Optimal Tax-efficient Retirement Income and Lifestyle Planning: Making the Most of One s Nest Egg (Part II) INFORMS New York Metro Wednesday, December 18, 2013 Lewis Coopersmith, Ph. D. Associate Professor, Rider University
Outline Motivation for Service Development Slides 3-5 Original Process For Planning Retirement Withdrawals..Slides 6-8 Enhancements...Slides 9-11 Benefits.Slides 12-13 Typical Scenario Results...Slides 14-30 Future Development...Slide 31
Motivation For Service Development Questionable Advice Prior to retirement, I did NOT get the best planning advice Wealth Manager, CPA cited Common Rules: Initially withdraw safe amount, increase annually by inflation Draw your taxable savings before tax-deferred
Motivation For Service Development Complicated Tax Issues Tax deductions and exemptions offset taxes on tax-deferred withdrawals Higher tax brackets for delayed tax-deferred withdrawals due to federal required minimum distributions (RMDs) starting at age 701/2 Taxable savings leverage: Capital gains strategies Managing capital losses Impact of Roth conversions
Motivation For Service Development More problems Lifestyle issues: withdrawing a safe % implies adjusting lifestyle to what s left after taxes More sensible to figure what is needed to live a desirable lifestyle; then plan withdrawals for high savings growth; then assess risk safety Investment strategies: portfolio distributions vary depending on tax treatment, resulting in different ROIs and volatility risk for different account types Accounting for and evaluating impact of other income sources
Original Planning Process: Objective Provide decision support for retirees and their wealth managers in planning retirement withdrawals Use mathematical optimization to: Determine amount to withdraw from each wealth source Assure satisfaction of: Before-tax expense specifications Federal RMD constraints Approximate federal income taxes as an integral part of the process to maximize final accumulated wealth (Final Total Account Balance FTAB)
Original Planning Process* Withdrawal Plan Determination FIXED DATA Age, Account Values, Tax info, etc. OPTIMIZATION MODEL DATA (e.g., linear programming) NO DISCRETIONARY DATA FEASIBLE SOLUTION? Before-tax Expenses, Average Account RORs YES YES RE-EVALUATE Before-tax Expenses? RORs? OPTIONAL: Risk Analyses OPTIMAL PLAN Account Withdrawals (e.g., Monte Carlo Simulation) NO IMPLEMENT PLAN *patent pending Selected From OPTIMAL PLANS
Original Planning Process: Data Income Sources Both spouses Social Security start years, initial amounts Initial savings: taxable, tax-deferred savings (e.g., IRAs), tax-deferred fixed annuities Anticipated annual RORs for each account Annual expenses, with itemized deductions sub-totaled Fixed: birth dates for spouses, planning horizon of 25 years, federal tax constants, inflation rate
Enhancements: Data Data Income sources added Earned and other taxable Tax-free Taxable income deductions, capital losses Account sources and characteristics Addition of tax-free: Roths, munies Specification of long term capital gains sources for taxable savings Proportions in cash, stocks, bonds for use in MC
Enhancements: Process Process Married or single use Choice of planning horizon: 15 30 years Long term capital gains included in tax computation Roth conversions/withdrawals: Prohibit all, or Specify annually-- either limit or unlimited Monte Carlo risk assessment Income, initial account levels, living expense data fixed for each simulated scenario; only annual RORs vary randomly MC statistical results compared to plan based on anticipated RORs to confirm if plan within anticipated risk
Enhancements: Results Added annual results Taxed and tax-free income sources Annuity use details Amount converted to 10 year fixed or lifetime Amount of payments from all annuities Future annuity payments Contributions to tax-deferred Roth conversion amounts Tax-free withdrawals Monte Carlo Sustainability percent Selected statistical account balance trends
Benefits Tax-efficient vs. Other methods To retirees: Greater retirement wealth Focus on meeting desired lifestyle income needs Fast, flexible evaluation of impact of alternative lifestyle and/or investment scenarios Results feedback supports wide range of financial and lifestyle decisions, including Optimal management of retirement assets and expenses Property sales When to start Social Security
Benefits Tax-efficient vs. Other Methods To financial planners: Greater assets under management More assets under management for longer time period Client loyalty and asset retention Higher new client potential
Typical Scenario Fixed Data A couple: Max age 61, Melanie age 59 Planning horizon- 30 years First 4 years part time work Initial Social Security Combined annual earnings: $100,000 Includes annual payroll taxes: $6,000 Max: $24,000 starting 2018 Melanie: $14,400 starting 2020 Melanie s pension: $15,000 starting 2016 Assumed inflation rate: 2.3%
Typical Scenario Savings Data Initial savings: $1,342,000 split Taxable savings/investments: $102,000 Tax-deferred savings: $1,140,000 Anticipated ROR: 3.1%, Interest: 23%; LTCG : 41%; Growth: 36% 42% Stocks, 11% Bonds, 47% Cash Anticipated ROR: 5.1% 36% Stocks, 64% Bonds Tax-free Roths: $100,000 Anticipated ROR: 6.1% 25% Stocks, 75% Bonds
