Safe floor and Safe Withdrawal Rate

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CWRadio
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Safe floor and Safe Withdrawal Rate

Post by CWRadio »

I am retired now and starting to take money out of my IRA to live on. Have no pension.
I am confused about having a "safe floor" of investment for the necessary things in retirement, and using the Safe Withdrawal Rate for money in retirement.
What is a safe floor? Is it only made up of SPIA (inflation), cash, ladder of TIPs or are there other things?
If you use a 3% SWR do you also need a safe floor?
Thanks Paul
dbr
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Re: Safe floor and Safe Withdrawal Rate

Post by dbr »

A safe floor is a guaranteed, inflation indexed income stream that covers whatever your idea is of the income you absolutely have to/want to have. To be an income stream that pretty much needs to be an annuity. A TIPS ladder can work except that a ladder of bonds by definition has a fixed term at which it is exhausted. While this seems to be popular suggestion that might be just fine in practice, a ladder does violate the concept of lifetime guaranteed. There can be more exotic approaches such as delayed rather than immediate annuities. It is also not clear how practical it is to actually buy inflation indexed annuities, and even SS is potentially subject to reductions in the future (speculation against Forum rules).

You second question is a good one. Pretty much by definition simply following a safe rate of withdrawal from a volatile portfolio does not need a liability matching portfolio (aka income stream). The real question is how safe is safe. It has become stylish lately to raise alarms that people retiring today may not be "safe" even at 3% in spite of the fact that on historical average 4% is "safe" and 3% is bombproof.

I think it is up to each investor to examine his sources of income during retirement and take a broad view of the situation. Almost everyone has Social Security so there is already an inflation indexed annuity in place. There may be other sources of non-portfolio income. Next one should examine the degree to which one really is stressing their portfolio. Otar has examined this in his book and suggests that those flirting with 4% rates of withdrawal make sure significant fractions of needed income are annuitized. If a person already has SS, then pushing LMP concepts at a 3% withdrawal rate for additional income seems to be extreme to me. There is also the issue of how much income is involved. While a person might aspire to a lifestyle that needs $200K/year to support, that is a different issue from the situation of a person who would be near the poverty line. On the other hand SS would be a large part of the income of someone who plans to live a low income lifestyle and perhaps not so much part of the income for a wealthy lifestyle, and so on. I think there is risk that one thinks one needs more income than is really so and also risk that one is underestimating needed income and/or not taking contingencies seriously enough. Major contingencies can include extended ill health, death of one spouse, and divorce.

For me a major flaw in the LMP approach to financial planning is that I don't think that the distinction between necessary income (the floor) and discretionary income (the risk portfolio) is valid. In real life there just isn't a dividing line like that. It might be that one could devise an income stream system for all the income one needs discretionary or not. I don't think that is stupid as long as there is a significant emergency fund. That really goes back to the typical academic finance assumption that income in retirement will come from annuitizing the entire portfolio (meaning all of the portfolio actually expected to be used for income). Another consideration that affects many people is the desire to have assets to leave to heirs or charity. Of course, giving can be done in one's lifetime, and there are trusts that can be used to produce income and leave gifts. Annuitizing actually works that way as well as usually the amount needed to be annuitized(depending on age) is less than the amount needing to be saved for a safe withdrawal rate, and the rest can be invested for heirs.
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Re: Safe floor and Safe Withdrawal Rate

Post by YDNAL »

CWRadio wrote:What is a safe floor? Is it only made up of SPIA (inflation), cash, ladder of TIPs or are there other things?
A safe floor can mean different things to different people. I personally match future liabilities (expenses) with my investments.

