Tag: sequence of returns

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Retirement Asset Planning Retirement Income Planning

Don’t Plan to Squeak By Into Retirement

Let’s face it. We’re a “just in time” society. With our busy lives, we do a lot of things at the last minute. Many people thrive on the adrenaline rush that often accompanies completion of a project right before its deadline.

Retirement income planning lesson #1: Don’t plan to squeak by into retirement. We simply cannot apply our “just in time” thinking to retirement. Retirement income planning is complicated, with too many things that can go wrong, many of them beyond our control. It requires a totally different mindset that runs contrary to the way most of us are use to thinking.

While there are no guarantees, a retirement income plan that’s begun and frequently revisited well before and throughout retirement provides the best opportunity for success. The basic goal of any retirement income plan is for your money to outlive you. When you see headlines like “Boomers’ Retirement Confidence Sinks,” you know this isn’t an easy goal to achieve.

Retirement income planning is especially tricky. It is quite different from retirement planning where the primary objective is accumulation of assets to obtain financial security throughout one’s retirement years. Traditional retirement planning isn’t enough to get you to the finish line in most cases today.

It’s too easy to have a false sense of comfort that one’s accumulated assets are sufficient to last for the duration of retirement only to be unpleasantly blindsided by the “sequence of returns” in the first several years of retirement. For those of you who aren’t familiar with this term, it is a series of investment portfolio returns, usually expressed annually, that has a direct impact on the longevity of an investment portfolio during the withdrawal stage. See The Sequence of Returns – The Roulette Wheel of Retirement that includes a comparison of three scenarios to help you better understand the importance of this risk to a retirement asset plan.

Retirement income planning takes retirement planning a step further. It requires planning for a predictable income stream from one’s assets, that when combined with other sources of income, is designed to meet an individual’s or family’s financial needs for the duration of retirement. This is a very important distinction. Locking in a predictable income stream in advance of one’s retirement reduces the impact of a down market in the early years of retirement.

A retirement income plan needs to have a secure floor of retirement income that will last for your, and, if applicable, your spouse’s lifetime. The timing and after-tax amount of the floor needs to correspond to ongoing and one-time predictable and unpredictable expenses that will fluctuate during different periods of retirement adjusted for inflation. To the extent that known income streams, e.g., Social Security, aren’t projected to be sufficient to cover expense needs, other sources of sustainable income need to be developed well in advance of retirement.

Don’t plan to squeak by into retirement. Trust me – there won’t be any adrenaline rush.

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Annuities Fixed Index Annuities Social Security

Delayed Gratification is the Key to Maximizing Income with Fixed Index Annuities

When you’re planning for retirement, income is the name of the game. The more sustainable income that you can generate, the less you need to worry about things like sequence of returns and major stock market downturns – before and during retirement.

The idea is to build a base, or floor, of predictable income that will cover your day-to-day expenses. For most people doing retirement income planning, Social Security is the core element of an income floor. Although pre-retirees today can plan to receive a full Social Security benefit beginning somewhere between age 66 and 67 depending upon their year of birth, the benefit that they, and potentially their spouse, will receive will increase by 8% per year for each year that they defer their start date up until age 70. This equates to as much as a 24% – 32% greater benefit depending upon your year of birth and how long you defer your start date.

Assuming that your goal is to build a solid base of sustainable income with the ability to increase your lifetime income amount similar to Social Security, one of the best ways to do this is to invest in a flexible fixed index annuity (“FIA”) with an income rider. The reason that you want to use a flexible, vs. a single, premium FIA is to provide you with the ability to add to your investment should you choose to do so. In addition, you need to purchase an income rider, which is optional with most FIA’s, in order to receive guaranteed (subject to the claims-paying ability of individual insurance companies) income.

Like Social Security, the longer you wait to begin receiving your income, the greater it will be. Unlike Social Security benefits which are increased by cost of living adjustments (“COLA’s”), the lifetime income from the majority of FIA’s available today will remain unchanged once it’s started.

To demonstrate the benefit of deferring the start date of FIA income withdrawals, let’s use one of the contracts purchased by my wife and me two years ago when we were 55 and 48, respectively. I will use my wife’s age as a point of reference for the remainder of this post since income withdrawal amounts are always calculated using the younger spouse’s age.

