?  In his article, Mr. Kitces implies that the safe withdrawal rate approaches he anticipates aren't really the "set-it and forget-it" approaches anticipated by Bill Bengen, the inventor of the 4% Rule.  He implies that a safe withdrawal rate strategy needs to be revisited periodically to make sure that the client's spending plan remains on track (assets don't shrink too rapidly nor grow too large).  If this is true, however, there seems to be little gained by doing all those calculations that comprise a Monte Carlo projection over doing a simple deterministic projection (except perhaps the impression of more precision).  In both instances incorrect projections of future experience need to be adjusted for actual experience.
  
Even though it employs a deterministic projection, I continue to believe that the actuarial approach outline in this website is superior to the "set-it and forget-it" safe withdrawal rate strategies.  Once Mr. Kitces describes how the approach he anticipates actually determines how and when mid-course adjustments are made, I might be more open to endorsing it.

Retirement Planning in an uncertain world

Steve Vernon (CBS Moneywatch, August 7, 2013)
http://www.cbsnews.com/8301-505146_162-57597036/retirement-planning-in-an-uncertain-world/
 
Another excellent post from my friend and fellow Fellow of the Society of Actuaries. Steve succinctly outlines the risks involved in planning for retirement in today's world and suggests the following two-step strategy:

1. "Step 1: Plan to support the life you want, using your best estimate of the future regarding the economy, capital markets, your life expectancy and so on.
2. Step 2: Be prepared in the event that your forecasts are wrong."

It would not be unreasonable to address the risks Steve outlines by employing some combination of (i) guaranteed lifetime income (immediate or deferred annuities, annuities from defined benefit pension plans and Social Security, including deferring commencement of Social Security to effectively buy increased lifetime income protection as discussed in my previous posts) and (ii) periodic withdrawals from self-managed assets.

The actuarial approach outlined in my website enables you to coordinate the spend-down of your self-managed assets with your guaranteed lifetime income and allows you to make the periodic adjustments Steve refers to "in the event that your forecasts are wrong."

The Power of Diversification and Safe Withdrawal Rates

Geoff Considine (Advisorperspectives.com, July 30,2013)
http://advisorperspectives.com/newsletters13/The_Power_of_Diversification.php
  
Mr. Considine argues that the 4% Rule is still a valid decumulation strategy provided the retiree's assets are invested in a more diversified portfolio than originally anticipated by Bill Bengen, the rule's inventor.

The 4% Rule keeps resurfacing like a vampire in a bad horror movie. As I have said many times in this blog, the 4% Rule (and most other Safe Withdrawal Rate approaches) have just too many weaknesses to be considered an optimal decumulation strategy. I will briefly summarize the 4% Rule and what I believe to be its major weaknesses below.

The 4% Rule. In the first year of retirement, withdraw 4% of your accumulated savings. In each year thereafter, withdraw no more and no less than the first year amount increased by measured inflation since the first year. Make no adjustments for actual investment performance and hope that the assumptions underlying the Monte Carlo analysis performed to determine the "safeness" of the rule pan out and that you die prior to exhaustion of accumulated savings (without leaving too much behind). 

Weaknesses of the 4% Rule. 

• It doesn't accommodate a payout period other than 30 years without adjustment.
• It doesn't accommodate a different investment approach without adjustment.
• It doesn't accommodate a desire to leave a specific bequest at death
• It doesn't accommodate a flexible spending schedule (for example if needed for unanticipated medical expenses or to use more assets early as a means to delay Social Security benefits as discussed in the previous post)
• It doesn't coordinate with other fixed income payments such as immediate or deferred life annuities or payments from defined benefit plans
• It doesn't adjust for actual emerging experience.

Of course if I didn't believe that the actuarial decumulation strategy set forth in this website wasn't superior to the 4% Rule, I probably wouldn't be here blogging away.

Efficient Retirement Design--Combining Private Assets and Social Security to Maximize Retirement Resources

John B. Shoven and Sita N. Slavov
Stanford Institute for Economic Policy Research (SIEPR)
http://siepr.stanford.edu/system/files/shared/documents/Efficient_Retirement_Design-March_2013b.pdf
  
The authors conclude "with today's life expectancies and today's extremely low interest rates, it is almost to everyone's interest to delay the commencement of Social Security.  For many people, it is the value maximizing strategy."  The authors also discuss value-maximizing strategies for when to claim benefits for two-earner couples, and suggest that individuals consider delaying commencement of Social Security benefits either by spending other accumulated assets after retirement and before Social Security commencement, by continuing to work, or through a combination of the two.  An excellent read for anyone who has not yet commenced Social Security benefits (or who is still able to defer their Social Security benefit commencement date).

Readers are reminded that this website contains a simple spreadsheet that enables retirees to model using their accumulated savings to "bridge" the period between retirement and commencement of Social Security benefits while attempting to maintain constant total spendable income in real dollars.

Plan on Living to 95

In my previous post, I referred once again to withdrawal strategy risk--the risk of either withdrawing too much or too little each year.  If we only knew when we were going to die, planning would be so much easier.  Some retirees believe that it is sufficient and appropriate to base withdrawals on their current life expectancy.  As we will see in this post, the very significant downside of this strategy is that withdrawals may not keep pace with inflation (or may even decrease in dollar amount) if you have the good fortune of outliving the life expectancy you used for planning purposes when you first retired.  Based on the Society of Actuary mortality tables, it is much more prudent to assume that you will live to your mid-90s (unless you have already reached your 90s) rather than use published life expectancies when developing your spending budget.