That said, similarly Dr. William Bernstein has posted that one should have a "large hoard of cash or short-intermediate high quality bonds" -- IN retirement, it should cover 20 years of basic living expenses.
http://www.bogleheads.org/forum/viewtop ... d#p1761836
Bill Bernstein » Sun Jul 28, 2013 1:07 pm wrote: Re deflation risk, that's really a non-issue, since any sane investor sits on a large hoard of cash anyway, and cash (or, if you like, even short-intermediate high-quality bonds) will do fine with deflation.
Bernstein » Sun Jul 28, 2013 2:02 pm wrote: "Large hoard" =

1) Pre-retirement: The smaller of a) 25% of your portfolio (short bonds count) or b) 5 years living expenses
2) Retirement: Residual *basic* living expenses (after SS + pensions) for 20 years.
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claver
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Re: Safe floor and Safe Withdrawal Rate

Post by claver »

YDNAL wrote:
CWRadio wrote:What is a safe floor? Is it only made up of SPIA (inflation), cash, ladder of TIPs or are there other things?
A safe floor can mean different things to different people. I personally match future liabilities (expenses) with my investments.

That said, similarly Dr. William Bernstein has posted that one should have a "large hoard of cash or short-intermediate high quality bonds" -- IN retirement, it should cover 20 years of basic living expenses.
http://www.bogleheads.org/forum/viewtop ... d#p1761836
Bill Bernstein » Sun Jul 28, 2013 1:07 pm wrote: Re deflation risk, that's really a non-issue, since any sane investor sits on a large hoard of cash anyway, and cash (or, if you like, even short-intermediate high-quality bonds) will do fine with deflation.
Bernstein » Sun Jul 28, 2013 2:02 pm wrote: "Large hoard" =

1) Pre-retirement: The smaller of a) 25% of your portfolio (short bonds count) or b) 5 years living expenses
2) Retirement: Residual *basic* living expenses (after SS + pensions) for 20 years.
What is Bernstein's rationale for such an extreme recommendation?
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Re: Safe floor and Safe Withdrawal Rate

Post by YDNAL »

claver wrote:
YDNAL wrote:
CWRadio wrote:What is a safe floor? Is it only made up of SPIA (inflation), cash, ladder of TIPs or are there other things?
A safe floor can mean different things to different people. I personally match future liabilities (expenses) with my investments.

That said, similarly Dr. William Bernstein has posted that one should have a "large hoard of cash or short-intermediate high quality bonds" -- IN retirement, it should cover 20 years of basic living expenses.
http://www.bogleheads.org/forum/viewtop ... d#p1761836
Bill Bernstein » Sun Jul 28, 2013 1:07 pm wrote: Re deflation risk, that's really a non-issue, since any sane investor sits on a large hoard of cash anyway, and cash (or, if you like, even short-intermediate high-quality bonds) will do fine with deflation.
Bernstein » Sun Jul 28, 2013 2:02 pm wrote: "Large hoard" =

1) Pre-retirement: The smaller of a) 25% of your portfolio (short bonds count) or b) 5 years living expenses
2) Retirement: Residual *basic* living expenses (after SS + pensions) for 20 years.
What is Bernstein's rationale for such an extreme recommendation?
You should ask Bill, and "extreme" is subjective (or personal opinion).

That said, a retiree with a 50/50 Equity/Fixed Income split -- one who withdraws 4% to cover basic living expenses over an assumed 30-year retirement period -- has 15 years in Fixed Income, by AA design.
Last edited by YDNAL on Sat Aug 30, 2014 9:19 am, edited 1 time in total.
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Re: Safe floor and Safe Withdrawal Rate

Post by bobcat2 »

CWRadio wrote:I am retired now and starting to take money out of my IRA to live on. Have no pension. I am confused about having a "safe floor" of investment for the necessary things in retirement, and using the Safe Withdrawal Rate for money in retirement. What is a safe floor? Is it only made up of SPIA (inflation), cash, ladder of TIPs or are there other things?
It would also include SS and I-bonds. If you are able to do so, you should delay SS benefits to age 69-70 to increase the amount of safe income.