Typical Scenario Living Expenses + Payroll Taxes (Excluding Federal IncomeTaxes) $220,000 AnKcipated total over 30 years 7% less than CR $200,000 $180,000 $160,000 $140,000 $120,000 Mortgage Ended 2023 Reduce travel, entertainment, car expense aser 2031 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 2039 2040 2041 2042 $100,000 Common Rule: Initial Safe Inflation A djusted Anticipated Detailed
Typical Scenario Scenarios Evaluated Common Rule (CR) 1. Baseline Tax Efficient (TE) 2. 3. 4. 5. Taxable first, then tax-deferred, then tax-free CR expenses, itemized deductions replace standard Optimization model determines withdrawal sequence Scenario 2 with detailed expenses Scenario 3 with Roth Conversions Scenario 4 with some tax-deferred annuities
Typical Scenario Scenario Results Summary
Scenario 1: Common Rule Total Account Balances $1,800,000 $1,600,000 FTAB: $492,853 % Sustainable: 73% Total taxes: $567,741 $1,400,000 $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 Roth and other Tax- Free Savings Tax- Deferred Savings Taxable Savings 2042 2041 2040 2039 2038 2037 2036 2035 2034 2033 2032 2031 2030 2029 2028 2027 2026 2025 2024 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 2013 $-
Scenario 1: Common Rule $250,000 Revenue Sources $200,000 $150,000 $100,000 $50,000 $- Total Income Taxable Savings Withdrawal Tax- Deferred Savings Withdrawal (non- Roth) Roth and other Tax- Free Savings Withdrawal Living Expenses Total Expenses
Scenario 2: Baseline Tax Efficient (TE) Total Account Balances $1,800,000 $1,600,000 FTAB: $713,734 % Sustainable: 76% Total taxes: $417,224 $1,400,000 $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 Roth and other Tax- Free Savings Tax- Deferred Savings Taxable Savings 2042 2041 2040 2039 2038 2037 2036 2035 2034 2033 2032 2031 2030 2029 2028 2027 2026 2025 2024 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 2013 $-
Scenario 2: Baseline Tax Efficient (TE) Revenue Sources $250,000 $200,000 $150,000 $100,000 $50,000 $- Total Income Roth and other Tax- Free Savings Withdrawal Taxable Savings Withdrawal Tax- Deferred Savings Withdrawal (non- Roth) Living Expenses Total Expenses
Scenario 3: TE + Detailed Expenses Total Account Balances $1,800,000 FTAB: $ 1,164,614 % Sustainable: 85% Total taxes: $ 397,892 $1,600,000 $1,400,000 $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 Roth and other Tax- Free Savings Tax- Deferred Savings Taxable Savings 2042 2041 2040 2039 2038 2037 2036 2035 2034 2033 2032 2031 2030 2029 2028 2027 2026 2025 2024 2023 2022 2021 2020 2019 2018 2017 2016 2015 2014 2013 $-
Scenario 3: TE + Detailed Expenses Revenue Sources $250,000 $200,000 $150,000 $100,000 $50,000 $- Total Income Roth and other Tax- Free Savings Withdrawal Taxable Savings Withdrawal Tax- Deferred (non- Roth) Savings Withdrawal Anticipated Detailed Total Expenses
Scenario 4: Scenario 3 + Roth Conversions Comparison of Account Balances and Roth C onversions Roths vs N o Roths $1,600,000 $400,000 $350,000 $1,500,000 $1,400,000 $250,000 $1,300,000 $200,000 $150,000 $1,200,000 $100,000 $1,100,000 $50,000 $1,000,000 $- 2041 2039 2037 2035 Unlimited R oth Conversion Account B alances Roths Limit $50K 2033 2031 2029 2027 2025 2023 2021 2019 2017 2015 2013 Limited R oth Conversion Account B alances Unlimited R oths Account B alances Scenario 3 Roth Conversions Account Balances $300,000
Scenario 4: Scenario 3 + Roth Conversions $1,600,000 Total Account Balances FTAB: $1,251,429 % Sustainable: 85% Total taxes: $404,631 $1,400,000 $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 $- Roth and other Tax- Free Savings Tax- Deferred Savings Taxable Savings
Scenario 4: Scenario 3 + Roth Conversions Revenue Sources $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $- Total Income Roth and other Tax- Free Savings Withdrawal Taxable Savings Withdrawal Tax- Deferred (non- Roth) Savings Withdrawal Living Expenses Total Expenses
Scenario 5: Limited Roths + $600K To TDAs Total A ccount Balances $1,600,000 FTAB: $979,595 % Sustainable: 93% Total taxes: $390,287 $1,400,000 $1,200,000 $1,000,000 $800,000 $600,000 $400,000 $200,000 $- Annuity Balance & Future Payments Roth and other Tax- Free Savings Tax- Deferred Savings Taxable Savings
Scenario 5: Limited Roths + $600K To TDAs Revenue Sources $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $- Total Income Tax- Deferred Annuity Withdrawal Roth and other Tax- Free Savings Withdrawal Taxable Savings Withdrawal Tax- Deferred (non- Roth) Savings Withdrawal Living Expenses Total Expenses
Scenario 5: Limited Roths + $600K To TDAs $6,000,000 Key Monte Carlo Account Balances Results Max $5,000,000 Accout Balances $4,000,000 $3,000,000 75th %ile $2,000,000 Median $1,000,000 25th %ile Min $- 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Year Ahead Anticipated RORs Median MC Average MC 75th %ile MC Min MC Max MC 25th %ile MC
Future Development Add assessment of account values prior to age 591/2 resulting in lifetime income planning Enhanced Monte Carlo methods Greater tax computation accuracy Scenario suite, including guidance in evaluating: Age to start Social Security Immediate annuity Selling property
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