Client retirement withdrawals come with sequence of returns risk: When and how clients draw down their retirement savings can affect returns in the long term, said Michael Kitces, blogger and head of planning strategy at Buckingham Wealth Partners, who spoke Wednesday at the Schwab Impact 2020 online conference.
He provided three strategies for advisors to manage this risk for clients.
His presentation included examples of how clients can translate various buckets of money — like 401(k)s, IRAs, pensions, annuities and Social Security — into “sustainable cash flow” over a 30-year retirement period.
Obviously, one crucial factor is the type of market in which they retire, Kitces said, adding “the best time to retire is when the [price-to-earnings ratio] is low” — in other words, not today’s market.
Kitces discussed these three strategies:
1. Safe Spending Rate
This is the most conservative method and one that 50% of advisors watching the webinar stated they used in an instant survey. This is picking a withdrawal rate that is conservative and sticking with it, no matter how the market or inflation affect savings. One problem: This method could be too conservative and leave most of a retiree’s savings to heirs, Kitces said.
He showed a chart on spending rate with 30-year sequences as far back as 1871. The average “safe” rate was 6.5%, but Kitces notes that would have failed 50% of the time.
Most likely, if a savings rate is too low, the retiree will “lift spending,” Kitces said.
“I know there’s been a lot of discussion about whether the 4% rule is broken … but keep in mind the 4% rule was not based on average returns; it was based on worst sequences we’ve had in 150 years.”
But by selecting the lowest withdrawal rate — “that is, [preparing for] the worst we’ve seen in 150 years” — 96% of the time retirees in the 20th century “would have finished with more than what they started with.”
2. Dynamic Asset Allocation
This method, used by 20% of the audience, looks at how a portfolio investment mix is adjusted. “In some way, shape or form, we change how our assets are allocated in order to do this,” he said.
One way to do this is to use “bucket strategies,” which break up the portfolio into different time horizon buckets, so the first spending in retirement would be either cash or short-term investments. Next after a few years would be bonds, which have some premium that can be used, and the third is stock dividends. “By definition, you won’t need to touch the equity bucket for 10 years because of using [cash and bonds first],” Kitces said.
Also, spending has to be divided by essential (food, clothing) and discretionary. Essential spending can be covered by annuities that guarantee an income stream for life, he added.
Stock returns can then cover discretionary spending, and shifting the portfolio mix toward more stocks as a client ages is an option. He noted stocks could go up for 30 years, or down for 30 years, “and in that case it doesn’t matter what you do because everything’s going to fail.”
As chances are stocks will go up and down, a client who starts with a conservative mix and grows more aggressive “actually makes the retirement sequence work better.”
3. Dynamic Spending
This method, used by 30% of the audience, looks at adjusting spending between upper and lower bands. He notes the “ratcheting” option is starting with an example of a 4% withdrawal rate and moving it up as a portfolio increases in value. However, spending shouldn’t be ratcheted up until a portfolio is “so far ahead that even if the market pulls back you won’t have to cut your spending.”
One “super simple strategy” is if there is a 50% extra cushion of excess returns, take a 10% increase every three years, Kitces explains, adding that “this is for clients who want raises but can’t tolerate cuts.”
Another option: guardrail strategies that have floor and ceiling bands. When spending bumps against either band, it has to be reduced or can be increased. The bands can be calculated through the Monte Carlo method.
Kitces also recommended that advisors use official withdrawal policy statements for clients to outline retirement distribution.
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