Comparing Income Planning Methods for Retirement
It seems there will always be a difference of opinion when it comes to income planning and which method provides the optimal level of income in retirement. Insurance licensed advisors may try and convince you that you should put all your money into annuities, touting guarantees and payout rates. Stock brokers and mutual fund salesmen paid on a fee-only basis or commission basis may try and convince you that you must put all your money in a “balanced portfolio” of stocks and bonds and take out the safe withdrawal rate of 4% (this withdrawal rate is pretty safe if you only live to 85 or 90) It may fail if you live past 90. With 10,000 people in America already at age 100, your plan should be designed to last until you live to age 100. The best solution actually involves a little of both using a math and science proven combination of securities and insurance products.
I compared the 2 most common methods to see which one had a higher chance of success. Forget about the “bond ladder”. Interest rates are too low at the time of this article to achieve high level of success to age 100.
Option 1 : Balanced portfolio of 60% stock funds and 40% bond funds or fixed income with 4% systematic withdrawals. Sometimes called the “bucket approach”
Option 2: Buy income and invest the difference in a growth focused portfolio.
Here are the results:
Case study: Female client age 70 with $500,000 IRA
Current income: $40,000 comprised of:
$25,000 Social Security
$15,000 pension
Expenses $65,000
This means she needs to generate $25,000 from her $500,000 IRA. This is a 5% withdrawal rate. (500,000 X .05) Lets take a look at this problem and use Systematic withdrawals and the bucket approach to solve for needed income shortfall. It might look something like this.
The Bucket Approach and Systematic withdrawals from a balanced portfolio of stock funds / ETF’s and intermediate term bond funds / ETF’s
Bucket 1-$50,000 Bucket 2-$125,000 Bucket 3-$325,000
Year 1-2: $50,000 added to money market account. (This will be spent to $0 over the next 2 years)
Year 3-7 $125,000 to Fixed income (short to intermediate bond funds or short term bonds) to be spent down to $0 starting in year 3
Year 8-10 – Harvested gains from the balanced portfolio (bucket 3) estimated annual total return at 5% annually (no losses hypothetically shown in any years… which may not happen)
Over 7 years, the balanced portfolio hypothetically grew to $81,250. Every year or in year 8, the total growth is added to the cash account. This could provide income until the end of year 10.
In year 11– Repeat the above steps. Note: Your account balance should be somewhere around $150,000 principle left of your $500,000 after repeating previous steps unless the portfolio performed better than 5%.
At beginning of year 21, repeat the process. At 93, you stand the chance of being out of money…unless you earn more than 5%, (barriers to success: Long term care needed, market crashes and delivers less than 5% annualized returns, unplanned expenses increase your required income needs)
Lets look at another option. Countless studies have been done at the PhD level (Mechem Yaari, Moshe Milevsky, David Babel) proving there is an OPTIMAL way to achieve lifetime retirement income using math and science. Hundreds of studies exist to determine the “safe withdrawal rate” (Bengen, Blanchett, Pfau, Stern, Bernicke) Notice I did not say “best”. We don’t know how long you or your surviving spouse will live if married, so “best” is difficult to plan for. Also, many studies as pointed out by Michael Stern (1998 -Prosperous Retirement Guide) and Ty Bernicke (2005-Reality Retirement Planning) suggest that using a fixed inflation percentage based on historical averages actually ignores reality spending by retirees as they age. Actual data may support a reduction in spending as age 80 and higher is attained.
OPTION 2 Buy income and invest the difference in Growth Portfolio.
This strategy requires generally less money to achieve the same income target because it is age based and not “rate of return” based. With fixed income needs covered with guaranteed lifetime income, you are more free to invest the remaining dollars for growth (80/20 or 100% equity portfolio) or to buy products designed to create a larger inheritance for your heirs or favorite charities.
Bucket 1- $50,000 money market Bucket 2-$120,000 Deferrred Income Annuity (DIA) Bucket 3 – $120,000 DIA-2 Bucket 4- $210,000 (80/20 stocks/ ETF’s / fixed income or 100% stocks /ETF’s )
Year 1-2 $50,000 -money market
Year 3-7 – $120,000 – deferred income annuity 1* -This provides a 70 year old female with almost $26,000 income for life beginning in year 3.
Year 8-Life $120,000 – deferred income annuity 2*- This provides $32,016 more income beginning in year 8 and pays until the death of the annuitant
Growth portfolio- $210,000 – At an 8% return (less than 20 year S&P average annual return) which is achievable using basic index funds with very low fees over time, (no recommendation being made) this amount could potentially have grown back to $420,000. You could buy more income or not if needed. The choice is yours.
By separating assets that provide income from assets that provide growth, you generally get a more efficient retirement income plan. Since your income shortfall can be guaranteed with Lifetime income insurance contracts, you may not have to watch what the stock market does every day. What would that mean for you?
By year 8 our client could enjoy an increase in income for life of nearly $26,000 more dollars. There are several ways to approach the income dilemma but math and science prove that it is very hard to beat a strategy that works no matter how long you live. To see how guaranteed lifetime income could work in your retirement planning visit us online at www.robertscottwealth.com and book a complimentary appointment. Don’t take our word for it, let us prove it to you.
notes: payout rates are based on the age, payout method, gender of the annuitant and the date issued. These variables may change on a case by case basis.. Investing in securities involves risk and past performance is no guarantee of future performance. Any guarantees mentioned refer in no way to investments or investment advisory services. Guarantees are provided by the claims paying ability and financial strength of the insuring company. Nothing in this post should be construed as investment, legal, or tax advice. You should seek the counsel of an appropriately licensed professional for this kind of advice.
*life with 5 year guarantee payout used, female age 70. Cash refund design would work as well but would require more money at inception. No investment, tax, or legal advice being given with this post.