If you take a fixed lifetime income guarantee solutions approach, you are looking beyond the ongoing obsession with account balances and annual returns, which are far less important than the amount of sustainable lifetime income you can expect to receive for the rest of your life, no matter how long you live (to supplement Social Security benefits, pension income, rental income and so forth). This approach is "fixed" because you know exactly what your income will be - to the penny - each year for the rest of your life.
For example, if you are preparing for retirement, or in retirement - you can purchase an Immediate Income Annuity from an insurance company and receive guaranteed income payments for the rest of your life starting immediately - and/or you can purchase a Deferred Income Annuity and receive guaranteed income payments for the rest of your life starting at a specific time in the future.
With company pension plans increasingly becoming relics of a bygone era, Immediate Income Annuities and Deferred Income Annuities enable you to, in essence, create your own pension-like guaranteed income streams for life (together with Social Security and your company pension, if you are lucky enough to have one), completely insulated from the performance of the stock market.
While Immediate Income Annuities and Deferred Income Annuities aren't for everyone, they are great transfer of risk strategies that specifically solve for principal protection, lifetime income guarantees, and legacy planning. If you need to solve for one of these items, then you may want to consider adding an Immediate Income Annuity and/or Deferred Income Annuity to deliver the guaranteed part of your retirement income portfolio - to lower the risk of your overall investment portfolio - and to help solve for longevity risk so you don't outlive your money.
"... Immediate Income Annuities and Deferred Income Annuities enable you to, in essence,
create your own pension-like guaranteed income streams for life...
completely insulated from the performance of the stock market."
- Leeland Gray
By contrast, the primary goal of purchasing fixed lifetime income guarantee solutions is not to invest to maximize returns, but instead, to maximize the chance of being able to meet your future retirement income and lifestyle needs and not outlive your money. The focus is not on the value of your investment portfolio, or to make as much money as possible - the focus is on cash-flow and the ability of your portfolio to meet your retirement income and lifestyle needs - regardless of what the stock market is doing.
You need to ask yourself one simple question: Do you place greater faith in the stock market's ability to perform well over a reasonable investment time horizon (and in your financial and emotional ability to stick with a plan through good times and bad) - or do you place greater faith in insurance companies and bond issuers' ability to meet their contractual guarantees? Your answer to this question should, in large part, help determine how you choose to build your retirement income and lifestyle plan.
Flexible systematic withdrawal plans and fixed lifetime income guarantee solutions both have inherently different mind-sets and approaches to structuring your retirement income and lifestyle plan. And it is important to have a basic understanding of both approaches before committing to a long-term plan that you feel comfortable with - both form a financial and emotional perspective.
"From a financial perspective,
retirement is all about cash-flow and lifestyle."
- Leeland Gray
Prior to William Bengen's 1994 research, the rule of thumb was that an investor could safely withdraw around 7% of his or her investment portfolio each year (to supplement Social Security Benefits, pension, rental income and so forth) without outliving his or her money. However, due to a combination of historically low interest rates, the sobering effect of two stock market crashes since 2000, and folks living longer, the current prudent thinking is that a retiree can safely withdraw around four percent of his or her investment portfolio each year without much risk of outliving his or her money.
So if an investor estimates that he or she will need $50,000 per year to cover retirement expenses (after accounting for Social Security benefits, pension, rental income and so forth), then he or she can divide $50,000 by four percent (4%) to arrive at $1,250,000, the estimated amount that his or her retirement nest egg must grow to in order to create a sustainable retirement income and lifestyle.
And of course, depending upon the taxable status of his or her investment portfolio, if all of the retirement savings are in qualified accounts [such as a 401(k) or Traditional IRA], then taxes on the withdrawals will increase the estimated amount that his or her retirement nest egg must grow to.
Please keep in mind that while the four percent (4%) rule for retirement portfolio withdrawals is a good rule of thumb for an investor several years away from retirement, there is nothing cast in stone - and you may want to be more conservative and take out less, whereas another investor may want to be more aggressive and take out more - or vice-versa.
And if your investment portfolio becomes devastated by sequence-of-returns risk should the financial markets crash shortly after retiring, or if you incur extraordinary costs at some point, or if you outlive your life expectancy, then the oversimplified four percent (4%) rule may need to be further modified to realistically meet your future retirement income and lifestyle needs at such time.
