Decumulation more than you ever wanted to know about post retirement income Steve Schubert Director, Superannuation Russell Investment Group
Decumulation A new phase of financial life Pre retirement: asset accumulation Post retirement: asset decumulation Pre retirement: all about wealth Post retirement: all about income Pre retirement: known time horizon Post retirement: unknown time horizon Pre retirement: contribution and investment policies Post retirement: spending and investment policies
Why the focus on income? Money is better than poverty, if only for financial reasons.. Woody Allen
Some things you need to know The truth about death and taxes The 10/30/60 rule How many buckets of money do I need?
We re all going to die In this world nothing is certain but death and taxes. Benjamin Franklin author, statesman, inventor
Though some of us are in denial I m not seeking immortality through my work I want to achieve it by not dying. Woody Allen
Longevity for retirees the facts Life expectancies are improving. Retirees with substantial savings are a select group: They have already survived to retirement age They are not truly representative of the broader population They are commonly part of a couple No one lives for the average life expectancy: There is a wide range of possible outcomes You can influence your own life expectancy
All men are created equal..except when it comes to longevity! Published mortality tables are based on the broad population. Retirees who will largely rely on their own savings are not representative: They will have been employed most of their life. Generally will come from higher socioeconomic groups. New Zealand, Australian and UK research indicates that those in the top economic quintile may live 2 to 3 years longer than the average. Tobias and Cheung, Monitoring health inequalities: life expectancy and small area deprivation in New Zealand, April 2003 Report of the NSW Chief Health Officer, Socioeconomic Status. Life Expectancy, 2006 UK Office of National Statistics, Trends in life expectancy by social class an update, 1999.
How uncertain is your life A question: expectancy? The life expectancy of a typical New Zealand male 60 year old is 20.6 years what is the standard deviation of that expectancy (the range that covers twothirds of a group of similar people)? Answer: Close to 10 years Source: Calculated from NZLT 2000 2002 mortality tables. For illustrative purposes only.
The standard deviation declines with age but this doesn t mean the risk reduces Life expectancies and standard deviations (in years) Male age Expectancy Std Dev Female age Expectancy Std Dev 60 20.6 9.1 60 24.1 9.4 65 16.7 8.2 65 20.0 8.6 70 13.1 7.1 70 16.1 7.6 75 10.0 6.0 75 12.4 6.6 Calculated from NZLT 2000 2002 mortality tables
Which uncertainty is greater, investment or longevity? Consider two hypothetical worlds Longevity fixed (everyone lives to the average age) and variable returns Returns fixed (everyone gets the average return) and variable lifespans Both introduce uncertainty into the distribution of dollar outcomes. But which one has the wider distribution?
Longevity becomes proportionately more uncertain the older you get Consider two hypothetical worlds Longevity fixed (everyone lives to the average age) and variable returns Returns fixed (everyone gets the average return) and variable lifespans Longevity uncertainty has about same impact as investment uncertainty from fixed income at age 60 By age 70, longevity is more uncertain than equity return uncertainty
Here is another way to look at it Consider 100 people aged 65 Age 65 80 85 90 95 100 Men Alive 100 69 51 31 14 4 Women Alive 100 79 66 47 25 9 Calculated from NZLT 2000 2002 mortality tables, with mortality improvement from ALT 2000 02.
Why are couples special? Age Men Alive Women Alive One or both alive 65 100 100 100 80 69 79 94 85 51 66 83 90 31 47 63 95 14 25 35 100 4 9 13 Calculated from NZLT 2000 2002 mortality tables, with mortality improvement from ALT 2000 02.
