Retirement Distribution Strategies - FPA CTfpact.org › ... ›...

© 2010-2014 Income Discovery.

Manish Malhotra, President & CEO, Income Discovery @manish96 and @incomediscovery

Retirement Distribution Strategies “What works and what doesn’t under

investment return and tax uncertainty”

Takeaways

• Synergistic interaction among retirement income strategy components

• A framework to find these synergies

• Discover up to 20% higher post-tax retirement income at higher safety

2

Retirement Income Strategies

3

Annual Income

Bond Ladder

Social Security

$

Systematic Withdrawal

Portfolio

Annuities

Finding optimum among multiple

strategies

Current Approach

• Portfolio expected return and volatility – not sufficient

• Probability of success -> sustainable withdrawals

• Reward: Retirement Income

• Prob. of success – appropriate framing?

4

Presenting Risk

• Improve risk presentation by using learning from Behavioral Finance research

• First, a primer on Behavioral Finance

5

Fast Thinking

• Reaction to this picture

• Instantly see that she is angry;

• System 1 of the mind processed it

• Associative Memory

6

Slow Thinking

• 185 X 27 = ? Takes effort

• Different part of your mind used, called System 2 – conscious reasoning self

• Impressions and decisions are an interaction of System 1 & 2

7

WYSIATI

• What You See Is All There Is

• Will John be a good leader? He is intelligent and strong

• Answer: Yes. Associative Memory.

• Did you think about attributes of a good leader?

8

John – Good Leader?

• .. He is intelligent, strong, corrupt and cruel – Still Yes.

• He is corrupt, cruel, intelligent and strong – No, not a good leader

• First Impression is the Last Impression.

9

75% Probability of Success

• What does client think?

• Associative Memory Triggered

Appropriate risk presentation?

10

75% Probability of Success

• Good – context of gambling and sports, very good

• Does client understand 25% chance of failure?

• No – WYSIATI explains it

• Issue with both words, probability and success

11

Alternative Presentation

• Out of 1000 retirees,

• 750 were successful in generating the desired income

• 250 were not successful

12

System 1 Processing of Frequency

Real people like them and their peers

They imagine a room full of retirees; 250 unsuccessful segregated in a corner.

Why call them a failure?

13

Partial Income Retirees

Systematic Withdrawal

Portfolio exhausts,

creating shortfall

14

No Success or Failure

• Full Income or Partial Income

• 85% of desired income in shortfall years is not a complete failure

15

Story of individuals, not a statistic

Risk: # of retirees out of 1000 that received partial income.

16

Unfortunate Retiree

20th highest Cumulative Shortfall out of 1000 retirees

17

Social Security

Systematic Withdrawal Portfolio

Pension

Bond

Ladder

Immediate Annuity

Retirement Income By Source Over Time

Shortfall Years

Short

fall

$

Risk – Unfortunate Retiree Case

18

Years of full income for Unfortunate

Retiree

Percent of

Income

during

Shortfall

Years

Again, Story of an Individual

Risk-Reward Framework

• Primary Reward: Retirement Income

• 1st Risk: Retirees with Full Income

• 2nd Risk: Years of Full Income for Unfortunate Retiree

• 3rd Risk: % of Income in Shortfall Years for Unfortunate Retiree

• Secondary Reward: Average Legacy

19

Distribution Strategies

• Social Security – defer or take early

• Single Premium Immediate Annuity

• Withdrawal order across different accounts and purchase account for annuities

20

Brady Case Study

• 66 year old couple

• Total Assets: $800K

• Monthly Pension: $500

• Social Security @66

- $2.5K and $2K pm

Low Return (µ 2% than history) and Moderate Inflation (2.5% µ and 2% σ) Capital Market Assumptions; Conservative inflation protected model portfolio. Same as in JFP paper.

21

Real Income Over Time

22

Early Middle Late

Discretionary spending reduces as

they age; essential spending rises -

10% drop in total spending. $100K

$90K

Essential

Spending

Higher Medical

Expenses

Discretionary

Spending

Strategy 1 – Social Security @66

23

Real Income By Source Over Time

$100K

$90K

Social Security of $54K

Systematic

Withdrawal Portfolio (SWP)

Pension Pension

Strategy 2 – Social Security @70

24

$100K $90K


Higher withdrawal from SWP for 4 years

Social Security increases to $71.2K

lowering withdrawal from SWP over

last 26 years

Pension

Social Security @70 Better

• 214 retirees with full income

• 3 years of full income

• 18% in shortfall • 1.9 times Legacy

Why? 15-20% lower withdrawal from SWP over 26 years

25

$100K $90K

Social Security of $71.2K @70

Hig

he

r w

ith

dra

wa

l

fro

m S

WP

fo

r 4

yrs

. Lower withdrawal from

SWP over last 26 years

Pension

Annuity – Mortality Credits

Sam, Peter & John pool their assets together to provide income for all who survive

Only Peter survives to claim benefit from the pooled assets

Annual Income

Sam Peter John

Annual Income

Peter

26

After 20 years

Immediate Annuity

• $160K Purchase – can it help?

• Inflation adjusted payout: $6,047

• Level payout: $9,329

• Which is better?

Inflation adjustment is based on CPI-U index

27

Strategy 3 – Inflation Adjusted Annuity

28

$100K $90K

Social Security of $71.2K


Pension

Annuity payout of $6K

Strategy 4 – Level Payout Annuity

29

$100K $90K



Pension

Annuity payout of $9.3K

Purchasing power of nominal

payout falls with inflation

Annuity Comparisons

Level payout better than inflation adjusted

48 Full Income Retirees

4 Years of Full Income for Unfortunate Retiree

24% Average Legacy

Inflation adjusted annuity based on negative real yields not attractive under moderate inflation

Based on quotes as of Mar 15, 2013.