Per our annuity contract, my wife and I are eligible to begin income withdrawals at least 12 months after our contract was issued provided that both of us are at least age 50. It generally doesn’t make sense to take withdrawals from a FIA income rider before age 60 since the formula used to calculate the withdrawal amount is less favorable and the withdrawals will be subject to a 10% IRS premature distribution penalty and potentially a state penalty. Assuming that we plan on retiring after my wife is 60, there would be no need to begin income withdrawals before this age.

I have prepared a spreadsheet with various starting ages in increments of five years beginning at 55 through 75. The spreadsheet shows the projected percentage increase in our annual income withdrawal amount that we will realize by deferring our income start age compared to ages that are 5, 10, 15, 20, and 25 years younger, depending upon the starting age chosen.

Using an example that’s comparable to the Social Security starting age decision, suppose that we decide to defer our income start age from 65 to 70. This would result in a 31.2% annual increase in lifetime income. We will receive 120.3% more income if we begin our income withdrawals at age 70 instead of at 60. The percentage increases are significant in many cases depending upon the chosen withdrawal starting age compared to another potential starting age.

Similar to the Social Security starting age decision, there are numerous factors that need to be considered when determining the optimal age to begin income withdrawals from a FIA with an income rider, a discussion of which is beyond the scope of this post. Like Social Security, when possible and it makes sense, delayed gratification is the key to maximizing lifetime income.

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Retirement Income Planning

A Retirement Paycheck is Essential

Retirement Income Center

Last week’s post, Where Have All the Pensions Gone? made the point that given (a) the scarcity of traditional defined benefit pension plans, (b) the inability of 401(k) plans, employee and self-employed retirement plans, and many nonretirement investment vehicles to provide for a predetermined monthly lifetime income beginning at a specified age, and (c) the inadequacy and uncertainty of the Social Security system, it behooves each and every one of us to create our own pension plan.

With this week’s post, I want to expand upon and clarify the conclusion in last week’s post. I understated the point when I said that it behooves each and every one of us to create our own pension plan. It isn’t simply beneficial or worthwhile to create our own pension plan – it’s imperative that we do so. To do otherwise is to leave our retirement exposed to too many variables beyond our control and, in turn, risk that we will outlive our retirement assets.

Retirement Roadblocks

Outliving one’s retirement assets can happen in any number of ways, including, but not limited to, experiencing one or more of the following eight retirement roadblocks:

  • Insufficient investment assets to sustain a longer- than-average life expectancy
  • Prolonged higher-than-average inflation
  • Sequence of returns with bad early years. See the October 5, 2009 post, The Sequence of Returns – The Roulette Wheel of Retirement.
  • Withdrawal drag. See the September 28, 2009 post, Withdrawal Drag – The Silent Killer.
  • Excessive investment withdrawals relative to available retirement assets
  • Uninsured events, e.g., long-term care
  • Unfavorable income tax law changes
  • Poor investment management

As you can see, too many things can happen, many of which are beyond our control, that can prematurely deplete one’s investment assets. Although unplanned, the occurrence of one or more of these events could easily derail what’s suppose to be our golden years.

Something we have the ability to control, and, furthermore, as previously stated, is imperative for us to do, is creation of our own pension plan. Specifically, we need to replace employment income with a retirement paycheck.

The risk that we will outlive our retirement assets is shared by individuals of all means. A sizeable nest egg, while it can sustain one through many years of retirement, can also be depleted before the end of one’s and one’s spouses, if married, lifetime(s) in the absence of a sound retirement income plan.

Although a retirement paycheck doesn’t guarantee that we won’t outlive our retirement assets, it will eliminate our exposure to several of the eight retirement roadblocks, and, in turn, improve our odds for success.

Categories
Annuities Deferred Income Annuities Retirement Income Planning

The Thrive® Income Distribution System – A Revolutionary Retirement Income Planning System

Retirement Income Center

Talk about innovative strategies for creating and optimizing retirement income! Today, I have the distinct pleasure and good fortune to be interviewing Curtis Cloke, the inventor of the Thrive® Income Distribution System (“Thrive®”), one of the leading retirement income planning solutions available to financial advisors. I personally use the Thrive® system with my clients who have been receptive and enthusiastic. The following are eight questions I asked Curtis about the system together with Curtis’ answers.

