In summary, we like Steve’s approach. It is arguably simpler than our approach, but in our opinion, it is not as robust. We believe the extra functionality of our approach outweighs the possible extra complication of using it. However, we may not be unbiased in this matter and, if Steve’s approach appeals to you, we have absolutely no problem if you would like to use it (in addition to or in lieu of our approach) in your retirement planning.
Background
Steve is president of Rest-of-Life Communications and a research scholar for the Stanford Center on Longevity. He has:
- written six books on retirement (and is working on his seventh),
- has published many, many online articles,
- is quoted frequently by other retirement experts, and
- is active with research, writing, and speaking on retirement planning issues, including finance, health, and lifestyle.
Steve Vernon’s Retirement Income Strategy
Steve’s basic retirement income strategy (referred to as Spend Safely in Retirement Strategy, or SSiRS) is discussed in the joint Stanford Center for Longevity/Society of Actuaries report entitled, “Viability of the Spend Safely in Retirement Strategy.” This report was co-authored by Steve, Dr. Wade Pfau and Joe Tomlinson. Full disclosure: Ken participated in the project oversight group for the Society of Actuaries on this project. Readers may be interested in reading Section 7.1 of this report, Actuarial Methods, which discusses how Actuarial Approaches can be more robust than the SSiRS (and potentially more complex), and the report actually refers readers to our website for an example of application of an Actuarial Approach.
Steve’s SSiRS strategy involves:
- Deferring commencement of Social Security benefits,
- using cash (or other low risk investments) during the “bridge period” between retirement and Social Security benefit commencement to replace Social Security benefits that could have been received, and
- annual withdrawals from accumulated savings using a Systematic Withdrawal Plan (SWP) based on the IRS Required Minimum Distribution (RMD)
Steve has apparently recently modified his basic SSiRS somewhat in light of the recent stock market drop to make it more effective as a risk management strategy. In his April 6 Forbes article, Steve said,
“The good news: There’s an overall retirement income strategy that can really help nowadays. With this strategy, retirees cover their basic living expenses with guaranteed sources of retirement income, such as Social Security, pensions, Annuities, and systematic withdrawals from fixed income investments. Then they can pay for discretionary living expenses with the money they receive from systematic withdrawals from assets that are significantly invested in stocks. They should always be prepared to reduce their discretionary spending during financial crises, like the one we’re in the midst of today.”The recent modification involves estimating basic living expenses and discretionary expenses and using different types of assets to fund these expenses. Structured withdrawals from fixed income investments would be used (together with income from other less risky investments like Social Security and pensions) to fund basic living expenses, and structured withdrawals from equity investments would be available to fund discretionary expenses. Since we have been promoting a very similar risk management strategy involving establishing a Floor Portfolio of low-risk investments to fund Essential Expenses and an Upside Portfolio of risky assets to fund Discretionary Expenses, we like Steve’s recent modification of SSiRS.
Side by side comparison of approaches
The table below briefly summarizes the two approaches. Steve’s approach develops a spending budget by cobbling together annual income expected from various sources, and our approach develops an annual spending budget by using basic actuarial principles to spread all assets over the individual’s (or couples) expected lifetime and anticipates annual future increases in the actuarially determined spending budget. Both approaches anticipate annual adjustments to adjust for actual experience.
| Item | Steve’s Approach | Our Approach |
| Estimate expenses | Estimate current year’s expenses and categorize them as either
| Estimate current year’s expenses and categorize them as
|
| Current year spending budget for basic living (essential) expenses | Current year amount expected from Social Security, pensions, Annuities and RMD-determined withdrawal from fixed income investments. Presumably, amount invested in fixed income is increased if total current basic living budget is less than estimated current basic living expenses. | Current year actuarially determined spending budget for:
|
| Current year spending budget for discretionary expenses | RMD-determined withdrawal from assets that are significantly invested in stocks | Current year actuarially determined spending budget for non-recurring and recurring discretionary expenses from Upside Portfolio (Present Value of investments in more risky assets like stocks). Upside Portfolio expected to fund Present Value of lifetime Discretionary Expenses. |
| Periodic adjustment process |
|
|
Why we think it is worth your while to use our approach
Instead of cobbling together various sources of income and comparing the sum of your income for the year with the sum of your expenses for the year, we favor using basic actuarial principles and Present Values to determine a sustainable spending strategy for the rest of your expected lifetime based on all your assets and all your spending liabilities. For that reason, we are not big fans of Strategic Withdrawal Plans (SWPs) in general and the RMD SWP specifically, as discussed in our post of March 3, 2018. You may also wish to visit our post of December 4, 2018 where we describe the Top 10 Reasons Why the Smoothed Actuarial Budget Benchmark is Superior to the IRS RMD for Developing Spending Budgets, including
- RMD was not designed to be part of a sustainable spending plan. It was designed by the IRS to make sure that individuals pay taxes on their tax-sheltered accounts.
- The RMD withdrawal factors are not based on one’s life expectancy, but the joint life expectancy of the account owner and a hypothetical spouse ten years younger. It is also based on a 0% discount rate assumption, and therefore is more conservative than the Actuarial Approach.
- Application of RMD is unclear for ages under 70 (now 72).
- RMD doesn’t coordinate with other sources of income. For example, it doesn’t coordinate with income expected to be received in a future year, such as a spousal pension or a deferred Annuity (such as a QLAC). It also doesn’t coordinate with income that may only be received temporarily, like installment payouts from a 401(k) plan or part-time employment income.
- RMD doesn’t consider Non-Recurring Expenses.
- RMD doesn’t work very well for couple’s budgeting.
- RMD is inflexible and doesn’t accommodate “budget shaping,” where expected expenses vary over the period of retirement
For those who don’t mind using a slightly more complicated version of our approach, you might try using more aggressive assumptions to determine budget amounts payable from your Upside Portfolio as discussed in our post of November 12, 2019.
Summary
While we applaud Mr. Vernon’s efforts to improve the SSiRS to make it a more effective risk management strategy, we believe our Recommended Financial Planning Process using our Actuarial Budget Calculator (ABC) is a much more robust approach. However, if Mr. Vernon’s revised SSiRS approach appeals to you, we have no problem if you want to use it. We suggest, however, that you compare the budgets produced by the two approaches before you commit.
Note
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