Having the safe floor is the minimum in safe income. You can have much more of your retirement income in safe income sources, including all of your retirement income, but at a minimum you want your floor income to be safe. For example, early in retirement you could have 25% of your retirement income above your safe floor in a TIPS ladder or annuitized income. How you get to your aspirational level of retirement income above your safe income is up to you. Personally in doing retirement planning I would want most of my income to be safe beyond age 85, i.e. I want most of my planned retirement income annuitized (life annuities and SS) once I reach 85. I don't want to be messing with AA & portfolio withdrawal strategies at a possible future age when I will have trouble knowing what day it is. :(

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.
claver
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Re: Safe floor and Safe Withdrawal Rate

Post by claver »

YDNAL wrote:
claver wrote:
YDNAL wrote:
CWRadio wrote:What is a safe floor? Is it only made up of SPIA (inflation), cash, ladder of TIPs or are there other things?
A safe floor can mean different things to different people. I personally match future liabilities (expenses) with my investments.

That said, similarly Dr. William Bernstein has posted that one should have a "large hoard of cash or short-intermediate high quality bonds" -- IN retirement, it should cover 20 years of basic living expenses.
http://www.bogleheads.org/forum/viewtop ... d#p1761836
Bill Bernstein » Sun Jul 28, 2013 1:07 pm wrote: Re deflation risk, that's really a non-issue, since any sane investor sits on a large hoard of cash anyway, and cash (or, if you like, even short-intermediate high-quality bonds) will do fine with deflation.
Bernstein » Sun Jul 28, 2013 2:02 pm wrote: "Large hoard" =

1) Pre-retirement: The smaller of a) 25% of your portfolio (short bonds count) or b) 5 years living expenses
2) Retirement: Residual *basic* living expenses (after SS + pensions) for 20 years.
What is Bernstein's rationale for such an extreme recommendation?
You should ask Bill, and "extreme" is subjective (or personal opinion).

That said, a retiree with a 50/50 Equity/Fixed Income split -- one who withdraws 4% to cover basic living expenses over an assumed 30-year retirement period -- has 15 years in Fixed Income, by AA design.
"Extreme" = "well outside the norm," which by your own example his recommendation is. Why 20 yrs? What stock market event in market history has had a twenty year recovery period? And given the very real opportunity costs of his recommendation, is it wise to fully insulate against "extreme" market events? Seems like an argument for buying annuities.
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Re: Safe floor and Safe Withdrawal Rate

Post by YDNAL »

claver wrote:"Extreme" = "well outside the norm," which by your own example his recommendation is. Why 20 yrs? What stock market event in market history has had a twenty year recovery period? And given the very real opportunity costs of his recommendation, is it wise to fully insulate against "extreme" market events? Seems like an argument for buying annuities.
I don't offer "examples" -- but implied facts derived from AA design.
  • 1. I could have EASILY selected a 40/60 Equity/Fixed Income split that represents 18 years in Fixed Income of an assumed 30-year retirement period.
    2. Or pick someone Vanguard Target Retirement Income (VTINX), as primary savings vehicle, and (s)he has 21 years in Fixed Income.
Having said all that, IF you are looking to pick a fight or argue semantics or the subjective, you would have to wait since I'm one my way to the boat for a day down in the Florida Keys. 8-)
Last edited by YDNAL on Sat Aug 30, 2014 9:51 am, edited 1 time in total.
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Re: Safe floor and Safe Withdrawal Rate

Post by LongerPrimer »

+1, to dbr
Well said. :sharebeer
dbr
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Re: Safe floor and Safe Withdrawal Rate

Post by dbr »

YDNAL wrote:
That said, similarly Dr. William Bernstein has posted that one should have a "large hoard of cash or short-intermediate high quality bonds" -- IN retirement, it should cover 20 years of basic living expenses.
http://www.bogleheads.org/forum/viewtop ... d#p1761836
Bill Bernstein » Sun Jul 28, 2013 1:07 pm wrote: Re deflation risk, that's really a non-issue, since any sane investor sits on a large hoard of cash anyway, and cash (or, if you like, even short-intermediate high-quality bonds) will do fine with deflation.
Bernstein » Sun Jul 28, 2013 2:02 pm wrote: "Large hoard" =