  1. What is the Thrive® Income Distribution System?

    Thrive® is a retirement income solution that helps advisors utilize the least amount of a client’s portfolio to provide for their income gap needs with a known and precise amount of their retirement assets. This creates contractually-guaranteed and inflation-adjusted income that allows the client to invest the portion of their portfolio not needed to generate their income needs in traditional accumulation investments providing a significant horizon appropriate for longer-term strategies without being concerned about the sequence of returns. Thrive® is a turnkey web-based platform, including educational tools, marketing materials, client presentations and a calculation system that trains and helps advisors implement the strategy using a compliance-approved action plan and report for the client. The system is designed to help implement the purchase of income products that will create solid and authentic retirement income solutions for which advisors will never have to apologize.

  • Why did you develop the Thrive® system?

    In 1999, I became concerned with the typical withdrawal strategy generally being recommended by the industry and manufacturers of investment products that supported modern portfolio theory as an end-all solution. I had seen an amazing run-up on the market and became very aware that at some point the house of cards would fall and sequence of returns or dollar cost averaging in reverse would become the great demise for many of those who had retired or would be retiring.I realized that the gross rates of return being highlighted were suspect to the real return being generated for the general public. There were fees and taxes on asset accumulation and then when income distribution became a necessity, the volatility of the market, in combination with all of the moving parts, became a significant danger zone for retirees.

    My goal was to show that there are ways to contractually guarantee an inflation-adjusted income solution without high fees, focusing totally on real return without trading off the legacy of the client’s wealth in order to provide income free of market risk. My goal was to revolutionize the way retirement was done.

  • How is the Thrive® system different from other retirement planning software that financial advisors use?

    Thrive® uses some relatively not-so-well-known income products that provide significant tax and pricing efficiencies that simply discount the amount of dollars required from the client’s portfolio to generate their income needs on a contractually-guaranteed basis with built-in inflation adjustment. Because this method of allocating dollars can be done at anytime pre- or post-retirement, Thrive® can also help eliminate the “Danger” or “Red Zone,” with which many of us have become familiar, that can annihilate a client’s portfolio when all assets are held in the market too close to retirement.

  • Who is the target audience for the system?

    Not only does the system serve clients who are at or post-retirement, it also provides new opportunities for growth and accumulation with established guarantees for future income with clients who are five, ten or even fifteen years before they retire. The system is not a respecter of portfolio size. It works with both large and small portfolios. The higher the tax bracket and the larger the portfolio size, the more powerful the tax efficiencies are. Though there are no minimums or maximums, the most common portfolio range is $250,000 – $5,000,000.

  • How many years before retirement should the system be used?

    The earlier one invests in the income products, the greater the returns generated during the accumulation and distribution phases, while also eliminating the “Danger” or “Red Zone” from market volatility prior to retirement. The rates of return for the accumulation period are also the same rates of return applied to the distribution phase, making this one reason why the portion of the portfolio needed to generate income is less than other more typical income distribution methods. The accumulation period is always tax-deferred no matter what asset class is used. There are significant tax efficiencies during the distribution phase as well. The sooner a client is able to understand and appreciate the value of this strategy, the more beneficial it may be. We have implemented it with clients up to 20 years prior to retirement.

  • Is it a one-time or ongoing solution? If ongoing, how often should it be used?

    Though the strategy allows assets to be allocated all at once or over time, we recommend an annual review with each client since there will be changes in the retiree’s life that require flexibility and changes in the system along the way. Many of the products used allow flexibility to change the income start date, increase or reduce income, and monitor assets used to accumulate ongoing wealth for future needs and the legacy of heirs.

  • Where can the public go to see a list of financial advisers who are using the system?

    Thousands of advisors have access to the Thrive® Income Distribution System via a network of financial service organizations across the country. Interested members of the public can ask their financial advisor about the Thrive® solution, or can ask their advisor to contact Thrive® directly if he/she doesn’t currently have access to the Thrive® system.

  • How can I learn more about the Thrive® system?

    Advisors can find educational material as well as contact information at our website, www.thriveincome.com.

