What’s wrong with this picture? We have a client who has recently retired. This client has managed to save over $2.5 million for his retirement. In addition to Social Security, he needs about $80,000 per year to pay all of his expenses.
Simple math tells us that that represents 3.2% of his nest egg—well below the expected 4% safe withdrawal rate. He is told that if he continues spending at that rate with normal inflationary increases, he should have no problem supporting his needs during retirement.
We have run the numbers and assured him that all is OK. Yet in spite of our assurances and the quantitative data we have provided, he agonizes over market volatility. We get calls every time the Dow suffers a triple-digit loss. He fears that he will lose his retirement savings and run out of money during his lifetime. We show him, with empirical data, that it would be highly unlikely since he is withdrawing less than 4%. We may even tell him that he could spend more if he wanted to and still not be in danger. Unfortunately, none of these assurances seem to work.
What is missing from the advice that we are giving to this hypothetical client? In my opinion, it is that he is dealing with what is an emotional issue with quantitative information. As we have written before, you cannot solve interior problems with exterior solutions. In spite of proven strategies that may help the situation such as establishing a liquidity account with laddered bonds, periodically rebalancing the portfolio, limiting withdrawals to no more than 4%, etc., we may need to address the fears our clients may have in more creative ways. Adjusting to retirement is emotionally difficult for most people, and worries about money will only make it more so. There may be strategies and products—often overlooked by many advisors—that can significantly help.
Here’s a question to ask yourself: Do you find that clients who have lifetime pension incomes are less likely to agonize over market fluctuations than those who must rely on portfolio withdrawals to meet their expenses? As we know, clients who are eligible for pension income and have a choice invariably ask us whether they should take a lump sum or a lifetime income.
The answer to this question may look like a simple mathematical calculation. Using assumptions about expected return, mortality, etc., we determine the choice that leaves the client with the most money. However, this approach may be flawed for several reasons. First, we have no idea what future returns will be. And we certainly do not know the date of death. And most important, we may have ignored what may be the most important consideration in this decision. What will be the emotional impact of taking a lump sum instead of a pension income? It is our job to determine which clients can handle lump sums and provide alternative advice to those who are likely to agonize over market volatility. A robust discovery process will help us determine this.
However, since traditional pensions are becoming rarer, many of our clients do not have that option, so they come to us with a lump sum. Many will accept your recommendations for a safe withdrawal rate and the strategies you implement to provide income for them. They fully understand that market fluctuations are inevitable, and they are not likely to panic when these fluctuations occur. But for others, we may need to be more open to using techniques that are largely ignored by many advisors. We may need to reassess products such as immediate annuities, reverse mortgages and other new products being developed by companies that understand income during retirement is a requirement that needs to be met.
I’d like to share with you a story about one of our clients (we’ll call him John). John was one of those people who panicked every time the Dow was down by triple digits. This, in spite of the fact that we had a liquidity account with bonds that were laddered for three to five years. The face amount of each bond was enough to provide one year of income. We did not withdraw money from the investment account to replenish this liquidity account when the market was down. He is a highly intelligent man and he understood this strategy. That knowledge, however, did not reduce his anxiety. A couple of years ago, I discovered a product that I thought would be perfect for John. It would not be appropriate for me to endorse any company, so I will leave it up to the readers to do their own research.
While the product is provided by an insurance company and is technically an annuity, it works much differently. The client is permitted to maintain his own investment account with the custodian of his choosing. There is a guaranteed income provided from that account, and the percentage that is paid is based on the age of the client and the risk characteristics of the portfolio. Unlike other annuities, the portfolio belongs to the client and he can withdraw it and stop the program anytime he chooses. It is best to use an example to describe how this program works. Assume your client has $1 million. Based on his age and the makeup of the portfolio, his withdrawal percentage is 4.5%, or $45,000. The amount he withdraws from the portfolio can never go below $45,000 regardless of the performance of his investments. If the $1 million is reduced by 10%, he still receives $45,000. However, if the portfolio increases by 10% his new income will be $49,500 and that will be his new base, which can never be reduced. This calculation is made annually. So in essence he has a guaranteed income of no less than $45,000, which can only be increased but never decreased.
So let’s get back to John. He needed to withdraw $54,000 per year to meet his expenses. This was considerably less than 4% of his portfolio, so he was in no danger of running out of money, barring some catastrophe. In spite of this, he agonized and lost sleep over market fluctuations and would call to express his fear.
So at a review meeting I told him that I had discovered a new product that he might want to consider. I told him that we would transfer enough money from his investment portfolio into another account that would provide him $54,000 per year regardless of what the market did. I also told him that if he decided to enroll in this program it was highly likely that he would die with less money. I will never forget his answer: “If I am guaranteed $54,000 per year, I don’t care. We need to do this.” He’s been in the program for about three years now and because the market has cooperated, he now receives $58,000 per year and that can never be reduced.
By the way, we don’t receive those calls when the market is down. John is happy his retirement is not full of the worries about money that he used to have. I have actually had some advisors tell me that this was a “stupid” strategy because of the added expense (about 1%) that the insurance company was charging. It would be just as easy to do it ourselves. If we were quantitative planners who ignored emotional issues, they would be correct. But as financial life planners, it is our job to use all strategies at our disposal to ensure two things: that our clients do not run out of money and that they are free from worrying about money during their retirement. In John’s case, we fulfilled both of those responsibilities.
Roy Diliberto is the chairman and founder of RTD Financial Advisors Inc. in Philadelphia.
A Worry-Free Retirement
February 2015
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Sounds like you placed an indexed income annuity on behalf of your client, am I right?