If you haven't read the first four parts of this series, I suggest you go there first:
- Part 1: Sequence of Returns Risk, Inflation Risk, and the Safe Withdrawal Rate
- Part 2: Getting income from your various asset classes
- Part 3: Non-Portfolio Income and how it relates to your portfolio
- Part 4: Early Retiree issues and Tax Diversification
In Part 5, I'm going to discuss a few last issues relevant for the retired investor.
The Retiree Spending Cycle
Retirees don't generally spend money in the same way financial planners usually model it (i.e a constant level of spending or an inflation-adjusted level of spending). They spend lots of money early in retirement in the “go-go years.” Then they spend decreasing amounts in the “slow-go years.” Then, during the “no-go years” they spend less and less until the very end, when spending goes through the roof, usually on health care and long-term care related costs. If you really want to delve into the details on this subject, I suggest the Bogleheads Wiki page on it. But the point is that all that stuff you imagine when you think about retirement isn't nearly as appealing at 80 as it was at 60. You're probably not going to want to go on a cruise every month. This effect (higher spending in early retirement) can exacerbate the sequence of returns issues discussed earlier in this series, of course.
Bonus points for naming the beheaded guy
What Happens When You Die?
If you're reading this post, there's a good chance you're the one in your marriage or partnership who handles the money and is good at it. You know about all the investing accounts, insurance policies, bank accounts, bills etc. While every investor needs to have a plan in place in case something happens to them, this becomes more of an issue for a retiree, especially an older retiree. Perhaps having your investments spread across 15 mutual funds in 12 different accounts at 4 different brokerage houses isn't such a good idea. The older you get, the more appealing a simple investing plan should be. Combine all your 401(k)s and IRAs into one place. Keep your taxable accounts all at one brokerage house or mutual fund provider. Reduce the number of asset classes and consider fund of fund investments like Vanguard's Life Strategy and Target Retirement Funds. You don't necessarily want to sell low-basis taxable shares (especially if you're likely to die in the next decade) but you can transfer them in kind. Consider holding taxable investments in the name of the older, sicker spouse to enable the step-up in basis to occur sooner. Maintain an updated instruction list for what to do financially in the event of your death. If this isn't something you envision your spouse doing, have a plan for a trusted family member or advisor to assist. Don't make your spouse feel guilty about getting help that you don't need. Remember it may not take avoiding very many mistakes to more than make up for reasonable advisory fees.
Your Own Incompetence
How many 90 year olds do you know who really seem to be competent enough to manage their own money without assistance? What makes you think you're going to be any different? Just like you need a plan for your spouse in the event of your death you also need a plan in the event of your own incompetence. A trusted child you've spent 60 years training might be a great choice to step in. An adviser who might not be needed at 60 might be very useful at 90. It's dreary to think about, but seems better than the situation many of us have watched grandparents go through.
Balancing Estate Planning, Asset Protection, Investing
Finally, just like throughout the rest of your life, you'll see that there is a balance to be struck between solid investing returns, asset protection, and estate planning. In retirement, the return of your principal often becomes more important than the return on it. Asset protection is likely less of a concern for you once you have quit practicing medicine (unless you're an OB/GYN or pediatrician with a long statute of limitations!) Protecting assets from conniving family members or unscrupulous advisers may become more of an issue.
Estate planning will likely become much more important to you as you move into retirement. If you don't yet have a revocable trust to keep most of your assets from going through probate, it's time to do that. Keep your will updated. You may want to redesignate beneficiaries for retirement accounts or insurance policies. Your children (if you've done your job well) may be in a good financial position and you can leave that stuff to the grandkids. Consider the benefits of stretch IRAs. Consider doing Roth conversions (far better to inherit a Roth IRA than a traditional one!) If you're going to have an estate tax problem, start giving money away to your heirs and charities, or start an irrevocable trust. Spend some money on a meeting with a good estate planning attorney in your state. If you expect to leave money to both heirs and charities, remember which accounts should go where:
Best for heirs:
- Tax-free
- Life Insurance and Taxable
- Tax-deferred
Best for charity:
- Tax-deferred
- Life insurance and Taxable
- Tax-free
Investing in retirement has a few unique issues associated with it, as discussed in this five part series. Proper planning, whether done on your own or in association with highly-qualified professionals is critical.
What did you think? Did I miss anything in the series? Comment below!
Great series. If you ever add a part 6 I’d be interested in hearing your take on 1. Imputed rent 2. Use of reverse mortgage as a backup plan (maybe to allow increased withdrawal rates).