One of the most difficult decisions that inevitably confronts most investors preparing for retirement, or in retirement, is how to create a sustainable retirement income and lifestyle out of their retirement nest egg.
Should you (a) take flexible systematic withdrawals from the assets that you have accumulated over the years, or (b) purchase fixed lifetime income guarantee solutions, that are not subject to stock market losses, so you do not outlive your money (longevity risk).
There are countervailing benefits to each approach. You may find that the optimal solution is not 0% or 100% for either approach, but somewhere in between.
It's fascinating to see how folks plan on when they're going to retire. People work all of their lives to build up a retirement nest egg and yet, surprisingly, relatively few individuals give serious thought as to how they will transition from accumulating assets for retirement ("the accumulation growth phase") to turning that investment portfolio into income during retirement ("the decumulation income phase").
We have found that more often than not, most individuals just kind of wing it when it comes to retirement income planning. In such cases, their resources are whatever they are, and the challenge becomes making the most of them.
While some folks simply want to see their investments grow over time, other people have a pre-conceived milestone that they envision reaching before retiring. For example, some investors follow the "$1 million payday approach" (or some other pre-conceived figure), whereby they plan on retiring once they have a million dollars in savings and investments put away.
Wall Street firms and insurance companies spend a ton of marketing dollars promoting magical ways to calculate your "retirement number" - the amount your retirement nest egg needs to grow to in order to retire comfortably. However, despite what all the sales propaganda may lead you to believe, the fact of the matter is that retirement income planning is not an exact science - there are several important moving parts involved - financial and otherwise - and they are constantly evolving over time.
Each investor's situation is different, and your "retirement number" will most likely be predicated on several investment variables as well as non-investment variables - some of which are in your control, such as location (where do you plan on living during retirement) and lifestyle (do you plan on living it up or living conservatively during retirement) - and some of which are out of your control, such as luck (how will your health hold up over time) and how long you will live.
If pure flexibility and growth is your goal, and you are comfortable with shouldering all of the risk in your investment portfolio, then you may feel more at ease sticking with a flexible SWP approach to fund your retirement income and lifestyle needs.
If you are concerned with sequence-of-returns risk, the emotional stress of investing that oftentimes results in performance chasing, or the travails of cognitive decline, then you may feel more at ease with a lifetime income guarantee solution approach (read next section) to fund your retirement income and lifestyle needs.
Regardless of whatever combination of withdrawal approaches you are comfortable with, our advice to you is simple - save more than you think you will need. The value of having more money during retirement, instead of less, makes a world of difference to your retirement lifestyle.
Click on the Guaranteed Income Now and Guaranteed Income Later drop down tabs to learn more about these solutions - that we use in conjunction with the investment management programs - to deliver the guaranteed part of your retirement income portfolio that you cannot outlive.
The primary goal of taking flexible systematic withdrawals from the retirement assets that you have accumulated over the years is to invest to maximize returns (within your risk attitude) so you will be able to meet your future retirement income and lifestyle needs and not outlive your money.
If you take a flexible approach to retirement income planning, you will invest and grow your investment portfolio over time until retirement, whereupon you will continue to invest the funds during retirement, and make systematic withdrawals from your investment portfolio each year over your lifetime to cover your retirement income and lifestyle needs. For example, you can take systematic withdrawals from your Green Pastures Defensive Growth Models, All Weather Models and PEACE OF MIND Models managed accounts to help fund your retirement income and lifestyle needs (to supplement Social Security benefits, pension income, rental income and so forth).
The value of your investment portfolio will fluctuate (be "flexible") every year - and will go up or down - depending upon if the rate of the systematic withdrawal percentage (%) that you distribute from your investment portfolio - is greater than or less than - the return on your investment portfolio.
For example, let's assume that your investment portfolio grows to $1,000,000 during the asset accumulation growth phase leading up to your retirement. Then, let's further assume that you determine you will need to take an annual $50,000 systematic withdrawal from your $1,000,000 investment portfolio (5%) when you begin the retirement income distribution phase to maintain your quality of life during retirement (with a slight annual Cost Of Living Adjustment to help offset inflation each year thereafter). Given this example, if your investment portfolio generates a return higher than five percent (5%), then your investment portfolio entering the following year of retirement will be greater than $1,000,000.... However, if your investment portfolio generates a return lower than five percent (5%), then your investment portfolio entering the following year of retirement will be lower than $1,000,000.
