If your clients are seeking sustainable income in retirement, perhaps they need to become a little more flexible — at least in terms of their withdrawals.
Variable withdrawal strategies — tactics that permit clients to adjust their spending habits according to market activity, time horizon and portfolio value — were the focus of a Tuesday session at the AICPA's Personal Financial Planning conference.
The search for sustainable income is top-of-mind for advisers, given that wealthier couples have a 43% chance that one of two spouses will live beyond age 95, noted panelist Michael Finke, a professor in Texas Tech University's personal
financial planning program.
But it's not enough to just accumulate assets. Market conditions in the first few years of retirement are extremely important in shaping whether the nest egg will last 30 years. That's what's known as sequence of return risk, noted panelist Michael Kitces, partner at Pinnacle Advisory Group
Indeed, modeled into a 30-year time horizon from 1969 to 1999, a portfolio that was allocated 60% in equities and 40% in bonds had an average return of 11.48%. But that performance average over time masks the fact that the hypothetical investor has some very painful results for the first 12 years of that retirement.
ZERO PERCENT RETURN
“Unfortunately, you get [the average return of 11.48%] by having returns of almost zero for 12 years and 8% for the next 18 years,” said Mr. Kitces. “You're broke in five years.”
Wade Pfau, professor of retirement income at The American College, noted that economic conditions and timing of retirement are also key when looking at retirees around the world. In an analysis of a list of nations and their most difficult economies, he calculated what would be considered a safe withdrawal rate for that period.
Japan, for instance, experienced a rough period of hyperinflation after World War II.
“A retiree [at that time] would have been looking at a safe withdrawal rate of 0.26%,” Mr. Pfau said
David Blanchett, head of retirement research at Morningstar Investment Management, discussed the three stages of retirement, noting that retirees' spending patterns tend to shift throughout that period.
During the “go-go” stage, young retirees travel and maintain their lifestyle. They slow down in the period between ages 70 and 84, with costs dropping by up to 30%, and they become “no-go” afterward, as they're elderly and no longer spending as much.
Hence, retirees should be adjusting spending as they go, pending economic conditions and lifestyle needs.
“If inflation is higher than you expect, spend less,” said Mr. Blanchett. “There are different levers.”
Mr. Finke noted that wealthy clients who socked away every cent during their working years tend to continue those miserly spending habits in retirement. Referring to the allegory of the ant who stored up his food for the winter and the grasshopper who didn't save up and went hungry in winter, Mr. Finke noted, “the ants have a difficult time turning into grasshoppers in retirement.”
Nevertheless, it's not really a win if clients skimp on retirement when they can afford to spend a little more, conditions permitting.
“You kind of lose if you die with a ton of money in the bank,” said Mr. Finke. “Why not say at some point that you can ramp up spending a little bit if you're doing so well? Reduce your risk if your portfolio doesn't do so well.”
“Make spending a little more variable,” he added.
