Such approaches are very problematic. For one thing, many middle-income retirees are already balancing very low savings against their retirement needs, so they need something more concrete.

Adjusting expenditures to market ups and downs has limited real-life possibilities. If a couple spends too freely in the early years and markets plummet, they may be destitute or, at a minimum, desperate—whereas a more cautious plan would leave them more secure.



Perhaps more to the point, it seems unlikely that most financial advisors would remain that involved in the day-to-day lifestyle decisions of a retiree whose portfolio is unwinding. The strategy is not realistic.

We rarely know our own longevity, so we are balancing decision-making against two foundational unknowns: our individual life expectancy and the future returns of the stock and bond markets. By adjusting expenditures according to asset returns, we are attempting to “self-insure” our individual longevity risk—insuring against both the vagaries of the market and the possibility of becoming centenarians. Marginally, this is possible, but talk to enough children of retirees and you’ll soon hear stories of anguish and dashed hopes.

Consumers buy life insurance (even though there’s only a slim chance they’ll unexpectedly die) because there is a large downside for the remaining family members if the person dying is also an income earner. We pool our risks with an insurance company, and this allows us to pay low premiums and receive large death benefits for our families. Our alternative is to have savings in advance early in life for our children’s education, home mortgage payouts and spousal retirements.

The WealthVest/Pfau/Shiller rule and all of the other competing strategies are attempts to manage longevity for individuals. This is why the resulting payouts are so low. Each individual or couple is self-insuring for a very broad set of potential outcomes, including long life and negative markets.

The WealthVest/Pfau/Shiller dynamic safe withdrawal rates are much lower (“safe” defined as a probability of failing less than 5% of the time, taking into account fees and all current market risk and the January 1 market pricing). These rates are 1.70%, for those who assume they will have a 30-year life expectancy (their retirement beginning at 63 and continuing to age 93), and 1.26% for those with a life expectancy of up to 40 years.

It is important to remember that these sustainable rates anticipate rising cash flows to match future inflation.

This is why Pfau and others incorporate annuities into their analysis of sustainable withdrawal rates. Annuities (single-premium immediate annuities, fixed index annuities and fixed annuities) lack stock and bond market risk while they pool longevity risk. Fixed index annuities (with rising income provisions designed to help retirees’ future income increase with inflation) generally offer payout rates of 3.5% to 4% for 65-year-olds. So they create approximately twice the retirement income cash flow of our 60/40 stock/bond portfolio.

The key is the same risk-pooling dynamic that insurers use in life insurance pricing, only it’s applied to longevity. Annuity payouts are able to provide retirees far greater lifetime income benefits because the insurance company is pooling the longevity risk and balancing long life spans against shorter life spans.
There is no simple answer to this complex question. Retirees seek certainty and simplicity. Generally, systems with great variability cannot provide those things. And factors like individual longevity and market return are inevitably complex.

However, if investors in 2015 are attempting to self-insure their longevity risk without annuities, they need to be prepared to receive far less income than has historically been recommended. 

 

Wade Dokken is the founder of WealthVest Marketing. To see the white paper on which this article was based, Rethinking Retirement - Timing Risk click here

 

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