A final word on longevity.. You can live to be a hundred if you give up all the things that make you want to live to be a hundred.. Woody Allen
Investment decisions in decumulation remain important Investors seem surprised by the 10 30 60 rule: An individual saves a constant percentage of pay from age 25 through age 65 And then decumulates for 25 years Under reasonable assumptions, each dollar decumulated consists of approximately: 10 cents of original savings 30 cents of investment return in accumulation 60 cents of investment return in decumulation Source: Analysis by Matt Smith, Managing Director, Retirement Services, Russell Investment Group
One possible solution: lifetime annuities Insurance company guarantees payments for life (by pooling the risks of a large group) But lifetime annuities are not popular anywhere Framing: income seems puny relative to capital I used to be a millionaire, now I have to live on $79,700 a year Loss of control, irreversibility What if I die? I want protection, not a gamble Bequest motive I ll outline a more flexible approach later
Here s how a lifetime annuity really works Effectively, a swap: Pay for average longevity, and receive payments for the buyer s own longevity 120000 100000 Dollars 80000 60000 40000 20000 0 1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46 49 52 55 58 61 Year Buyer s longevity Standard longevity For illustrative purposes only.
The good and the bad aspects of a lifetime annuity The good aspect: An inexpensive way to buy longevity protection For a male aged 60, it would cost 50% more to buy a fixed term annuity that gives (only) 2 SD protection The bad aspect: Looks expensive to investors A new risk: decumulator can lose life and capital together And is forced into fixed income Also, it s unnecessarily capital intensive You really want the option to buy an annuity, which costs much less than annuity itself
But options won t be sold (for some time.) Until then, work with a financial plan (anticipating that you ll have enough money to decumulate over your life expectancy)
How many buckets of money do you need to retire on? That depends on: What is the cost of the lifestyle you want to adopt in retirement? How much money is there in a bucket? But seriously Here s a way to divide assets into four buckets And see how large each bucket needs to be, for you So that you can compare the amount you have with the amount you need for each bucket
The spending plan: hard work, but useful Helps with tax planning, estate planning, thinking about the future Requires answers to fundamental questions* these may help to frame objectives: 1. You have all the money you need. How would you live your life? 2. You ve just found out you have five to ten years to live. How will you change your life? 3. You ve just found out you have 24 hours to live. What are your regrets? It s always an iterative effort * Based on: Life Planning by George Kinder, Wall Street Journal, October 6, 2007
Of course Woody has some thoughts on plans If you want to make God laugh, tell him about your plans. Woody Allen
So here s a way to think about buckets of money Bucket #1: The essentials bucket In addition to lifetime income streams you may already have (eg. NZ Super), how much money would you need to buy a lifetime annuity for what you d consider the essentials of life (that is, the worst lifestyle you d consider tolerable)? Bucket #2: The lifestyle bucket How much more money would you need for a lifetime annuity for the lifestyle you desire? Bucket #3: The kids and bequest bucket All the additional money you have Bucket #4: The endowed bucket (For the fortunate or frugal few) So much money that it ll never run out, because you can live off the income alone
The more wealth you have, the more choices you have The endowed bucket: Accumulate and enjoy! Lifetime Annuity Requirement The kids and bequest bucket: Decumulate, monitor, talk to the kids The lifestyle bucket: Buy a lifetime annuity, or satisfy your risk appetite The essentials bucket: Buy a lifetime annuity
How else can we manage these risks? Account based pension Choose initial decumulation rate Then fixed or linked to inflation or to percentage of balance Account balance managed to static or dynamic allocation Variable Annuity Similar to account based pension Various guarantees can be purchased at transparent premium Unit trust with longevity pooled Payments continue for life Each death generates a mortality bonus for the survivors Advanced life deferred annuity (ALDA) Forward contract, pay today, collect specified lifetime annuity from age 80 or 85
Notice how they deal with the negative features of lifetime annuities Framing: now you can think in terms of both capital and income Loss of control, irreversibility: pure decumulation products permit cashing out Gamble of early death: pure decumulation products return the balance Bequest motive: the balance Forced into fixed income: no longer Unnecessarily capital intensive: the ALDA reduces the size of that objection
A final word from Woody Life is full of misery, loneliness, and suffering and it's all over much too soon. Woody Allen