30

Social Security and Annuity

• Does level payout Annuity help if Social Security was taken at 66?

• No. Compared to SS@66, buying the annuity causes


30% Avg. Legacy

31

Why Annuity doesn’t help with SS@66?

32

Immediate Annuity with 3.9% avg. flow rate

Immediate Annuity with 5.8% initial payout under 3% inflation expectation has

avg. flow rate of 3.9%

$100K

$90K

Social Security of $54K

Pension

Systematic

Withdrawal Portfolio (SWP)

Portfolio avg. flow

rate is $37K /

$800K = 4.6%

Why Annuity doesn’t help with SS@66?

33

4.6% Flow

Risk

3.9%

How Annuity helps with SS@70?

34

Portfolio avg. flow

rate is $29.3K /

$800K = 3.7%

Immediate Annuity has 3.9% avg. flow rate

Fixed Annuity with 5.8% initial payout under 3% inflation expectation has avg. flow rate

of 3.9%

$100K

$90K


Pension

Why Annuity helps with SS@70?

35

3.7% Flow

Risk

3.9%

Key Learning

• Not the isolated impact of the component of a strategy

• But, their cumulative impact

• Rules are not general

• Need to optimize for each client; DON’T rely on intuition

36

Tax Sensitive Analysis

• Tax sensitive analysis valuable for a higher net worth client

- Full tax brackets and standard deductions

- Rules for taxable portion of Social Security

37

HNW Brady’s

• Taxable Joint Account: $1 million

65% average cost basis

• Peter’s IRA: $1.25 million and Lisa’s IRA: $800K

Both 15% post-tax basis

• Roth IRA: $200K

38

Tax Sensitive Strategies

• Strategy A

- Withdrawal Order: Taxable, IRA, Roth

- Purchase $800K of immediate annuity in Peter’s IRA

• Strategy B

- Withdrawal Order: Taxable, Roth, IRA

- Purchase $800K of annuity in Taxable

39

Tax Strategies Comparison

Strategy A is better – Taxable-IRA-Roth; Annuity in IRA

• 66 Full Income Retirees

• 1 Year of Full Income for Unfortunate

• 6% point Partial Income

• 8% Avg. Legacy

40

41

1. If Annuity

bought in Taxable

Account, it runs

out in 1.5 years

Strategy B Cash Flow

42

2. Roth hasn’t

had time to grow,

it can give

income only for

2.5 years


43

3. Full taxable withdrawals

from IRA in the later

phases exhaust it faster


44

1. Taxable Account

has assets to

sustain longer as

annuity is bought

in IRA

Strategy A Cash Flow

45

2. Then, IRAs kick in


46

3. Roth has time

to grow tax free

and fund 7+

years of

withdrawal


Summary

• Synergistic interaction among retirement income strategy components

• A framework to find these synergies

• Discover up to 20% higher post-tax retirement income at higher safety

47

Appendix

48

Variable Annuity with Guarantees

49

Contr

act

Valu

e

Benefit Base Locks

@Highest Past Value

GMIB contracts also allow

min guaranteed growth

Of Benefit Base

Time

Contract Value

Strategy 5 - Variable Annuity GLWB

• Immediate lifetime income at 4.5% of benefit base

• GLWB rider at 0.95% fee and 0.3% MEA fees

• Moderate inflation protected allocation

• 160K purchase with Social Security@70

50

VA GLWB – helps?

• Risk increases


3 Years of Income for Unfortunate Retiree

5% points guaranteed income for Unfortunate Retiree

8% in Avg. Legacy

51

Strategy 6 - Variable Annuity GMIB

• Growth phase with 1.75 times guaranteed income base after 10 years

• Rider fees 1.5%; MEA Fees 1.3%

• Payout rate: 4.75% of Income Base

• Moderate Inflation Protected Model

• 160K purchase with Social Security@70

52

GMIB – helps?

• Risk increases

- 84 Full Income Retirees

- 7 Years of Income for Unfortunate Retiree

- ↔ guaranteed income for Unfortunate Retiree

- 43% in Avg. Legacy

53

Current VAs – why risk?

• For Retirees that barely got full income:

• Fees and poor returns combination doesn’t let Income Base step-up.

• Without Income Base , VA behaves like an immediate annuity, but with payout

• payout means in risk as more retirees can’t get full income

54

Older VAs with Guarantees

• 6% compounded return for 10 years

• 200% guaranteed income base @10yrs

• MEA Fees 0.85%, Rider fees 1.1%

• Payout rate at 6% when clients are 76 years old

• This VA reduces risk

55

VA under Better Returns

56

Percentile Last year’s GLWB Benefit in today’s dollars

25th Percentile $4,082

50th Percentile $5,246

75th Percentile $7,399 81% higher than 25th Percentile

Current VAs– Use?

• Not very appropriate for essential expenses

• But a good strategy for discretionary expenses that can be locked

• Client frees rest of the portfolio to be structured for inheritance

57

Certain Cash Flow Using Bond Ladder

58

Cash flow not sensitive to

interest rate movements if

bonds held-to-maturity

Principal Maturity

Semi-annual coupons

Fill-in for Social Security Using Ladder

59

TIP

S

La

dd

er


$100K

$90K

Social Security

Pension

TIPS Ladder Performance

• Psychological comfort of safe cash flow

• But because of negative real rates

• 25 Full Income Retirees

• 1 Year of Full Income for Unfortunate Retiree – stability of cash flows

• 20% Avg. Legacy

60

Bond quotes as of 25 March 2013

Retirement Distribution Strategies - FPA CTfpact.org › ... ›...

Documents

Transcript of Retirement Distribution Strategies - FPA CTfpact.org › ... ›...