Clients need a frame­work to guide with­drawal de­ci­sions in re­tire­ment.

With­drawal rates that take guar­an­teed in­come into ac­count help clients ac­cept the im­pact of dips in their port­fo­lio’s value

Investment Executive - - FRONT PAGE - BY GOR­DON POW­ERS IE

un­less clients an­nu­itize most of their re­tire­ment sav­ings, they need a frame­work to guide their with­drawal de­ci­sions or risk run­ning out of money.

Most re­search on “safe” with­drawal rates has fo­cused on the re­tire­ment port­fo­lio in iso­la­tion, mod­el­ling dis­tri­bu­tions with lit­tle heed to other sources of guar­an­teed in­come.

But in­cor­po­rat­ing guar­an­teed in­come di­rectly into the equa­tion — par­tic­u­larly for clients who can be flex­i­ble in their re­tire­ment spend­ing — can al­ter that safe with­drawal rate sig­nif­i­cantly, states a pa­per from David Blanchett, head of re­tire­ment re­search, in­vest­ment man­age­ment, with Chicago-based Morn­ingstar Inc.

Ac­cord­ing to Blanchett’s The Im­pact of Guar­an­teed In­come and Dy­namic With­drawals on Safe Ini­tial With­drawal Rates, re­cently pub­lished in the Jour­nal of Fi­nan­cial Plan­ning, the first step is to de­ter­mine the im­pact of dif­fer­ent fac­tors on re­tire­ment with­drawal rates and the prob­a­bil­i­ties of fail­ure of the re­tire­ment plan re­gard­ing the ad- equacy of funds through­out the client’s re­tire­ment.

Chron­i­cling the im­pact of five fac­tors — the amount of guar­an­teed in­come; the ex­tent to which the house­hold can ad­just spend­ing; the in­vest­ment port­fo­lio’s risk; the re­turn as­sump­tions used for pro­jec­tions; and the de­gree of de­sired in­come sta­bil­ity — on po­ten­tial dis­tri­bu­tions, Blanchett found that the level of guar­an­teed re­tire­ment in­come is, by far, the most im­por­tant fac­tor in de­ter­min­ing op­ti­mal with­drawal rates from in­vest­ments.

With­drawal rates are linked to prob­a­bil­i­ties of success of the re­tire­ment plan, which vary based on in­di­vid­ual cir­cum­stances.

Longer re­tire­ment pe­ri­ods, higher prob­a­bil­i­ties of success and more con­ser­va­tive port­fo­lios tend to yield l ower sus­tain­able with­drawal rates.

If you use such success-based met­rics, then em­ploy­ing a lower success level (i.e., a 75% success rate vs 95%) is likely to be the pre­ferred route, al­though the op­ti­mal per­cent­age de­pends on client char­ac­ter­is­tics, Blanchett’s pa­per notes.

The good news is that more guar­an­teed in­come from out­side the port­fo­lio sup­ports the client’s in­creased abil­ity to ac­cept lower port­fo­lio re­turns. For ex­am­ple, a sharp 20% cut in dis­tri­bu­tions from the port­fo­lio rep­re­sents only a 10% over­all change if re- tire­ment sav­ings sup­port only half of the re­tire­ment ex­penses to be­gin with.

Ac­cord­ing to Blanchett’s analysis, op­ti­mal safe with­drawal rates var­ied by more than four per­cent­age points for dif­fer­ent lev­els of guar­an­teed in­come — from ap­prox­i­mately 6% an­nu­ally when 95% of wealth was in guar­an­teed in­come to ap­prox­i­mately 2% when only 5% was guar­an­teed.

Blanchett also found that with­drawal rates should be low­ered for clients with de­creased spend­ing flex­i­bil­ity — and in­creased when port­fo­lios have higher stock al­lo­ca­tions and higher re­turn as­sump­tions.

For clients with a healthy level of guar­an­teed re­tire­ment in­come and some i ncome flex­i­bil­ity, Blanchett de­ter­mined that with­drawal rates of 5% could prove quite rea­son­able when us­ing his­tor­i­cal re­turns in cal­cu­la­tions.

Al­though re­cent re­search us­ing for­ward-look­ing re­turns has sug­gested 3% as a more ap­pro­pri­ate with­drawal rate for re­tirees to­day, Blanchett be­lieves 4% could be sus­tain­able.

That’s so even us­ing more modest as­sump­tions about fu­ture re­turns — with the sup­port of pre­dictable in­come.

The take­away: as a client’s base of guar­an­teed in­come rises, so does the safe with­drawal rate for the re­lated port­fo­lio.

With­drawal rates of 5% could prove quite rea­son­able us­ing his­toric re­turns

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