Will You Run Out of Money in Retirement? The Right Income Plan Can Help
You may have heard of the 4% Rule, used to determine how much you can safely pull from your portfolio to fund your retirement. But here are three other income plan strategies that might be better for you.
One of the most persistent analogies I have heard in my career as a financial adviser is the story of climbing and descending Mount Everest. As the story goes, more climbers perish on the way down the mountain than do climbing up it. We then equate our clients’ wealth journey with that of climbing Mount Everest – spending lots of time and effort to get to the summit of peak financial wealth (i.e., retirement) only to be left with the question, “How am I to descend the mountain safely?”
While many analogies are tired and overdone, this is actually not a bad one. The problem is this: We as an industry have done an awful job at guiding our clients down the mountain with the same degree of care that we provide on the way up.
Until just within the last decade or so, our standard answer for descending the retirement mount has been the venerated “4% Withdrawal Rule,” popularized in the mid-’90s by historical study of withdrawal rates by William Bengen. Although this rule has been regarded as relatively failsafe, many of the assumptions used in its origination are incongruent with many of the assumptions we make for our clients’ retirement roadmap today.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
There is a better way to help clients build an income strategy for retirement, and our clients deserve just that.
3 Alternatives to the 4% Rule for Your Income Plan
Most advisers are already familiar with the concept of probability-based planning using Monte Carlo analysis. The same concept holds true for distribution planning. Although we cannot ensure a given level of income from the portfolio over time, we can reasonably expect the portfolio to provide it in most scenarios.
The task becomes how to actually structure the withdrawals to stay within the acceptable probability of success range. Within this category there are two similar but distinct ways to converting a portfolio into income throughout retirement.
Income Approach No. 1: Dynamic Systematic Withdrawals
The first approach is what is called dynamic systematic withdrawals, or systematic withdrawals with guardrails.
This approach modifies the traditional systematic withdrawal approach by introducing decision rules, or “guardrails,” to determine when and how distributions may increase or decrease over time. These decision rules are set forth at the creation of the plan and inform the decision to reduce withdrawals to accommodate increased risks related to the markets, longevity, inflation or sequence risk.
Some examples of these rules inlcude Jonathan Guyton’s and William Klinger’s decision rules, floor and ceiling rules, and targeted portfolio adjustments. In their study, Guyton and Klinger found that a sound set of decision rules could potentially increase the initial withdrawal rate by as much as 100 basis points.
Who may want to use this method: This approach may be the most appropriate for retirees who are willing to tolerate some fluctuation in their retirement paychecks (subject to some limits, of course) but who want to start out with as high an income as possible.
Income Approach No. 2: Bucketing
The second probability-based philosophy of converting a portfolio into retirement income is called time-segmentation or, more commonly, bucketing. The term “bucketing” has been used and reused to fit a wide set of applications. Within the context of retirement income planning, bucketing refers to the breaking up of retirement into distinct time increments and investing for specific outcomes at specific times. The idea is, if I know I won’t need to touch a sum of money until some specified date in the future, I will be more comfortable riding out fluctuations in the value of that bucket.
A simple way to set up buckets is to separate the portfolio into time segments corresponding with the “Go-Go” years, the “Slow-Go” years, and the No-Go” years of retirement, although there are many ways to achieve the same end using other methods of segmentation. These different time periods in retirement typically represent different spending patterns.
Who may want to use this method: This second approach to retirement income planning may be the most appropriate for retirees who desire more structure in their plan and who would typically need more behavioral coaching along the way using systematic withdrawals. These clients may have a lower-than-average risk tolerance for their age, and they are likely to be more detail-oriented.
Income Approach No. 3: Safety-First Planning
Our third approach to retirement income planning has wide acceptance in the academic community, garnering support from multiple Nobel laureates and a wide array of academic thought leaders. The safety-first approach, also known as the flooring approach, is tied to the academic theory of life-cycle finance. This theory seeks to address the question of how to allocate resources over one’s lifetime so as to maximize lifetime satisfaction, given existing spending constraints.
Put simply, in the safety-first approach you help the client categorize their expenses into needs, wants and wishes. You then create a floor for their needs using pensions, Social Security, bond ladders and income annuities. In this process, it is essential that the financial adviser does not project their own perception of what should be considered needs and/or wants. This should be left entirely up to the client(s), with the adviser as a guide.
Who may want to use this method: This approach lends itself more to individuals and couples who focus more on their cash flow than their wealth and to those couples who are relatively healthy with long expected lifespans.
The Bottom Line on Income Planning
Whichever approach you and your client ultimately decide upon, one thing is inevitable: You will have presented your client with a thoughtful and methodical approach to designing their plan, their way. After all, what good is a Sherpa who guided you all the way to the top of Mount Everest only to tell you he didn’t know how to safely get back down?
To continue reading this article
please register for free
This is different from signing in to your print subscription
Why am I seeing this? Find out more here
As Director of Financial Planning at Spotlight, Brian Blackwell is responsible for the company’s financial planning and advice program. He focuses on enhancing our clients’ experience through the development of complex plans and strategies to improve their overall financial well-being. Brian holds the Chartered Financial Consultant designation from the American College, is a CERTIFIED FINANCIAL PLANNER™ professional and has over a decade of experience advising high-net-worth households.
-
How to Help Your Kids Without Ruining Your Retirement
Here are some general considerations to ensure the gift of assets to your kids will not negatively affect your financial future.
By Mario Hernandez Published
-
AI to Power the Next Generation of Robots
The Kiplinger Letter There's increasing buzz that the tech behind ChatGPT will make future industrial and humanoid robots far more capable.
By John Miley Published
-
How Annuities Can Help You Retire Early and Delay Social Security
Waiting until 70 to claim Social Security benefits can pay off, so how do you bridge the gap between giving up your paycheck and filing for benefits?
By Ken Nuss Published
-
How to Get Your Kids to Step Off the Gravy Train
A surprising number of young adults live with their parents. Setting some financial ground rules could get the kids out on their own faster.
By Neale Godfrey, Financial Literacy Expert Published
-
Spring Is a Good Time to Clean Up Your Finances, Too
While you’re decluttering your home for spring, consider taking a crack at cleaning up your finances and old paperwork, too.
By Tony Drake, CFP®, Investment Advisor Representative Published
-
Is Your Retirement Solution Hiding in Plain Sight?
Here’s how to use your home equity in combination with an annuity contract to produce late-in-life income.
By Jerry Golden, Investment Adviser Representative Published
-
How to Choose Your Trustee or Executor of Your Will
Above all, you should choose someone you trust, keeping in mind that acting as a trustee or executor can be a complex, thankless and sometimes long-term job.
By John M. Goralka Published
-
Three Steps for Women to Take Control of Their Finances
These strategies are especially for women who are new to managing their money because of divorce or the death of a spouse.
By Emily Glassman Published
-
How AI Can Help Take the Emotion Out of Investor Decisions
AI-driven recommendations can complement human judgment, leading to more rational choices that aren’t as influenced by biases and blind spots.
By Francis Geeseok Oh Published
-
Can You 1031 Exchange into a REIT?
No, you can't, but two other REIT-like alternatives let you defer capital gains taxes while giving you exposure to institutional-quality real estate assets.
By Daniel Goodwin Published