Retirement Distribution Strategies

Manish Malhotra, President & CEO, Income Discovery @manish96 and @incomediscovery

Retirement Distribution Strategies

Takeaways

• Synergistic interaction among retirement income strategy components

• A framework to find these synergies • Discover up to 20% higher post-tax

Current Approach

• Portfolio expected return and volatility – not sufficient

• Probability of success -> sustainable withdrawals

• Reward: Retirement Income

Presenting Risk

• Improve risk presentation by using learning from Behavioral Finance research

Fast Thinking

• Reaction to this picture • Instantly see that she is

angry;

• System 1 of the mind processed it

Slow Thinking

• 185 X 27 = ? Takes effort

• Different part of your mind used, called System 2 – conscious reasoning self

WYSIATI

• What You See Is All There Is

• Will John be a good leader? He is intelligent and strong

• Answer: Yes. Associative Memory.

John – Good Leader?

• .. He is intelligent, strong, corrupt and cruel – Still Yes.

• He is corrupt, cruel, intelligent and strong – No, not a good leader

75% Probability of Success

• What does client think?

• Associative Memory Triggered

75% Probability of Success

• Good – context of gambling and sports, very good

• Does client understand 25% chance of failure?

• No – WYSIATI explains it

• Issue with both words, probability and

Alternative Presentation

• Out of 1000 retirees,

• 750 were successful in generating the desired income

System 1 Processing of Frequency

Real people like them and their peers

They imagine a room full of retirees; 250

unsuccessful segregated in a corner.

Partial Income Retirees

Systematic Withdrawal Portfolio exhausts,

No Success or Failure

• Full Income or Partial Income

Story of individuals, not a statistic

Unfortunate Retiree

20th highest Cumulative Shortfall out of 1000 retirees

Social Security Systematic Withdrawal Portfolio

Pension

Bond Ladder

Immediate Annuity

Retirement Income By Source Over Time

Shortfall Years

Sh

ortfal

l

Risk – Unfortunate Retiree Case

Risk-Reward Framework

• Primary Reward: Retirement Income • 1st Risk: Retirees with Full Income • 2nd Risk: Years of Full Income for

Unfortunate Retiree

• 3rd Risk: % of Income in Shortfall Years for Unfortunate Retiree

Distribution Strategies

• Social Security – defer or take early • Single Premium Immediate Annuity

Brady Case Study

• 66 year old couple • Total Assets: $800K

• Monthly Pension: $500 • Social Security @66 - $2.5K and $2K pm

Real Income Over Time

Discretionary spending reduces as they age; essential spending rises - 10% drop in total spending.

Strategy 1 – Social Security @66

Strategy 2 – Social Security @70

$100K

$90K

Real Income By Source Over Time

Higher

withdrawal from SWP for 4 years

Social Security increases to $71.2K lowering withdrawal from SWP over last 26 years

Social Security @70 Better

Why? 15-20% lower withdrawal from SWP over 26 years $100K $90K Social Security of $71.2K @70 H igher w it hdraw al from SW P f or 4 y rs

. _{Lower withdrawal from}

Annuity – Mortality Credits

Sam, Peter & John pool their assets together to provide income for all who survive

Only Peter survives to claim benefit from the pooled assets

Annual Income

Sam Peter John

Annual Income

Immediate Annuity

• $160K Purchase – can it help?

• Inflation adjusted payout: $6,047 • Level payout: $9,329

• Which is better?

Inflation adjustment is based on CPI-U index

Strategy 3 – Inflation Adjusted Annuity

$100K

$90K

Social Security of $71.2K

Real Income By Source Over Time Pension

Strategy 4 – Level Payout Annuity

$100K

$90K

Social Security of $71.2K

Real Income By Source Over Time

Pension

Annuity payout of $9.3K

Annuity Comparisons

Level payout better than inflation adjusted

48 Full Income Retirees

4 Years of Full Income for Unfortunate Retiree

24% Average Legacy

Social Security and Annuity

• Does level payout Annuity help if Social Security was taken at 66?

• No. Compared to SS@66, buying the annuity causes

Why Annuity doesn’t help with SS@66?