1) Pre-retirement: The smaller of a) 25% of your portfolio (short bonds count) or b) 5 years living expenses
2) Retirement: Residual *basic* living expenses (after SS + pensions) for 20 years.
To me language like "hoard" is hyperbolic and does not lead to useful advice. Mr. Bernstein is also prone to refer to eating dog food, which is also not a useful way to discuss the issue. However, in his defense if hyperbolic language helps someone recognize that a point is being made, then maybe there is a point there.

But note that the sentence above is much more nuanced than first appears. To begin with we are talking about providing for spending after SS and pensions. SS and pensions will go a long way with many people. Not clear in this nuance is whether or not pensions includes people deliberately purchasing annuities. If that is done SS and pensions annuities may leave almost anyone with no need for a "hoard" of cash.

A second nuance is the ". . . if you like, short-intermediate high quality bonds . . ." So a person holding a portfolio that is somewhere in the 40/60 to 60/40 and needing this residual after SS and pensions in cash/short/intermediate bonds almost certainly already has that in the bonds they would hold anyway.

Frankly, in my mind, this "extreme" advice of Mr. Bernstein comes down to no advice at all. Now every retiree will have to look at his own situation and decide how all this fits together. I can say with a certainty that for me this advice absolutely does not result in me going out and stashing away hoards of cash. In fact I don't have any cash beyond the come and go of normal transactions. I do have a significant portion in high quality, as the case is intermediate, bonds, more than enough to be the above mentioned "hoard."
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Re: Safe floor and Safe Withdrawal Rate

Post by claver »

YDNAL wrote:
claver wrote:"Extreme" = "well outside the norm," which by your own example his recommendation is. Why 20 yrs? What stock market event in market history has had a twenty year recovery period? And given the very real opportunity costs of his recommendation, is it wise to fully insulate against "extreme" market events? Seems like an argument for buying annuities.
I don't offer "examples" -- but implied facts derived from AA design.
  • 1. I could have EASILY selected a 40/60 Equity/Fixed Income split that represents 18 years in Fixed Income of an assumed 30-year retirement period.
    2. Or pick someone Vanguard Target Retirement Income (VTINX), as primary savings vehicle, and (s)he has 21 years in Fixed Income.
Having said all that, IF you are looking to pick a fight or argue semantics or the subjective, you would have to wait since I'm one my way to the boat for a day down in the Florida Keys. 8-)

I actually was looking for an explanation of his rationale, which snark is not. Hope it's not too hot down there today.
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Re: Safe floor and Safe Withdrawal Rate

Post by livesoft »

One's required (not discretionary) expenses in retirement could be rather meager if one had a paid off house, good car, medicare, and lived in a low cost of living area. After all, many seniors live on SS benefits or less already.
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Re: Safe floor and Safe Withdrawal Rate

Post by Leeraar »

It's a question of cash flow. That's the way to look at it.

What do you need to live on? Make a spreadsheet with a line for every year from now until you are age 75. Yearly expenses go in 3 columns: Must Have, Nice to Have, and Luxuries. Now, add columns for income streams: Pension, Social Security, Annuities, From Savings, Lottery Winnings, Inheritance, Loving Children, ...

Does the incoming cash flow match your needs? Really, are you sure? Can you look out 15 years in the future and know the money will be there?

This is the game you have to play.

L.
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Re: Safe floor and Safe Withdrawal Rate

Post by heyyou »

Wait and see. As mentioned, SS plus your bond allocation may be enough at the start. Time could resolve the situation in that mid-seventies age retirees get increasingly better rates on annuities, so watch while you learn more to see if they fit your future. At a 3% WD rate, you currently do not need the safe income cushion that annuities provide so you can avoid their current expensive prices (young age, low interest rates). Later, you may see if your longevity is above average.