For as many people as I have had ask for this series, I was surprised at how few comments there were this week on it. I get lots of comments on more controversial stuff than on this more practical information. Or perhaps everyone already knows this stuff, or its over their heads. Don’t know.
Regarding imputed rent, I think it’s silly to discuss. This is basically the concept that owning your home is like getting paid rent. I just look at stuff like this as reducing your need for retirement income. I don’t really care if it reduced it by $1000 a month or $3000 a month. It’s off the table in my calculations. You basically just need less income to live on if you own your home.
Regarding a reverse mortgage, it’s an okay back-up plan. Reverse mortgages have lots of downsides that I wouldn’t look at them as a main part of your plan. There’s a lot of bad deals out there in reverse mortgages and most (all?) are products designed to be sold, not bought. I love the concept, it’s the execution that is a problem.
Great series. Thanks. You might not have had as many comments because it was more educational than controversial. BTW your answer to me in Part 3 about paying off mortgage versus investing came up on the first page of a Google search on the topic! I found several online calculators comparing the two choices. For us even though investing was financially “better” the actual dollar amount was small enough to not be worth the risk. Because our timeframe was only 10-12 years even at a market return of 12% annualized the amount was about 11K. We’d rather be done with the mortgage than take the risk for such a small reward. Thanks again.
You’re welcome. About half the visitors I get to the site each day come off the search engines just looking for topics like that.
St Denis?
Correct you are. Catholic?
This was a great series and I eagerly awaited to read each section for the last 5 days. Thanks.
I think the reason for so few comments is because there no controversy here.
WCI,
Great series. I have been checking for comments too. I am 57 and paying close attention. I have dropped down to working 3 days a week. I think you really can’t contemplate retirement without really knowing your spending EXACTLY. I personally have made looking at online calculators a hobby. I have read your book and most of Mike Piper’s books. I have recently transferred all my money to Vanguard and “met” with one of their CFPs. The process is interesting. You get a computer generated plan followed by a virtual meeting with a human. I am following most of the asset allocation advice. I think retirement is all about planning. I recommend starting to think about this the day you finish residency.
Even though I love Vanguard and use mostly Vanguard funds and ETFs, I wouldn’t necessarily trust a Vanguard employee to provide the best advice for the following reasons:
1) Advice has to be comprehensive, so it has to include all assets, not just those at Vanguard. This means retirement plans, CDs/money markets, after-tax investments such as individual municipal bonds. Unless you hire a wealth manager, Vanguard is under no obligation to provide comprehensive advice.
2) Advice has to cover all aspects of your finances. For many new grads this means loan consolidation and repayment, tax planning advice (including backdoor IRAs and retirement plans). New grads don’t have much assets, but they do have a lot financial needs, and unless you have assets, most firms won’t provide advice to you.
3) However much I hate to say it, Vanguard employee is not an independent adviser, so they are not necessarily going to do what’s in your best interest. They are after all working for Vanguard, and that in itself is a conflict of interest. I use Vanguard myself for all of my accounts, but not because I get paid to recommend it. If that CFP worked for Schwab, he or she would recommend Schwab funds. An independent adviser who knows that Vanguard funds are better than Schawb funds (though Schwab has several great low cost ETFs) will use Vanguard funds over Schwab funds. Would a Vanguard employee recommend investor share funds in a Roth IRA vs. using ETFs? I would use ETFs exclusively, because they are lower cost than investor shares. Vanguard ETFs cost less, but building a multi-asset class portfolio using ETFs is more complex because it has to be rebalanced (which is more difficult than with mutual funds). Would Vanguard provide this asset allocation advice and re-balancing service?
4) Can a Vanguard employee provide you the best asset allocation advice? Is their advice tailored to each individual? I think independent advisers provide better quality advice than an employee of a mutual fund company.
5) Some examples of a possible conflict of interest. Ameritrade has Vanguard ETFs but with no commission, while some of the ETFs that are offered at no commission at Ameritrade have a commission at Vanguard. Vanguard is under no obligation to recommend that you go to Ameritrade if you want a Roth IRA. Same thing with Solo 401k. While I use Vanguard solo 401k, there may be cases when we need to roll assets INTO a solo 401k, in which case we might use Fidelity or other company instead. Also, using mutual funds vs. ETFs, or mutual funds vs. individual bonds can be a conflict of interest as well.
So to conclude,
1) Vanguard is probably the best place to keep your assets.