Immediate Annuity with 3.9% avg. flow rate

Immediate Annuity with 5.8% initial payout under 3% inflation expectation has avg. flow rate of 3.9%

$100K $90K Social Security of $54K Pension Systematic Withdrawal Portfolio (SWP)

Portfolio avg. flow rate is $37K /

Why Annuity doesn’t help with SS@66?

4.6% Flow

Risk

How Annuity helps with SS@70?

Portfolio avg. flow rate is $29.3K / $800K = 3.7%

Immediate Annuity has 3.9% avg. flow rate

Fixed Annuity with 5.8% initial payout under 3% inflation expectation has avg. flow rate of 3.9%

$100K

$90K

Why Annuity helps with SS@70?

3.7% Flow

Risk

Key Learning

• Not the isolated impact of the component of a strategy

• But, their cumulative impact • Rules are not general

Tax Sensitive Analysis

• Tax sensitive analysis valuable for a higher net worth client

- Full tax brackets and standard deductions

HNW Brady’s

• Taxable Joint Account: $1 million

65% average cost basis

• Peter’s IRA: $1.25 million and Lisa’s IRA: $800K

Both 15% post-tax basis

Tax Sensitive Strategies

• Strategy A

- Withdrawal Order: Taxable, IRA, Roth

- Purchase $800K of immediate annuity in Peter’s IRA

• Strategy B

Tax Strategies Comparison

Strategy A is better – Taxable-IRA-Roth; Annuity in IRA

• 66 Full Income Retirees

• 1 Year of Full Income for Unfortunate • 6% point Partial Income

1. If Annuity

bought in Taxable Account, it runs out in 1.5 years

2. Roth hasn’t

had time to grow, it can give

income only for 2.5 years

3. Full taxable withdrawals from IRA in the later

phases exhaust it faster

1. Taxable Account has assets to

sustain longer as annuity is bought in IRA

2. Then, IRAs kick in

3. Roth has time to grow tax free and fund 7+

years of withdrawal

Summary

• Synergistic interaction among retirement income strategy components

• A framework to find these synergies

Variable Annuity with Guarantees

Benefit Base Locks @Highest Past Value GMIB contracts also allow

min guaranteed growth Of Benefit Base

Time

Strategy 5 - Variable Annuity GLWB

• Immediate lifetime income at 4.5% of benefit base

• GLWB rider at 0.95% fee and 0.3% MEA fees • Moderate inflation protected allocation

VA GLWB – helps?

• Risk increases

36 Full Income Retirees

3 Years of Income for Unfortunate Retiree

5% points guaranteed income for Unfortunate Retiree

Strategy 6 - Variable Annuity GMIB

income base after 10 years

• Rider fees 1.5%; MEA Fees 1.3%

• Payout rate: 4.75% of Income Base • Moderate Inflation Protected Model

GMIB – helps?

• Risk increases

- 84 Full Income Retirees

- 7 Years of Income for Unfortunate Retiree

Current VAs – why risk?

• For Retirees that barely got full income:

• Fees and poor returns combination doesn’t let Income Base step-up.

• Without Income Base , VA behaves like an immediate annuity, but with payout

Older VAs with Guarantees

• 6% compounded return for 10 years

• 200% guaranteed income base @10yrs • MEA Fees 0.85%, Rider fees 1.1%

• Payout rate at 6% when clients are 76 years old

VA under Better Returns

Percentile Last year’s GLWB Benefit in

today’s dollars

25th Percentile $4,082

50th Percentile $5,246

75th Percentile $7,399

Current VAs– Use?

• Not very appropriate for essential expenses • But a good strategy for discretionary

expenses that can be locked

Certain Cash Flow Using Bond Ladder

Cash flow not sensitive to interest rate movements if bonds held-to-maturity

Principal Maturity

Fill-in for Social Security Using Ladder

TIP

S

Ladder

Real Income By Source Over Time $100K

$90K

TIPS Ladder Performance

• Psychological comfort of safe cash flow • But because of negative real rates

• 25 Full Income Retirees

• 1 Year of Full Income for Unfortunate Retiree – stability of cash flows