Creating a Retirement Income Strategy

Accumulating assets for retirement is only one phase of preparing for retirement. Decumulating retirement assets is the means by which one will try to spend down a portfolio in an effort to make it last potentially thirty years or more in retirement. Here is a brief summary of some of the methods that exist for spending down a portfolio. I'd like to thank Dr. Wade Pfau for providing some of the categorization that has influenced my thinking.

FIXED AMOUNT METHODS

1.) Constant dollar amount (adjusted for inflation each year). One method to accomplish this has historically been the creation of an "Income Portfolio" designed to spin off a fixed dollar amount every year; another iteration is a reverse systematic withdrawal from a portfolio, which is where one simply sets up an automatic deduction for a fixed amount, often selling equally across various holdings in the account to create the cash available for withdrawal.

2.) Fixed percentage amount - A fixed percentage of the portfolio (adjusted for inflation each year) is withdrawn each year. An example would be William Bengen's well-known 4% rule. Designed to address sequence of returns risk, the idea is that withdrawing 4% of a portfolio's total value each year resulted in the portfolio safely lasting for 30 years (spends down principal. 3.8% is the safe withdrawal rate if one does not want to spend down principal). The down side is that simply because a portfolio will last 30 years doesn't mean that it will meet one's income needs if that 4% is significantly too low. This simply represents a helpful point-of departure when beginning to frame the retirement income discussion.

3.) Evensky's Cash Flow Reserve Strategy - With a total return investment approach, this is a needs-based approach that is a fixed dollar amount, but is also in conversation with the fixed percentage amount. Typically a retirement planner works with a client to determine a realistic dollar amount that can be withdrawn (but this dollar amount can also be viewed as a percentage for discussion purposes). Then, 1-2 years of income needs and/or any additional short-term liquidity needs (e.g. a new home, car, wedding) are set aside in a cash reserve "bucket". This cash bucket can either sit statically as an emergency reserve for bear markets to prevent liquidating positions that have lost value, or it can be set up to pay out the client's actual income needs (most often the case). The rest of a client's retirement assets are invested in an investment portfolio "bucket" that is segmented to be able to provide for an additional three years of income in fixed income holdings and the rest of the portfolio in an equities portfolio designed to provide long-term growth. This approach is implemented with a total return approach that takes into account taxes (both in the types of accounts and liquidations), costs, goals, and other financial planning priorities.

4.) Annuity Methods - These range from putting small to significant amounts into immediate or deferred income annuities (SPIAs and DIAs). The idea is to protect against longevity risk and to ensure that a certain level of one's income needs are met in the form of an annuity income stream.

DYNAMIC AMOUNT METHODS

 5.) Floor and ceiling - This results in a variable percentage spending amount. It starts with a fixed percentage, but the percentage can decrease to a fixed dollar "floor" that is 15% below the initial amount or increase to a "ceiling" amount that is 20% above the initial amount depending on market factors.

6.) Guyton and Klinger's Decision Rules - Variable percentage amount. Withdrawals are a percentage, but can vary based on 4 rules:

• The withdrawal rule: Withdrawals are adjusted for inflation each year unless the portfolio loses money, in which case no inflation adjustment is allowed.
• The portfolio management rule: Extract the gains from an asset class that has performed best in the previous year to provide the income, and move excess portfolio gains (beyond what is needed for the withdrawal) into a cash account to fund future withdrawals.
• The capital preservation rule: If the current withdrawal rate rises above 20% of the initial rate, then current spending is reduced by 10%.
• The prosperity rule: Spending in the current year is raised by 10% if the current withdrawal rate has fallen by more than 20% below the initial withdrawal rate. Doing this means the client does not miss out on higher sustainable spending when markets are doing well.

7.) Kitces' Ratcheted 4% Rule - Another dynamic spending approach that allows spending to be increased ("ratched up") if the portfolio grows to a certain level but, unlike the Guyton approach, manages the increases in such a way that it does not necessitate spending cuts.

8.) Zolt's Glide Path Spending Rule - Retiree would like spending to keep pace with inflation, but is willing to forego spending increases above and beyond inflation-adjusted modifications to spending.

ACTUARIAL METHODS

9.) RMD Method - Follow a formula similar to the IRS' RMD formula so that each year's changing portfolio balance and remaining life-expectancy are taken into account when calculating how much can safely be withdrawn.

10.) Endowment Formula 1 - Weighted Average of Bengen's 4% Rule

11.) Endowment Formula 2 -  Fixed-Percentage of Three-Year Moving Average Portfolio Balance

If you'd like assistance with navigating this complex landscape of retirement income strategies, please contact Dunston Financial Group, and one of our retirement income specialists will be happy to help.

 

 

 

 

 

 

 

 

Originally Posted on: Creating a Retirement Income Strategy