Wednesday, December 21, 2016

Warning Labels Needed for Systematic Withdrawal Plans (SWPs)?

As discussed in our post of October 27, 2016 and November 11, 2016 Advisor Perspectives article, adding
  • the amount determined under one of the many systematic withdrawal plans (SWPs) advocated by retirement experts today (like The 4% Rule, for example) to 
  • income available from other sources in retirement
may, in many cases, produce a spending budget that is inconsistent with a retiree’s spending objectives.

Yet, much like in the 1960’s when cigarette smoking was much more prevalent, literature advocating new and improved SWPs is ubiquitous.  For example, just this month in his Forbes article, Dr. Wade Pfau compares ten SWPs that he unfortunately misclassifies as “retirement spending strategies.”

As suggested in our Advisor Perspective article, to avoid misleading financial advisors and DIY retirees, advocates of using SWPs should make it clear that simply adding the amount developed by their SWP algorithm to income available from other sources may not be consistent with a retiree’s spending goals in retirement.  Since the Surgeon General’s cigarette warning labels have been quite successful in helping to curb cigarette smoking in the U.S., we suggest a similar approach for SWPs.   We propose the following “Actuaries’ warning label” be attached to each SWP:

In addition to the normal investment and longevity risks associated with utilizing a systematic withdrawal plan (SWP), adding income from other sources to withdrawals determined under this SWP may NOT produce a reasonable spending plan in retirement. 

Now, to avoid misleading our readers, we must disclose here that the actuaries proposing this “Actuaries’ Warning” are the two retired actuaries responsible for this blog.  We want to make it very clear that our opinions do not represent those of the entire actuarial profession.  On the other hand, we would be more than happy to have one or more of the various actuarial organizations join us in proposing the use of such a warning.

What is Wrong with SWPs?

Why are we so down on SWPs?

  • SWPs are withdrawal approaches, not strategies focused on sustainable spending.  They tell you how much you can withdraw from your investment portfolio, but they don’t tell you how much you can afford to spend during the year.  As discussed in our December 16 post, we believe retirees need to know approximately how much they can spend. 
  • SWPs assume that all non-recurring expenses in retirement, such as long-term care costs, bequest motives and unexpected expenses, will be funded through some other unspecified resources. 
  • SWPs aren’t coordinated with income from other sources in retirement.  An SWP determines an amount to be withdrawn from one’s investment portfolio each year.  That amount is determined without regard to other income that may be available to the retiree that year.  If income from other sources is front-loaded, back-loaded or simply varies from year to year, adding the amount determined by the SWP algorithm to income from other sources will generally NOT produce a reasonable spending budget for that year. 
  • Even if income from other sources is relatively constant in real dollar terms over the retiree’s lifetime planning period, adding the SWP amount to the income from other sources during a year may not produce a spending budget that is consistent with the retiree’s spending objectives.  For example, a retiree with only an investment portfolio and a Social Security benefit that has already commenced may desire to have decreasing spending budget in future years, in real dollar terms.  For this retiree, this desire implies that she should have front-loaded withdrawals, not withdrawals that are expected to be constant in real dollar terms.
How can you get a Reasonable Spending Budget?

Well, you came to the right place.  Instead of using an SWP, you (or your financial advisor) can use the basic actuarial principle of matching the present value all your assets with the present value all your spending liabilities, discussed in this website, to develop a spending budget that is consistent with your financial goals in retirement.  We have also Excel Actuarial Budget Calculator (ABC) workbooks to make this task easier for you.