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Retirement Asset Planning Retirement Income Planning

Retirement Income Planning – The End Game

Retirement Income Center

If you’re a subscriber to Retirement Income Visions™, you may have noticed that, although there have been nine posts prior to this one, none of them has stayed true to the theme of this blog, i.e., Innovative strategies for creating and optimizing retirement income. This post will be no exception. As the saying goes, there’s a method to my madness. In order to understand and appreciate the strategies and apply them to your situation, it’s important to understand the origin of retirement income planning, including the limitations of the retirement asset planning approach.

As explained in The Retirement Planning Paradigm Shift – Part 2, retirement planning is undergoing a paradigm shift. Instead of relying on retirement asset planning as a solution for both the accumulation and withdrawal phases of retirement, people are beginning to recognize, understand, and appreciate the need for, and value of, employing retirement income planning strategies during the withdrawal phase. No doubt about it, per Retirement Asset Planning – The Foundation, retirement asset planning is the way to go in the accumulation stage to build a solid foundation for a successful retirement plan. However, as discussed in The Retirement Planning Shift – Part 2, as a result of the uncertainty of traditional retirement asset planning as a solution for providing a predictable income stream to match one’s financial needs in retirement, retirement income planning was born.

Is Your Retirement Plan At Risk? introduced six risks common to all retirement plans: inflation, investment, income tax, longevity, health, and Social Security benefits reduction.

Beginning with Retirement Asset Planning – The Foundation, the inadequacy of retirement asset planning during the “spend-down” phase was discussed. This begins with the process itself. Unlike most types of financial planning where you get to see the results of your plan after reaching a specified target date, this is not the case with retirement asset planning since the timeframe is undefined.

Withdrawal Drag – The Silent Killer contrasted the beauty of compound rates of return during the accumulation stage with the erosion of portfolio income and the associated benefit of compounding, otherwise known as “withdrawal drag,” in the withdrawal stage of retirement. There is yet another phenomenon that can wreak havoc on your portfolio if you only rely on a retirement asset planning strategy during your retirement years. The Sequence of Returns – The Roulette Wheel of Retirement exposed this investment phenomenon and provided an example of how “luck of the rate-of-return draw” can prematurely devastate a conservative, well-diversified portfolio.

As if all of these variables and financial phenomenon were not a wake-up call to your planning, we mustn’t forget about the “safe withdrawal rate.” Safe Withdrawal Rate – A Nice Rule of Thumb demonstrated how the widely-accepted 4% “safe” withdrawal rate doesn’t necessarily guarantee that you won’t outlive your investment portfolio. Furthermore, the withdrawal amount that is calculated using this methodology typically won’t match your retirement needs.

All of the foregoing financial risks and phenomenon contribute to the inherent uncertainty associated with the retirement asset planning process during the withdrawal phase of retirement. As pointed out in Retirement Asset Planning – The Foundation, even if you’ve done an excellent job of accumulating what appear to be sufficient assets for retirement, you generally won’t know if this is true for many years

Retirement income planning is truly the end game in financial planning. Assuming that your goal is to generate a predictable income stream to match your financial needs in retirement while minimizing your exposure to withdrawal drag, the sequence of returns, and the various risks common to all retirement plans, it generally makes sense for you to begin employing retirement income planning strategies for a portion of your assets ten years before you plan to retire. The amount of assets and the exact timing of implementation are dependent upon your particular retirement and other financial goals as well as your current and projected financial situation.

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Retirement Asset Planning

Safe Withdrawal Rate – A Nice Rule of Thumb

Retirement Income Center

Last week’s post, The Sequence of Returns – The Roulette Wheel of Retirement, showed how “luck of the rate-of-return draw” can have a dramatic affect on a retirement asset plan in determining whether you will outlive your investment portfolio. In two scenarios where the retirement age (65), portfolio beginning value ($500,000), average rate of return (7%), withdrawal rate (5%), and inflation factor applied to the withdrawal rate (3%) were identical, and the only variable was good vs. bad early years, there were quite different results. With the “Good Early Years” scenario, after 25 years, at age 90, distributions totaled $964,000, the portfolio earned $1.385 million, and the portfolio value was $921,000. Under the “Bad Early Years” scenario, the portfolio was depleted after 16 years at age 81 after taking distributions totaling $541,000 and the portfolio earning $41,000.

