Retired clients have several objectives, not all of which are financial in nature. But all retirees share two potentially conflicting financial goals: spending enough each year to maintain a certain standard of living throughout retirement and ensuring that their accumulated savings don’t run out prior to death.
The solution lies in developing and maintaining a spending strategy that results in a sustainable income from year to year from all sources (government pensions, withdrawals from accumulated savings, immediate annuities, part-time work, etc.), explains retired Watson Wyatt Worldwide pension actuary Ken Steiner in a recent Journal of Personal Finance paper entitled “A Better Systematic Withdrawal Strategy: The Actuarial Approach.”
That actuarial approach is one that matches the retiree’s current assets with liabilities, where such liabilities are defined as the present value of real dollar level spending over the retiree’s expected lifetime.
Although “safe” withdrawal rates (SWR) have been developed using different assumptions for future expected experience, these approaches generally involve applying the developed withdrawal percentage to accumulated assets and increasing the amount withdrawn in subsequent years by the rate of inflation, irrespective of actual investment performance.
Several studies have suggested SWRs should be adjusted periodically for real-world results; however, such adjustment details are seldom very clear, Steiner says. As a result, this approach doesn’t really suit clients who are planning for lengthy retirements or interested in leaving bequests. Nor does this calculation take into account the possibility that spending can vary widely over the course of retirement.
To complicate matters, the SWR doesn’t change as a client ages. An 83-year-old retiree who has enjoyed reasonable returns from her investments probably can afford to withdraw more later in life simply because her life expectancy now is far less than it was when she first started out.
Looking out 20 to 30 years, both you and your clients simply can’t count on fixed assumptions to match exactly what will happen in the future. It’s better, Steiner says, to manage family assets like those of a pension plan, starting each year with an assessment of where your client stands and, if necessary, making adjustments in any assumptions.
At the beginning of each year, he recommends that you retrieve a client’s retirement budgeting file, match it with his or her recent spending history and determine how much accumulated savings your client has left. This total should reflect how your client’s investments have performed in the prior year, as well as the amounts he or she has withdrawn.
Then, run the numbers again, based on current data and any revised assumptions, then decide whether and how to smooth the expected spendable amount compared with the previous year’s results.
If the spending budget for the previous year is within 10% of the product of the updated withdrawal percentage and updated assets, your client may stick with it for the coming year, increased with inflation. If not, however, the client needs to consider making immediate adjustments, Steiner warns, suggesting that regularly addressing the disconnection between client decisions and consequences in this way will improve clients’ retirement planning.
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