Enhancing Your Retirement Planning Toolkit

Transcription

1 Enhancing Your Retirement Planning Toolkit Wade Pfau, Ph.D., CFA RetirementResearcher.com/retirement-toolkit

2 What s Different About Retirement? Reduced earnings capacity Visible spending constraint Heightened investment risk Unknown longevity Spending shocks Compounding inflation Declining cognitive abilities

3 Pre-Retirement vs. Retirement

4 Key Retirement Risks

5 Retirement Goals

6 Human Capital Home Equity Financial Assets Continuing Career Part-time work Household Balance Sheet Assets Liabilities Checking Accounts Brokerage Accounts Retirement Plans Insurance & Annuities Social Capital Social Security Medicare Company Pensions Family & Community Fixed Expenses Basic Living Needs Taxes Debt Repayment Discretionary Expenses Contingencies Legacy Goals Travel & Leisure Lifestyle Improvements Long-Term Care Health Care Other Spending Shocks Family Community & Society

7 Model Portfolio

8 Three Enhancements for Low Interest Rates Delay Social Security Use an Income Annuity Open a Reverse Mortgage

9 Delay Social Security

10 Pascal s Wager for Social Security Claim Early Claim Late Short Retirement Long Retirement Worked out Permanently Reduced Lifestyle Minimal Harm Done Permanently Increased Lifestyle

11 Social Security is Insurance Don t think in terms of breakeven investment analysis Insurance value of Social Security Inflation-adjusted lifetime annuity backed by government Longevity risk protection Risk averse individuals: even more benefit from Social Security s insurance value Spousal, family, and survivor benefits

12 Social Security as an Investment Claiming age choice is meant to be actuarially fair But... Longevity has improved since 1983 actuarial calculations Interest rates have decreased too Financial planning clients live longer than average Couples can take advantage of joint longevity

13 Social Security as an Investment 2.9% Real Social Security Administration 0.6% Real 30-Year TIPS Yield August 2016

14 % Real Compounded Return from Delay to 70 8 Internal Rate of Return (Inflation-Adjusted) 6 * Healthy Couple (5.2%) 4 * Healthy Female (4%) * Healthy Male (3.2%) Age of Death

15 Social Security Claiming Example 62 year old, already retired Annual spending goal: $60,000 per year (inflation-adjusted) Social Security Benefit (inflation-adjusted) Age 62: $1,875 / month ($22,500 / year) Age 66: $2,500 / month ($30,000 / year) Age 70: $3,300 / month ($39,600 / year) Remainder of spending goal covered by withdrawals from financial portfolio

16 Real Spending in Retirement

17 Real Spending in Retirement

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19 Retirement Income Plan Impact of Social Security Delay on Retirement Withdrawal Rates Claim at Age 62 Claim at Age 70 Spending Goal $60,000 $60,000 Social Security Benefit $22,500 $39,600 Portfolio Withdrawal $37,500 $20,400 Investment Portfolio $800,000 $800,000 Set Aside for Social Security Delay $0 $316,800 Remaining Portfolio $800,000 $483,200 Withdrawal Rate 4.69% 4.22%

20 Retirement Income Plan Present Values (Assumes Live to 90) Real Discount Rate 0% 2% 6% Claim at 62 Claim at 70 Difference Social Security $652,500 $831,600 $179,100 Portfolio Needs $1,087,500 $992,400 ($95,100) Social Security $491,499 $574,949 $83,450 Portfolio Needs $819,164 $793,790 ($25,374) Social Security $305,791 $292,285 ($13,507) Portfolio Needs $509,652 $552,682 $43,030

21 Use an Income Annuity

22 Longevity Improvements: Historical Data for Remaining Life Expectancy at Age 65 Male Female SOURCE: Center for Disease Control

23 Source: Society of Actuaries, 2012 Individual Annuity Mortality tables, with projections for 2016 Longevity Risk

24 Fixed vs. Random Returns Wealth Glidepath Over a 30-Year Retirement For a 6.56% Initial Withdrawal Rate, 50/50 Asset Allocation, Inflation Adjustments Using SBBI Data, , S&P 500 and Intermediate Term Government Bonds

25 25 Distribution of Compounded Real Returns Over 30 Years Monte Carlo Simulations For a 50/50 Asset Allocation Based on SBBI Data, , S&P 500 and Intermediate Term Government Bonds Lump Sum Accumulation Retirement 1st Percentile 0.7% 0.2% -0.1% 5th Percentile 2.0% 1.6% 1.3% 10th Percentile 2.6% 2.4% 2.0% 25th Percentile 3.8% 3.7% 3.4% Median 5.1% 5.1% 4.9% 75th Percentile 6.4% 6.6% 6.6% 90th Percentile 7.6% 7.9% 8.2% 95th Percentile 8.3% 8.7% 9.3% 99th Percentile 9.7% 10.2% 11.3% Mean 5.1% 5.2% 5.1% Std. Deviation 1.9% 2.2% 2.5% Source: Own calculations with 100,000 Monte Carlo Simulations for 30-year periods for a portfolio with a 5.6% arithmetic real return and 10.8% volatility.

