I’m looking forward to presenting with Chip Castille of BlackRock in the session on the topic of retirement costs at the upcoming Financial Advisor Retirement Symposium. BlackRock has developed the CoRI Retirement Indexes, and I have developed my own retirement indices at my Retirement Dashboard. Each set of indices employs a different methodology and seeks to investigate different aspects of the retirement puzzle, but ultimately both are geared toward helping retirees track how well they are doing with their retirement plans.

The CoRI Retirement Indexes

The CoRI Retirement Indexes are constructed to help clients understand the cost of $1 of cost-of-living-adjusted (COLA) income for the remainder of their lives. They provide the indexes for those aged 55 to 74. For the age 55-64 indexes, the goal is to put together a collection of bond investments that can track the dynamic cost of purchasing a single-premium immediate annuity with a 2.5 percent fixed, annual inflation rate at age 65. After age 65, the indexes are meant to track the evolving cost of purchasing a single-premium immediate annuity (SPIA).

These indexes provide investors with a clear way to understand how much sustainable income they could expect with their savings. For instance, on March 3, the CoRI 2024 Index level was $16.35. Someone who saved $100,000 and invested in a fund that tracked this index could insulate his ability to purchase a SPIA to provide annual income of $6,116, or $100,000 divided by $16.35, starting at age 65 -- regardless of market moves. The CoRI 2014 Index is meant for a 65-year-old, and its price on March 3 was $20.83. One divided by this number would give us a spending rate, which in this case is 4.8 percent. This reflects the median price of commercial SPIAs with unisex mortality assumptions (as required for ERISA plans) and the 2.5 percent COLA. The CoRI 2014 Index is priced higher because there is no deferral period for the investment to earn interest before income begins. After age 65, the index value decreases. This is because the present value of a lifetime income would get smaller as the remaining time horizon gets shorter at more advanced ages.

The planning notion is that assets in the CoRI Index could be used to purchase a SPIA at 65, and the investments track the cost of this SPIA. There are no guarantees with the investment, as the fund managers are essentially using bonds to track the hypothetical cost of a deferred income annuity. By properly matching the duration of the bond investments with the duration of the underlying projected income, the index should be immune to interest rate risk and should do a good job of tracking its objective. Eliminating this interest rate risk means that the costs of retirement are hedged, and this should reduce the impact of sequence risk for retirees as they near retirement. It provides an alternative option to purchasing a deferred income annuity in the years leading up to retirement for those seeking to take market risk off the table.

What is really exciting about BlackRock’s development is how it allows clients to invest in a fund, which gets them to think in terms of lifetime income rather than wealth maximization. Ultimately, individual investors seek to fund their retirement spending, and the CoRI Indexes let retirees get a better feel for how an income annuity works, but without actually locking in the purchase. Clients can test drive a SPIA through age 75 before making an irrevocable commitment to annuitize. They may ultimately not decide to annuitize as well. CoRI provides an effective and intuitive way for individuals to think about the cost of retirement and about how they can translate their savings into sustainable spending.

The Retirement Dashboard

My Retirement Dashboard also seeks to provide readers with an idea about how much sustainable income can be expected in retirement. The first part of the dashboard looks at historical wealth accumulations for a hypothetical client who saves 15 percent of his salary in a target-date fund up to the age of 65, and then translates these wealth accumulations into a sustainable income amount assuming a strategy which closely approximates building a 30-year ladder of TIPS. This shares a feature with the CoRI Index in that I’m trying to demonstrate the amount of retirement income that can be safely obtained. Clients may wish to use different strategies, and the second part of the Dashboard considers a broader range of possibilities.

The second part of the dashboard considers sustainable spending levels for a variety of retirement income strategies for the case of a 65-year-old couple. The retirement income strategies considered include both those based on dedicated income sources that can match retiree spending needs without exposing them to market volatility, and those based on investment portfolios in which market volatility will play a much bigger role in determining retirement sustainability.

For the dedicated income strategies, I look at current costs for different combinations of income annuities (SPIAs and their cousins, deferred income annuities – DIAs) and retirement income bond ladders. For my most recent update in January, I consider a couple seeking inflation-adjusted spending. Presently, a SPIA supports a spending rate of 3.75 percent. This strategy would eliminate liquidity and upside for the assets, but it would guarantee an income for life. This payout rate is lower than the 4.8 percent suggested by the CoRI Index, because I assume a joint and 100 percent survival annuity purchase for a couple, whereas BlackRock’s CoRI Index assumes annuitization on a single life. The CoRI Index also uses a 2.5 percent COLA instead of CPI adjustments.

If instead the couple wishes to build a 30-year ladder of Treasury Inflation Protected Securities, or TIPS, the initial spending rate would be 3.65 percent. A bond ladder for retirement income consists of holding different individual bonds that mature in each year and support the desired spending level for each year. This strategy provides the ability to leave a legacy for any unused assets, but nothing would be left for those living beyond the 30-year horizon.

A third option is to combine a 20-year TIPS ladder with a DIA that begins income in year 21 of retirement. Currently, this strategy offers a payout rate of 4.03 percent of retirement assets, which is higher than the other two options. By giving up liquidity for a portion of assets (as it would require 25 percent of assets to purchase the DIA, with the other 75 percent of assets used for the 20-year bond ladder), this strategy does provide greater flexibility relative to a SPIA, while also including greater longevity protection relative to just a bond ladder.

As for a total returns investing strategy with volatile investments, we must allow for a probability of portfolio depletion. These strategies may not always work. In today's low-interest-rate environment, I estimate that sustainable withdrawal rates could vary from 2.35 percent to 3.51 percent depending on the clients’ aggressiveness, which I define as using a higher stock allocation and also spending more with an understanding that this increases the risks of running out of money.

It is important to recognize and understand why sustainable spending rates with these strategies can potentially be less than with dedicated income. The answer relates to market volatility and the tradeoffs between upside and downside. Dedicated income protects on the downside, but at the expense of losing upside growth potential. A 2.35 percent withdrawal rate might lead to a 5 percent chance that wealth runs out too soon, but on the other hand it could potentially be the case that the retiree would end up fine using a 7 percent withdrawal rate. We cannot know in advance what the specific sequence of returns will be, and so sustainable withdrawal rates must inherently be conservative to allow for a spending rate to work in the vast majority of cases. While there is additional upside potential with these investment strategies, initial projected spending rates can be less than with dedicated income. Clients can still gauge just how conservative they wish to be.

Being flexible with spending does provide a way to support a higher initial spending rate in retirement. A natural way for clients to increase the initial withdrawal rate with investment portfolios is to build in some flexibility to reduce spending if markets perform poorly (to the extent that one can conceivably cut their spending). For instance, with the Guyton and Klinger decision rules for retirement spending, I estimate an initial spending range between 4.77 percent and 6.03 percent, depending on how aggressive one is.

At the Retirement Symposium, Chip Castille and I will each be talking about our approaches to helping clients obtain a better sense about the costs for their retirement plans. Though our approaches are not the same, we share much common ground, and I’m looking forward to a great discussion with Chip as well as members of the audience.

Wade D. Pfau, Ph.D., CFA, is a professor of retirement income in the Ph.D. program in financial services and retirement planning at the American College in Bryn Mawr, Pa. He is also the director of retirement research for McLean Asset Management and inStream Solutions. He actively blogs at RetirementResearcher.com. See his Google+ profile for more information.