Many people would argue that 5% seems like a reasonable withdrawal rate, however, as we saw, under the “Bad Early Years” scenario, this proved to be too aggressive. The financial planning industry, after many years of debate, has settled on a rule of thumb of 4% as a “safe withdrawal rate.” That is to say, you can withdraw 4% of the value of your portfolio in your first year of retirement and then increase your withdrawal amount by an inflation factor in subsequent years without depleting your portfolio during your lifetime. As an example, assuming a portfolio value of $500,000 at retirement and a 3% inflation factor, you could withdraw $20,000 ($500,000 x 4%) in Year 1, $20,600 ($20,000 x 1.03) in Year 2, $21,218 ($20,600 x 1.03) in Year 3, etc.

Is a “safe withdrawal rate” something we should live by or is it simply a rule of thumb? While a 4% withdrawal rate during retirement can potentially enable you to sustain your retirement capital for the duration of your retirement, this is not always the case, particularly in “Bad Early Years” scenarios. In addition to the withdrawal rate, the interplay of the following ten variables will determine whether or not you will outlive your portfolio:

  1. Type of portfolio, i.e., nonretirement vs. retirement
  2. Income tax rates
  3. Source of income tax payments, e.g., checking account, nonretirement sales proceeds, IRA withdrawal, etc.
  4. Retirement duration
  5. Average rate of return
  6. Sequence of returns
  7. Timing of earning of income
  8. Inflation rate
  9. Frequency of withdrawals
  10. Timing of withdrawals

As an example of the interplay of several of these variables, let’s make the following assumptions:

  1. Retirement age: 65
  2. Beginning portfolio value: $500,000
  3. Average rate of return: 6%
  4. Sequence of returns: Bad early years
  5. Withdrawal rate: 4%
  6. Inflation rate: 3%
  7. Frequency of withdrawals: Annual
  8. Timing of withdrawals: Beginning of year

In this scenario, despite the fact that the withdrawal rate has been reduced from 5% per the “Bad Early Years” scenario in the last post to 4%, which is generally considered to be a “safe” withdrawal rate, by simply changing one other variable, i.e., reducing the average rate of return from 7% to 6%, per Bad Early Years Assuming 6% Average Rate of Return, the portfolio is depleted at age 85. While the frequency and timing of withdrawals in this example may not be typical, the “safe withdrawal rate” of 4% isn’t conservative enough.

There are other scenarios where the interplay of the various variables is such that a withdrawal rate of 4% can prove to be problematic. As is typically illustrated, the previous example assumed an inflation rate of 3% each and every year. What happens if inflation averages 3%, however, the sequence of inflation rates is such that it is much higher in the first five years, say 7%. This would result in larger withdrawals in years 2 through 6, and, depending upon the rate of return, sequence of returns, and duration of retirement, this could result in premature depletion of the portfolio.

Mathematics aside, there are several other issues to consider when planning to use a safe withdrawal rate. For starters, why should you base your withdrawals for the duration of your retirement on the value of your retirement portfolio on a single day, i.e., the day before you retire? Also, it does not consider the fact that a sizeable portion of your expenses may be for mortgage and/or other fixed payments that don’t increase each year, and, as such, don’t require an inflation factor to be applied to them. In addition, the safe withdrawal rate methodology doesn’t take into consideration the fact that we typically incur nonrecurring expenses, planned and unplanned, e.g., new car, home improvements, wedding, etc., in addition to our ongoing expenses.

Another factor not incorporated in safe rate withdrawal calculations is the affect of differences in sources and amounts of non-portfolio income, e.g., Social Security, pensions, part-time income, etc. on portfolio values. What about the impact of inheritances on the amount of subsequent withdrawals? Finally, who is going to be responsible for doing the accounting to ensure that the amount of withdrawals doesn’t exceed the targeted amount in a particular year?