26 Planning Horizon (Age) Relationship between Interest Rates, Planning Horizon, and Sustainable Spending for a 65-year old with $1 million Interest rate 0% 1% 2% 3% 4% 5% 70 $200,000 $204,000 $207,998 $211,995 $215,988 $219, $100,000 $104,537 $109,144 $113,816 $118,549 $123, $66,667 $71,410 $76,299 $81,327 $86,482 $91, $50,000 $54,867 $59,958 $65,258 $70,752 $76, $40,000 $44,957 $50,216 $55,755 $61,550 $67, $33,333 $38,364 $43,774 $49,533 $55,606 $61, $28,571 $33,667 $39,218 $45,184 $51,517 $58, $25,000 $30,154 $35,839 $42,002 $48,580 $55, $22,222 $27,431 $33,245 $39,597 $46,406 $53,583

27 Sources of Income for Income Annuity Purchased by 65-Year Old Female

28 Cost of Funding $45,000 Annually for 36 Years

29 Open a Reverse Mortgage

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31 The Spectrum of Potential Reverse Mortgage Uses Portfolio/Debt Coordination for Housing Portfolio Coordination for Retirement Spending Funding Source for Retirement Efficiency Improvements Preserve Credit as Insurance Policy Pay off an Existing Mortgage Transition from Traditional Mortgage to Reverse Mortgage Fund Home Renovations to Allow for Aging in Place HECM for Purchase for New Home Spend Home Equity First to Leverage Portfolio Upside Potential Coordinate HECM Spending to Mitigate Sequence Risk Use Tenure Payments to Reduce Portfolio Withdrawals Tenure Payments as Annuity Alternative Social Security Delay Bridge Tax Bracket Management & Taxes for Roth Conversions Premiums for Existing Long-Term Care Insurance Policies Support Retirement Spending After Portfolio Depletion Protective Hedge for Home Value Provides Contingency Fund for Spending Shocks (In home care, health expenses, divorce settlement) 2016 Wade D. Pfau,

32 Initial Principal Limit (Principal Limit Factor) Expected rate = 10-year Libor Swap Rate + Lender s Margin

33 Understanding Line of Credit Growth Principal Limit = Loan Balance + Available Line of Credit + Set-Asides Loan Balance Line of Credit Set Asides

34 Understanding Line of Credit Growth Comparing Principal Limits Based on When the Reverse Mortgage Opens

35 HECMs and the Interest Rate Environment Low interest rate environment favors HECMs: Lower expected rate = larger initial principal limit Subsequent principal limit growth is lower, unless interest rates subsequently rise and accelerate growth

36 HECM Calculator: Net Available Credit Home's Appraised Value $400,000 HECM Eligible Amount $400, Year LIBOR Swap Rate 2.10% Lender's Margin 4.00% Monthly Insurance Premium 1.25% Age of Youngest Eligible Spouse 65 Modified Expected Rate Age Principal Limit Factor 41.40% % Loan origination fee $0 $6,000 <- Maximum Possible Initial mortgage insurance $2,000 <- When borrowing less than 60% of Other closing costs (appraisal, titling, etc.) $2,500 available credit in the first year Total Upfront Costs $4,500 Percentage of Upfront Costs to be Financed 0% Life-Expectancy Set-Aside (LESA) Requirements $0 Net Available HECM Credit $165,600 Source:

37 HECM Strategies for Portfolio Coordination Ignore Home Equity Home Equity as Last Resort ( Conventional Wisdom ) Use Home Equity First Sacks and Sacks Coordination Strategy Texas Tech Coordination Strategy Use Home Equity Last Use Tenure Payment

38 Probability of Success Probability of Success for a 4% Post-Tax Initial Withdrawal Rate $1 million portfolio, $500,000 home value, 25% Marginal Tax Rate Ignore Home Equity Home Equity as Last Resort 40 Use Home Equity First Sacks & Sacks Coordination Texas Tech Coordination 30 Use Home Equity Last Use Tenure Payment Retirement Duration

39 Real Legacy Value Median Real Legacy Value for a 4% Post-Tax Initial Withdrawal Rate $1 million portfolio, $500,000 home value, 25% Marginal Tax Rate $1.6 mil $1.4 mil $1.2 mil $1 mil Home Equity as Last Resort Use Home Equity First Sacks & Sacks Coordination Texas Tech Coordination Use Home Equity Last Use Tenure Payment $800K $600K $400K $200K $0K -$200K Retirement Duration

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