This article has already been published on May 15, 2021.
When it comes to retirement planning, there are a few things you can safely put in the “settled business” pile. In this age of ultra-low returns, for example, it stands to reason that most retirees will need to have a large exposure to equities if they want their portfolios to last. The current low interest rate environment also means that most retirees will have to derive some of their cash flow from reduced appreciated assets rather than relying exclusively on income distributions to cover their living expenses. An increasingly reduced share of retirees will be able to count on pensions, which embellishes the interest of delaying social security for many.
But for every “settled” question, there is another aspect of retirement planning that is the subject of heated debate, even among experts. Here are three tough decisions facing people planning for retirement today, along with how to know what to do.
Whether to withdraw at a popularized rate
It’s no wonder there is disagreement over withdrawal rates. How much you can safely withdraw from your retirement portfolio per year without running out of money over your retirement horizon isn’t just questionable – it’s impossible to know. You don’t know what the major asset classes will fetch or how high (or low) inflation will be during your retirement. You also don’t know how long you will live; your spending horizon could be 15 years or 40 years. For all these reasons, it is impossible to tell at the start of retirement what the “right” withdrawal rate is. She’s a known unknown.
But you have to use something, and that’s where the disagreements come in. Most retirement planning experts believe that today’s low returns and high stock valuations demand a withdrawal rate of. lower start than would have been the case 20 years ago, when the return on a balanced portfolio would have been much higher. In a 2013 research paper, for example, researchers Wade Pfau, Michael Finke and David Blanchett argued that for portfolios positioned conservatively with only 40% equities, the standard 4% withdrawal recommendation would carry an unacceptably high risk of running out. money – similar to a raffle. Pfau reiterated this point last year, even more emphatically because yields on cash and bonds had fallen further. Our recent research concluded that new retirees with 50% equity and 50% bond portfolios should start with a withdrawal rate well below 4% if they want to have a 90% chance of not running out of money. funds over a 30-year period. temporary horizon.
Some other experts, meanwhile, believe that a higher withdrawal rate may be feasible under certain conditions. In an interview with Michael KitcesWilliam Bengen, the creator of the 4% guideline, noted that if inflation remains low, retirees may be able to take more than 4%. But he also acknowledged in a recent interview onThe long view podcast that high inflation could jeopardize higher withdrawal amounts.
What to do: While retirement experts disagree on a safe starting withdrawal rate, there is heartwarming consensus in a few key areas. Older retirees with shorter time horizons (life expectancy) can reasonably take larger withdrawals than younger retirees with expected spending horizons of 25 or 30 years. Additionally, much of the research on withdrawal rates points to the value of being flexible with withdrawals, especially taking less when the portfolio is down. This leaves more of the portfolio in place to recover when the market does eventually.
Whether to purchase long-term care insurance
Long-term care is an uncomfortable subject from all angles. The prospect of needing such care is of course unattractive, as it implies a loss of independence. And paying for long term care can be financially devastating. In its 2020 survey on the cost of healthcareGenworth estimated the value of a year of care in a long-term care facility at more than $ 100,000, a 3.6% increase from the previous year. Most of this care is not covered by Medicare, with the exception of “rehabilitation” following an eligible hospital stay.
What remains to be debated is whether and how to protect yourself against these costs should they arise. On the one hand, the likelihood of needing long-term care is inherently a snap: around half of people who reach the age of 65 will need some type of paid long-term care. during their lifetime; the other half no. Of course, if I told you that the odds were 50/50 that you would total your care in retirement, there is almost no chance that you would decide to go without insurance. And 20 years ago, the standard prescription for covering long-term care costs for middle- and upper-middle-income adults was to purchase long-term care insurance. (Wealthier people could afford to self-finance long-term care expenses if they did occur, and low-income adults would have to rely on long-term care coverage through Medicaid.)
But the long-term care insurance market is now deeply disrupted: thanks to the combination of low interest rates and bad claims experiences for insurers, premiums have increased and several insurers have completely withdrawn from the business. Consumers who thought they were doing the right thing by purchasing insurance had to choose between abandoning policies to which they contributed, simply reducing their benefits, or paying higher premiums. This troubled environment means that purchasing pure long term care insurance is by no means a given. Hybrid products have prevailed, offering a long-term care rider bolted to a life insurance policy or annuity. But the products are complicated, and because they are often purchased at a lump sum, buyers face an opportunity cost.
What to do: While there is no universal prescription to cover the costs of long-term care, long-term care expenses are a big wild card in the spending plans of many retirees. Only fairly wealthy retirees can afford a big spending shock later in life. This argues for a careful examination of your retirement portfolio to decide if your assets are sufficient to be self-sustaining, if you are likely to be eligible for Medicaid, or if you fall somewhere in between. From there you can create what I call a long term care action plan.
Whether to buy an annuity
University researchers have long championed the idea of purchasing simple income annuities for retirement, arguing that this offers protection against longevity risk and a higher payout than would be available from investment products at fixed rate like bond funds. Annuities have received even more attention recently as a component of retiree toolkits, as lower returns have valued risk pooling that increases annuity payouts over pure investment products. . (This pooling of risk simply means that some annuity buyers will die prematurely, which will increase the lifetime income of annuitants who live longer.)
But annuity types vary widely, from ultra-utility single-premium payout annuities to more complex products that offer equity exposure, guaranteed minimum life benefits, and death benefits. In an interview on The long view podcast, Kerry Pechter, annuity expert, noted, “Annuities don’t usually exist” because the products are so incredibly diverse.
The disconnect is that the annuity products that retirement seekers generally prefer – the simple immediate and deferred income annuities that David Blanchett discusses here – have struggled in the sales department. Research has shown that the peace of mind that accompanies the purchase of a basic annuity is higher than what would be associated with holding the same amount in investment assets. But sales of fixed payout annuities remained sluggish. This is likely due to a combination of factors: Investors may be reluctant to part with capital to purchase such an annuity, and advisers may not have a strong motivation to recommend such products.
What to do: While there is no consensus as to whether annuities are a must in retirement or what types of annuities to buy, there is no doubt that the lifetime income they offer is scarce. This is especially true given that only about a quarter of baby boomers who retire today have a pension, and that number tends to decline for generations that follow.
However, the starting point for thinking about life income is not an annuity. Instead, it maximizes your Social Security payment, which is essentially an annuity backed by the US government. As social security expert Mike Piper points out, delaying filing until age 70 often makes sense for healthy singles. For married couples, it often makes sense for the higher income partner to delay the deposit in an effort to increase the couple’s lifetime payment. It is only after maximizing lifetime income through Social Security that an annuity kicks in, if a retiree needs an additional Basic Income beyond what Social Security offers. Similarly, annuities will be less useful for retirees who derive much of their income from pensions.