IRS Proposes Neat New Way to Address Retirement Longevity Risk

IRS Proposes Neat New Way to Address Retirement Longevity Risk 

One of the big problems in determining how much of your accumulated savings you can spend each year in retirement results from the necessity of having to plan on living well into your 90s to make sure that you have enough money in case you actually live that long.  While this risk can be managed by buying an immediate annuity, many retirees balk at using most of their accumulated savings to purchase an immediate annuity when what they want is an annuity that starts at a later age.  However, the government's current minimum distribution rules under Section 409 of the Internal Revenue Code made purchases of annuities that deferred commencement after age 70 in qualified defined contribution plans or IRA's difficult.  In a welcomed change of policy, the new proposed rules would permit a specified portion of accounts in such plans to be used to purchase a "Qualified Longevity Annuity Contract" (QLAC) without affecting the minimum distribution rules for the remainder of the account.
 
Under the proposed regulations, premiums for the QLAC could not exceed the lesser of 25% of the account balance or $100,000.  The QLAC would provide for distributions to start at some date in the future but not later than when the contract holder attained age 85.  No benefits could be provided under the QLAC after the contract holder's death other than life annuities payable to designated beneficiaries.
 
More detail can be found in the proposed regulations published in the Federal Register on February 2 of this year.  It is important to note that under the proposed rules, QLACs will not be available (and therefore cannot be used) until the proposed regulations are finalized. 

Is the 4 Percent Rule Viable?

Is the 4 Percent Rule Viable? 
Ruffenach: A fresh look at the 4 percent retirement-withdrawal rule.
Glenn Ruffenach (SmartMoney, January 17, 2012)

Excerpt: "But here's the real lesson: Retirement planning -- or rather, good retirement planning -- is never really finished. Ideally, your particular plan is open to new ideas and research and, as such, is able to evolve."

Can you retire before 2013?

Can you retire before 2013?
Jeff Wuorio (MSN Money, December 23, 2011) 

Comment:  Not a bad article, but one that does demonstrate that when you plan for retirement, you need to pay attention to:

1) the tax treatment of various sources of income (and make sure that you treat them consistently), and

2) whether or not sources of income increase with inflation

In the example in the article, the author determines that the retiree will need $600,000 of taxable accumulated savings (like a 401k plan) to replace pre-retirement standard of living.  However, if we assume a 20% effective tax rate on all income sources, 3% inflation and a 5% return on assets, the net annual income target of $63,600 ($5,300 per month) becomes $79,500 before taxes and $59,100 after subtracting Social Security.  In order to generate annual real income of $59,100 per year for a 25 year period, the spreadsheet above indicates that the retiree would need to have about $830,000 in accumulated savings, not $600,000.

Floor-Leverage Rule Instead of 4% Rule

Floor-Leverage Rule Instead of 4% Rule 
SSRN - November 18, 2011 

Comment: Under this rule, the authors suggest building an income floor with 85% of accumulated assets, investing the remaining 15% of "surplus assets" aggressively in a portfolio with a 3x leverage factor and transferring assets from the surplus asset fund annually if it grows to be larger than 15% of total accumulated assets.

Retirement '4 percent' rule not sure thing

Retirement '4 percent' rule not sure thing 
Gail MarksJarvis (Chicago Tribune, November 14, 2011) 

 

Comment: Her solution to 4% rule problems--Take out 3.5% in initial year and skip inflation increases if market goes south.

"Research & Reality--A Literature Review on Drawing Down Retirement Financial Savings"

"Research & Reality--A Literature Review on Drawing Down Retirement Financial Savings" 
(Society of Actuaries) The stated objective of this paper is to "review the existing literature on this multifaceted topic so as to draw clear insight on the best approach to drawing down individual retirement savings." 

 

Comments:  Comprehensive (64 pages) review of academic literature focusing on combinations of annuitization and self-managed drawdown strategies.  Pages 48-54 provide considerations for a person "contemplating self-managing some or all of his/her retirement assets" (i.e., the individuals for whom this website has been designed).  Most of the considerations noted by the authors in these pages can be addressed using the simple spreadsheet and the process set forth in the March, 2010 article above.

Vanguard looks at ways to spend retirement savings

Vanguard looks at ways to spend retirement savings
Vanguard (March 1, 2011) 
 
Interesting read.  Stochastically testing three spending strategies using proprietary data and assuming a 50% equity/ 50% bond investment mix (rebalanced each year), the Vanguard Investment Strategy group determines that the "percentage-of-portfolio" approach with limits on annual increases or decreases in the previous year's amount is preferable to the other two approaches studied.  Article implies that a 4.75% initial withdrawal rate is reasonable for a 35-year payout period and the 50%/50% investment mix (implying about a 3.5% real annual rate of investment return using the "Excluding Social Security" spreadsheet above).  There appear to be some mixed messages in this article as the authors state that maintaining a flexible spending plan is key, but recommend a plan that is not flexible, and they fail to address how their recommended plan should be adjusted for adverse (or favorable) experience. 

Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle

Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle
Wade Donald Pfau (National Graduate Institute for Policy Studies, February 11, 2011) 
 
Take-away for retirees and those close to retirement: If you saved 16.62% of pay each year for 30 years preceding retirement, are targeting a 30-year pay-out period, invested 60% equities/40% fixed income pre-retirement (and intend to keep this investment mix post-retirement with annual rebalancing), received pay increases each year equal to the increase in inflation, then historical data shows that you can withdraw whatever you need each year after retirement to have inflation adjusted income from accumulated savings of 50% of your final year's pay. The 16.62% figure refers to what was needed in the worst-case scenario from the historical data. If some of these assumptions don't apply, you need to make necessary adjustments in your withdrawal rate. Table 1 of Pfau's paper provides hints for adjusting for experience different from base assumptions.

The Big Financial Stretch: Preparing for Those Later Decades

The Big Financial Stretch: Preparing for Those Later Decades
Knowledge@Wharton (December 06, 2010)

Good article.  Two comments:

The article asks (but does not answer) the question, "How much is enough for retirees to live on?"  I hope that visitors to this site realize that they can use the simple spreadsheet to "back into" how much accumulated savings they will need to produce their desired level of real annual income in retirement.

This is another article that raises concerns about the 4% Withdrawal rule.  "Critics say such guidelines should not be blindly followed.  The 4% rule 'just doesn't work' when investments are tumbling, says Stezfand [Director of Financial Security] of AARP."

Make Your Money Last a Lifetime, 3 ways to stretch your savings in retirement

Make Your Money Last a Lifetime, 3 ways to stretch your savings in retirement
Jane Bryant Quinn (December 1, 2010, AARP Bulletin)