Some of the key determinants of whether such a strategy will succeed - meaning that you will not outlive your money - are:
> your retirement age,
> the size of your investment portfolio,
> the rate-of-return on your investment portfolio,
> the rate at which you withdraw funds from your investment portfolio to live on during retirement,
> your lifestyle and standard of living,
> your health and healthcare costs, and
> your life expectancy.
The basic arguments in favor of taking a flexible SWP approach are:
> You can obtain a reasonable income stream for life;
> You can maintain control over, and flexibility of, your retirement assets;
> A well-diversified investment portfolio should safely support a spending plan without dwindling your wealth, while also preserving your liquidity and upside potential; and
> Safe withdrawal rates provide a "floor-with-upside approach", with the potential for greater spending or a growing legacy, IF your investment portfolio performs well during retirement.
The basic arguments against taking a flexible SWP approach are:
> Sequence-Of-Returns Risk
While all equity investors face market risk, which concerns how market volatility causes investment returns to vary over time in comparison to long-term average market returns, retiree equity investors are confronted with an additional phenomenon known as sequence-of-returns risk.
Sequence-of-returns risk - retiring before a bear market begins or during the early stages of a bear market - is one of the biggest risks facing retirees who choose a flexible withdrawal plan, and plan to live off the returns of, and take systematic withdrawals from, their investment portfolios.
The specific sequence of market returns matters significantly during the withdrawal phase of retirement when the impact of drawdowns (losses) is especially magnified. Losses - coupled with withdrawals - can deplete wealth rapidly - sending portfolio values spiraling downward, with relatively little left to benefit from a subsequent market recovery. Millions of retirees' investment portfolios were devastated by sequence-of-returns risk when they retired before or during the early stages of the 2000-2002 and 2007-2009 bear markets, causing their retirement income and lifestyle plans to implode;
> Emotional Stress And Performance Chasing
You must be able to overcome the emotional stress of investing and avoid the temptation to detour from a well thought out long-term retirement plan during volatile up and down markets, that oftentimes results in performance chasing - and poor buy-high and sell-low investment performance; and
> Cognitive Decline
The travails of cognitive decline could someday limit the ability to make complex decisions about suitable investments and withdrawal strategies.
Inevitably, one of the most important decisions you will make about your retirement income and lifestyle planning, is whether you choose a flexible systematic withdrawal plan approach, or a fixed lifetime income guarantee solutions approach, or a combination of the two approaches - to create a sustainable retirement income and lifestyle plan out of your retirement nest egg - so you do not outlive your money.
According to the National Association of Social Insurance, an average 65-year-old male can expect to live 19 more years, to age 84; while an average 65-year-old female can expect to live about 22 more years, to age 87. In addition, nearly three in 10 men and four in 10 women age 65 today can expect to reach age 90.
The rate at which you withdraw money from your investment portfolio can dramatically affect how long your money will last. For example, a retirement income planning study conducted by New York Life examined how long a growing $500,000 investment portfolio will last, based upon different withdrawal rates, and concluded the following:
A Yearly Withdrawal Rate Of... Will Last
5% 32 years
6% 24 years
7% 19 years
8% 16 years
9% 14 years
The greatest financial risk that most retirees face is running out of money. As modern medicine continues to improve, it's difficult to estimate how long you will live and, consequently, how long your money will need to last. As a result, longevity risk has stepped to the forefront of the retirement income planning process.
"The greatest financial risk that most retirees face is running out of money."
- Leeland Gray
When it comes to retirement income and lifestyle planning - there are countervailing benefits to taking systematic withdrawals (a flexible approach) - or purchasing lifetime income guarantee solutions that are not subject to stock market losses (a fixed approach).
You may find that the optimal solution is not 0% or 100% for either approach, but somewhere in between, that enables you to (1) secure your retirement income and lifestyle needs, (2) provide the potential for long-term growth and, most importantly, (3) help solve for longevity risk so you do not outlive your money.
Green Pastures Wealth Management LLC | 145 Eden Hill Road | Easton, CT 06612 | Phone 203.452.8100 | Toll Free 866.479.3258
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