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Planning In Retirement


Helping clients transition into and through retirement will be critical to the success of financial planning practices in the coming years. We provide a valuable service as many of our clients move into this phase of their lives. For our clients, managing the spend-down phase is very different on many levels than the accumulation phase. It is important for us to understand this also as we work with clients in this area.

The biggest fear we hear from clients entering their retirement years is if they will run out of money. Answering the question, “How much is enough?” is priority number one when helping clients develop a spend-down plan. Before you can answer that question, you need to understand your clients’ goals and priorities in life. You can’t develop a sustainable plan unless you know what they hope the future might hold for them. Building a deep relationship with your clients is critical to understanding what they want retirement to look like. There are many other areas of retirement planning where CPA financial planners are well positioned to provide advice, such as minimizing taxes. Helping clients develop a tax efficient withdrawal strategy in retirement could save them significant sums of money and lead to a more comfortable retirement.    

I had the pleasure of moderating a panel of the some of the top experts in the country on this topic at the AICPA Engage Conference in June 2017. Our panel discussed a wide range of topics in the retirement planning area. I will cover these four major topics in this article. All of these are important aspects of the planning in this area:

  • Safe withdrawal rates
  • Prudent asset allocation in the spend down phase
  • Cash flow challenges and understanding retirement spending patterns
  • Strategies for dealing with longevity assumptions

Safe Withdrawal Rates

Bill Bengen’s research on safe withdrawal rates, initially published in 1994, has led to a general rule of thumb in retirement planning known as the 4% rule. This research looked back through history to determine a safe initial withdrawal rate from a portfolio that would survive any 30-year retirement period. He assumed the portfolio had a 50/50 stock/bond allocation and the initial withdrawal amount was adjusted each year for inflation. He found that an initial withdrawal rate of 4% would have safely preserved a portfolio over all 30-year time periods. In other words, a $1 million portfolio could have sustained an initial annual withdrawal of $40,000, adjusted for inflation each year, throughout every 30-year period in history. There are numerous factors that are not considered in this analysis and every client situation is unique, but the 4% rule provides a starting point as we explore a “safe withdrawal rate” for our clients.

One critical issue raised by our panel regarding this research is that it is merely looking at the “safe” withdrawal rate, not the “optimal” withdrawal rate. In other words, Bengen set out to find the highest possible withdrawal rate that would survive ALL 30-year periods in history. What isn’t discussed as frequently is that in most of those 30 year periods, using a 4% withdrawal rate would leave a significant amount of money on the table at the end of the clients’ lives. Some clients will be comfortable making this assumption but others might be inclined to spend more in their early years, understanding they could be taking on more risk of running out of money.

Along these lines, we know that WHEN you start retirement can have a significant impact on the ability of your portfolio to last through retirement. In the retirement planning world, we call this “sequence of return risk,” because it represents the risk that clients could retire at the wrong time and experience a poor sequence of returns early in retirement. If this happens and the portfolio takes a hit just as your clients start depleting the portfolio, there will be a smaller asset base available to take advantage of a recovery in the markets. On the flip side, if a new retiree encounters a multi-year bull market when they start spending down their portfolio, they will have a much larger asset base to sustain a downturn when it occurs. In other words, losses in the initial years of retirement have a much higher impact than they do if they are experienced at the end.

Coming up with an optimal withdrawal rate and planning for sequence of return risk has led many planners to use Monte Carlo software to help plan for their clients’ retirement. This software will look at thousands of different “sequences of returns” rather than just assuming a straight-line average return occurs each year. It also enables you to adjust numerous assumptions related to your clients’ future and run different scenarios to judge the impact of various changes to their plan. Using this type of software to help clients plan for their retirement years can be a much greater guide than just relying on the 4% rule. There are some drawbacks to this software right now that were pointed out by our panel, primarily the inability to handle a dynamic withdrawal strategy where a client’s spending changes over time. Of course, developing the optimal withdrawal strategy for your clients is a balancing act, regardless of the planning tools you use. We can’t predict the future and you don’t want your clients to “leave happiness on the table” by not spending enough for fear of running out of money.

Prudent Asset Allocation Strategies

As discussed above, the initial studies that gave us the 4% safe withdrawal rate, were based on a 50/50 stock/bond mix, using only US Large Cap Stocks (S&P 500) and Intermediate Term US Government Bonds. An appropriate asset allocation must be based on not only the required rate of return you need to make the plan “work,” but also your clients’ risk tolerance. It should also likely be more diversified by including asset classes like small cap stocks and international stocks.

Two of our panelists have published research suggesting that a “rising equity glide path” (increasing your equity exposure through retirement,) might make more sense than reducing your stock allocation, which has historically been the advice given to retirees. Their research shows that increasing your stock allocation through retirement also increases the “initial safe withdrawal rate.” However, these researchers recognized that what looks best on paper might not always be applicable in the real world. Older retirees with a significant portion of their assets in stocks might have a hard time sitting through the volatility of that kind of portfolio when they know they don't have a long time period for the portfolio to recover.

Cash Flow Challenges

Understanding your clients’ living expenses is critical to retirement planning. While most clients can give you a sense of what they spend in total, it is important to get to a level of detail to know what is fixed and variable. You need to understand their needs, wants, and desires. Conscientiousness can be a double edged sword. In your pre-retirement years, not spending on impulse, staying within your budget, etc. are all admirable traits. In retirement, sometimes people go too far in this regard and worry about every expense. This is often motivated by a fear of running out of money. It has been noted that often, in retirement, people spend too little and they spend on the “wrong things.” This is why “life planning,” or really understanding what is important to your clients, is so important.

Strategies For Dealing with Longevity Assumptions

Retirees have an unknown time horizon in the retirement lifecycle phase. Studies also show the life expectancy of a higher income individual can be up to five years longer than those with lower income. We tend to overestimate our life expectancy as we get older and underestimate it when we are younger. It is clear that life expectancy is increasing and we need to consider that in our planning for retirement. The risk of running out of money is a valid concern when clients make that shift to spending down their portfolio. Any sources of lifetime income (such as a defined benefit pension, social security benefits, or other streams of income) can be an important part of their retirement cash flow picture. Unfortunately, most people cannot rely on these to meet the bulk of their living expenses.

More individuals are looking at annuity products to fill some of this need, and several of our panelists have done extensive research on how some types of fixed annuities can improve retirement plan outcomes. They can provide a dual benefit of increasing the amount of income that can be spent each year at a given probability of success and also address the consequences of a retiree outliving their savings. By pooling the “risk” of a long life, we are able to invest a portion of funds in an income stream that we will not deplete.

Financial planning through the retirement years requires the integration of a variety of areas of personal finance and also a strong understanding of your clients’ goals and plans for this phase of their lives. As baby boomers retire in record numbers, providing these services to your individual clients will be more important than it has ever been. 

The views expressed represent the opinions of L.K. Benson & Company and are subject to change.  These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person.

Please see Additional Disclosures more information.