2) When it comes to advice, you get what you pay for. Vanguard may not charge much for their advice, but you are also not getting much out of it either. Basic asset allocation is only a tiny fraction of the overall picture. This requires work which Vanguard will not do for the limited fee they charge.
It’s been a great series. Perhaps because of summer (travel and other leisure activities), folks have not been commenting.
Saint Denis at Notre Dame, of course!
I too liked this series, especially over some of the ones that do get more comments (i.e. whole life insurance). I think most that follow your site probably have heard most of this before, but might not always take the smartest approach given real life scenarios.
I’d love to see some examples… person A retires at 52, person B at age 62, person C at 70 with enough to generate $80K/yr in today’s dollars at a SWR of 4%. Each person has this much in Roth, 401K, HSA, traditional IRA, cash. All went through their residency at the same age, and all started earning enough to contribute to SS after residency. How much does each person plan to receive SS if they hold out till age 70 and how much do they withdraw from each account to reduce tax burden as best they can?
That might make for an interesting post. Keep in mind that choosing how much to take from each account is balancing your current tax burden with your future tax burden and your heirs future tax burden. Adjust as you like.
Unless I missed it, there has been much talk about 4% withdraw rate.
Is this 4% fixed and increased each year to account for inflation? Or, is it 4% of portfolio value, therefore withdraw more in years of good portfolio performance and less in bad years?
Very important consideration that should be spelled out.
4% fixed and adjusted to inflation as of your retirement date in the classic studies. If you only withdraw 4% of portfolio value, you will never run out of money, although that withdrawal could get quite small!
I believe your withdraw methodology should be based upon your expenses and proportion of mandatory vs discretionary expenses, as well as size of portfolio.
A well diversified investment portfolio will vary year to year, up and down, but hopefully low variability, so relatively constant withdraws with portfolio percentage take each year.
Taking a fixed percentage plus inflation each year is a recipe for running out of money.
I disagree Sam. Do you really think taking 1% of your portfolio out each year and adjusting up each year for inflation is going to cause you to run out of money in 30-40 years? Surely not. It isn’t the method that is worth debating. That’s fine. It’s the percentage.
Colleen M. Jaconetti, an investment analyst with Vanguard Investment Strategy Group…and Francis M. Kinniry Jr., a principal in the group, recently coauthored a research paper titled A More Dynamic Approach to Spending for Investors in Retirement. In it, they examine two familiar strategies [for making withdrawals] and present a third—a hybrid of the others that is more dynamic and flexible.
[The three strategies are:] …dollar amount grown by inflation, percentage of portfolio, and percentage of portfolio with ceiling and floor, the hybrid.
The first two methods have some clear drawbacks. Withdrawing a set amount adjusted each year for inflation provides a stable spending stream, but Ms. Jaconetti noted that “because this strategy is indifferent to the performance of the capital markets, retirees may accumulate unspent surpluses when markets outperform and face spending shortfalls when markets underperform.” Conversely, if you simply withdraw a fixed percentage of your portfolio each year, “you’ll (almost) never run out of money, but your income will fluctuate, substantially at times.” The benefit of the third approach, Ms. Jaconetti said, is that “you’re not cutting back too far if the market goes down and not overspending when you have an excess return. It limits both the upside and downside potential for spending.”
The researchers tested the three scenarios….For each strategy they ran 10,000 simulations starting with the following assumptions: a 35-year time horizon; a portfolio asset allocation of 35% U.S. stocks, 15% international stocks, and 50% U.S. bonds, rebalanced annually; a starting balance of $1 million; and first-year spending of 4.75% of the portfolio. The ceiling and floor limits [of the hybrid model] were 5.0% and 2.5%, respectively. (Taxes were excluded from the calculation.) The starting withdrawal of $47,500 “is a reasonable spending amount, given the asset allocation and time horizon,” Ms. Jaconetti said.
For each strategy, the researchers examined the percentage of simulations in which the portfolio still existed after 35 years. The results: for dollar amount grown by inflation, a 71% survival rate; for percentage of portfolio with ceiling and floor, 89%; and for percentage of portfolio, 100%….
Completely disagree with you on this.
Taking a fixed percentage out year 1, then increasing this amount by inflation each year could certainly cause you to run out of money. This would be especially likely if your portfolio had some years of negative returns the first few years of withdraws.
Yes. It could cause you to run out of money. The question is what percentage of time is that likely to happen if the future resembles the past. That’s what the SWR studies are.
If you want a guarantee not to run out of money, buy a SPIA.