The exhibits below are based on Society of Actuaries Annuity-2000 male mortality tables with mortality projection.  These tables are available in this website at this link.  In both exhibits, the hypothetical retiree is assumed to have $500,000 at retirement at age 65 and desires to have constant real dollar withdrawals throughout retirement.  In the first exhibit, the individual retiring at age 65 assumes he will live exactly the number of years equal to his life expectancy (in this case 21.9 years).  Every fifth year thereafter he adjusts his spending plan based on his revised life expectancy.  His assets are assumed to grow at 5% per year and inflation is assumed to be 3% per year.  He is assumed to use the methodology outlined in this website for his withdrawal strategy with no other annuity income and no amounts left to heirs at death.

The first exhibit shows that if he lives to age 80, his annual withdrawal will only be 75% of his initial withdrawal in real dollar terms and if he lives to age 85, his annual withdrawal will only be about 54% of his initial withdrawal in real dollar terms.

By contrast, if his withdrawal strategy is such that he can live with a 30% chance of outliving his savings (by assuming that he will die at age 93 for the first 15 years, 94 if he makes it to 80 and 95 if he makes it to 85), he will be able to keep his spending constant in real dollar terms for 15 years.  Even if he takes this more conservative approach, however, he is still at risk of lower real dollar withdrawals after age 80.  But arguably he may be in a better position at his advanced ages to live with decreased real dollar retirement income.

According to the Society of Actuaries tables, Females generally have a 30% chance of living to approximately 95 until they reach age 80, at which time their expected age at death increases past age 95 in much the same way as anticipated for males.

Marketwatch, July 2, 2013

3 reasons retirees don’t spend
Adam Wolf

In my March, 2010 article describing the actuarial process set forth in this website, I discussed several risks associated with not sufficiently annuitizing accumulated retirement savings.  I talked about withdrawal strategy risk-- the risk of either withdrawing too much or too little each year.  Most experts focus on the risk of withdrawing too much, but in this article, Mr. Wolf focuses on the risk of withdrawing too little.

I agree with Mr. Wolf that, "Knowing your options can help you enjoy the retirement you saved so hard to provide for."  And knowing the options of How Much Can I Afford To Spend In Retirement is what this website is all about.

Risky Business:  Living Longer Without Income for Life
(American Academy of Actuaries, June 19, 2013)

A discussion paper released by the American Academy of Actuary’s Lifetime Income Risk Joint Task Force. "The discussion paper focuses on the issue of ensuring retirees secure income that lasts their entire lifetime and discusses potential solutions through changes in education, plan design, and federal retirement policy."

"What can be done to lower these [unnecessarily high hurdles to finding the right lifetime income solutions] and better prepare current and future retirees to secure and manage their lifetime income needs."

It is nice to see the Academy taking action on this important topic.

The discussion paper advocates expanding financial literacy and education for prospective retirees, refocusing plan design on lifetime income needs and implementing Federal retirement policies to support lifetime income needs.

While I believe that investing some or all of a retiree's accumulated retirement savings in a life insurance annuity product can be part of a reasonable retirement strategy, it appears to me that the discussion paper over-emphasizes the use of these products relative to other approaches.  While managed structured-income payments are briefly mentioned as a source of lifetime income, the paper points out that such approaches are not guaranteed, and they are not included as part of the paper's discussion of potential solutions through changes in education, plan design and federal retirement policy.

While a good start, I would like to see the Academy take a broader view of the potential solutions to the problems facing current and future retirees.  My specific recommendations to the Academy in this regard include:

1. The Academy should acknowledge that retirees may want to use some or all of their accumulated savings to provide for their retirement income needs through a structured series of payments rather than through guaranteed lifetime income insurance products.  And, those who make this choice need better guidance than the 4% withdrawal rule set forth in the discussion draft.  As I have indicated countless times, I believe the actuarial approach recommended in this website is one such better approach, particularly if the retiree wishes to coordinate the structured series of payments with other fixed annuity income.
2. Lifetime income products that provide fixed dollar payments do provide payments for life (and therefore appear to address one of the paper's definitions of Lifetime Income Risk), but those payments will be eroded by future inflation.  Therefore, income may become inadequate over time (and may not address another of the paper's definitions of Lifetime Income Risk).  Communication of such fixed dollar amounts in defined contribution plans may be misleading because it can overstate real dollar income throughout retirement and it may also be misleading if participants do not elect to purchase an annuity at retirement.  The Academy may wish to consider these factors when discussing this issue with policymakers.
3. Retirement planning generally does not end at retirement.  It is an ongoing process involving periodic assessment of many factors.  Education changes and potential solutions proposed by the Academy should address this reality.
4. As noted in the discussion paper, the risk pooling argument in favor of investing in insured annuities is compelling.  But this argument must also be weighed against anti-selection and profits built into insurance company pricing.  The Academy may wish to explore ways to make these items more transparent to consumers.
5. Given its relationship with the insurance industry, the Academy may wish to consider exploring whether it should be disclosing a potential conflict of interest when discussing the pros and cons of life insurance annuity products in accordance with Precept 7 of the profession's Code of Conduct.