While the amount of withdrawals calculated using safe withdrawal rate methodology may match your income needs in some years, this probably won’t be the case in most years. This is arguably its single biggest weakness. I don’t know about you, but I don’t want to live my life based on a simple calculation that doesn’t consider my changing financial needs. While a safe withdrawal rate is a nice starting point, or rule of thumb, for calculating retirement withdrawal amounts, its limitations need to be considered when applying it to one’s retirement plan.

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Retirement Asset Planning Retirement Income Planning

The Sequence of Returns – The Roulette Wheel of Retirement

Retirement Income Center

So here you are, crossing the threshold from earning a living to going into retirement. You worked hard for many years. You built a sizeable, diversified investment portfolio. You hedged your bet by purchasing life insurance and long-term care insurance. Your will and other estate planning documents have been updated to reflect your current goals and financial situation. Everything’s in place, or so you think.

Welcome to the roulette wheel of retirement, otherwise known as the “sequence of returns.” If you haven’t planned for this financial phenomenon, your retirement could be quite different than you envisioned. To illustrate this important concept, let’s take a look at three hypothetical scenarios. In each one we’ll use the following five assumptions:

1. Retirement age: 65
2. Portfolio value: $500,000
3. Annual withdrawals: $25,000, or 5% of the initial portfolio value,
increasing by 3% each year
4. Life expectancy: 25 years, or until age 90
5. Average rate of return: 7%

The last assumption is the most critical one and can wreak havoc on your portfolio if you only rely on a retirement asset planning strategy during your retirement years.

Let’s start with Scenario #1 – 7% Return Each Year. While this scenario never occurs in real life, it’s often used for illustration purposes. Once you review Scenario #1 – 7% Return Each Year, you will see that even after taking out withdrawals that begin at $25,000 and more than double to $52,000 at age 90, your portfolio value increases from $500,000 at age 65 to $576,000 at age 78 and then gradually declines in value to $462,000 at age 90. You’ve taken distributions totaling $964,000 and your portfolio has earned $926,000 over 25 years. Nice result!

Scenario #2 – Good Early Years assumes that you are fortunate enough to retire at the beginning of a bull market where your investment returns exceed your inflation-adjusted withdrawal rate of 5% for several years, you experience a couple of years of negative rates of return, and a bear market kicks in your final three years, resulting in negative rates of return each year. Per Scenario #2 – Good Early Years, although it doesn’t occur in a straight line, your portfolio increases from $500,000 at age 65 to a peak of almost $1.5 million at age 87, with a final value of $921,000, or double the value of Scenario #1, at age 90. Like Scenario #1, you’ve taken distributions totaling $964,000 and your portfolio has earned $1.385 million over 25 years. Life is great!

So far, so good. To illustrate Scenario #3 – Bad Early Years, let’s simply reverse the order of investment rates of return that we assumed in Scenario #2. As in Scenario #1 and Scenario #2, over 25 years, we’re going to end up with the same average rate of return of 7%, however, the first three years are going to be bumpy, to say the least. Unlike Scenario #2, where your portfolio value increases by $208,000 the first five years, going from $500,000 at age 65 to $708,000 at age 70, per Scenario #3 – Bad Early Years, it decreases by $224,000, going from $500,000 at age 65 to $276,000 at age 70, or a swing of $432,000 during the same period.

Your portfolio continues to decrease in value each year until it is depleted at age 81. Instead of taking distributions totaling $964,000 as you did in Scenarios #1 and #2, your total distributions over 25 years are only $541,000. Furthermore, instead of realizing portfolio income totaling $926,000 in Scenario #1 and $1.385 million in Scenario #2 over 25 years, your total portfolio income is a measly $41,000. Yikes!

In both Scenario #2 and Scenario #3, there are negative rates of return in only five, or 20%, of the total of 25 years of retirement. Two years of negative rates of return out of ten years, on the average, is fairly typical for long-term historical rates of return for a diversified equity-based portfolio. As you can see, in Scenario #3, it doesn’t matter that 80% of the returns were positive, nor is it relevant that there was an average rate of return of 7%. As a result of the portfolio being depleted at age 81, the hypothetical individual in this situation wasn’t able to experience the 11.4% average rate of return during the final nine years.

The most important factor in Scenario #3, and the #1 risk to any retirement asset plan, is the sequence of returns. While you have no control over this investment phenomenon, you don’t need to play roulette with your retirement assets.