To better demonstrate the benefits, researchers tend to annuitize enough assets for retirement income starting on retirement day. That seems to contradict diversifying to buffer specific risks, thus my suggestion is to wait and see.

Wade Pfau has shown that annuities do outperform bond funds in the long run due to mortality credits and the longer compounded equity returns on the remainder of the portfolio. He hasn't compared them with bond ladders on a portfolio with a 3% WD rate. There are general guidelines with exceptions for those who are better prepared than others.
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Re: Safe floor and Safe Withdrawal Rate

Post by dbr »

Leeraar wrote:It's a question of cash flow. That's the way to look at it.

What do you need to live on? Make a spreadsheet with a line for every year from now until you are age 75. Yearly expenses go in 3 columns: Must Have, Nice to Have, and Luxuries.
Muuust . . have . . luxuries (drool) . .
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Re: Safe floor and Safe Withdrawal Rate

Post by Leeraar »

dbr wrote:
Leeraar wrote:It's a question of cash flow. That's the way to look at it.

What do you need to live on? Make a spreadsheet with a line for every year from now until you are age 75. Yearly expenses go in 3 columns: Must Have, Nice to Have, and Luxuries.
Muuust . . have . . luxuries (drool) . .
Yes,

I am told that the boxes from Sub-Zero refrigerators make much better accommodations under the freeway bridge than those from Whirlpool or GE.

L.
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Re: Safe floor and Safe Withdrawal Rate

Post by Cut-Throat »

CWRadio wrote:I am retired now and starting to take money out of my IRA to live on. Have no pension.
I am confused about having a "safe floor" of investment for the necessary things in retirement, and using the Safe Withdrawal Rate for money in retirement.
What is a safe floor? Is it only made up of SPIA (inflation), cash, ladder of TIPs or are there other things?
If you use a 3% SWR do you also need a safe floor?
Thanks Paul
Instead of using a 3% WR, have you looked at VPW? It will give you more in your early years and cannot fail.
I am also retired and using VPW.
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Re: Safe floor and Safe Withdrawal Rate

Post by YDNAL »

claver » Sat Aug 30, 2014 12:57 pm wrote:I actually was looking for an explanation of his rationale, which snark is not. Hope it's not too hot down there today.

Well, a suggestion to ask Dr. Bernstein would suffice to most.

But, apparently insufficient to others feel compelled to follow-up:
claver » Sat Aug 30, 2014 10:35 am wrote:"Extreme" = "well outside the norm," which by your own example his recommendation is. Why 20 yrs? What stock market event in market history has had a twenty year recovery period? And given the very real opportunity costs of his recommendation, is it wise to fully insulate against "extreme" market events? Seems like an argument for buying annuities.
[edit] ps. It was a wonderful day, a bit choppy in open waters once outside Biscayne Bay. 8-)
Last edited by YDNAL on Wed Sep 03, 2014 9:10 am, edited 1 time in total.
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CWRadio
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Re: Safe floor and Safe Withdrawal Rate

Post by CWRadio »

Thank you all for all the time and effect you put in to answering all the questions.
Sundays Wall Street journal has an article called A Retirement Income Plan or How to Ensure Adequate Retirement Income by Jonathan Clements.

http://online.wsj.com/articles/an-answe ... 1409445048
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Re: Safe floor and Safe Withdrawal Rate

Post by Leeraar »

CWRadio wrote:Thank you all for all the time and effect you put in to answering all the questions.
Sundays Wall Street journal has an article called A Retirement Income Plan or How to Ensure Adequate Retirement Income by Jonathan Clements.

http://online.wsj.com/articles/an-answe ... 1409445048
Very good advice. It seems so simple, doesn't it?

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
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