A different take on retirement income: time segmentation

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willthrill81
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A different take on retirement income: time segmentation

Post by willthrill81 » Sun Jul 15, 2018 5:36 pm

Withdrawal methods for retirees are obviously one of the most discussed topics on this forum. It is clear that there is no one-size-fits-all approach because everyone has different needs. But I've been contemplating a general withdrawal strategy that could be easily modified in countless ways to fit different people's needs. I think that it may have some real value, and I'd like to hear feedback about it.

The problems retirees with investable portfolios face can be tough to address. Perhaps foremost among these is that retirees don't want to run out of income before they run out of life. There are approaches for dealing with this, such as (1) starting with historically very low withdrawal rates, (2) buying lifetime annuities, or (3) creating income ladders. There are issues with all of these approaches though, potentially including having a high likelihood of having a very large portfolio left at death and not spending as much as was possible (1 & 3) or 'locking in' historically low rates of return and (usually) permanently giving control of the annuitized assets (2).

Another problem not mentioned nearly as often is that while most of the traditional withdrawal strategies assume relatively fixed income needs from the point of retirement until death, this is not supported by real world data. Approximately two-thirds of retirees report that their spending declines over their retirement (half of the remainder report no change in spending, and the other half report spending increases). Retirees tend to reduce their annual spending in real dollars by 1-2% annually, even during their latter years when increased medical costs are offset by reduced transportation, food, and discretionary spending; there are clearly exceptions to this, but they are indeed exceptions to the widespread trend.

This means that retirees' are likely to need/want to spend more in the early years of retirement and less in the later years of retirement. But since retirements have a significant possibility of lasting decades, spending more in early years raises the potential problems of encountering a poor sequence of returns early in the retirement, one's lifetime lasting longer one had planned for (e.g. when creating an income ladder or determining withdrawal rates), or both.

To date, the focus has been primarily on sacrificing retirees' need/want for more income in the early stages of retirement for the security of reducing the likelihood of running out of money. A notable exception to this are the concepts of time segmentation and essential-versus-discretionary strategies, which Wade Pfau briefly described as follows below.
Time segmentation also differs from an essential-versus-discretionary strategy because it does not build a lifetime income floor. Rather, there is an income front-end with contractual protections. The assumption is that people have not saved enough to fund their entire lifetime of spending. Importantly, time segmentation also accounts for the fact that spending needs may change, and this requires flexibility and the avoidance of irreversible decisions.

...

At its core, though, time segmentation involves investing differently for retirement spending goals falling at different points in retirement. Fixed income assets with greater security are generally reserved for earlier retirement expenses, and higher volatility investments with greater growth potential are employed to support later retirement expenses.
https://www.advisorperspectives.com/art ... ent-income

Potentially combining these two approaches may offset some of the disadvantages of the common withdrawal methods. The basic gist of what I propose is this: split retirees' portfolio into two, one for essential spending (ES portfolio) and another for discretionary spending (DS portfolio). Then, apply different withdrawal methods for the two portfolios, based on your need, willingness, and ability to take on risk for both ES and DS. Income strategies involving use of the ESP should logically be more conservative than those involving the DSP. And while the primary purpose of the DSP would be to fund discretionary spending, which typically declines as retirees' age, a secondary purpose could be to at least partially fund significant essential spending needs that might arise, such as long-term care.

For the ESP, income strategies could involve purchasing immediate or deferred income annuities, creating a bond or CD ladder, the '4% rule of thumb' or an even lower starting withdrawal rate if desired, or some combination thereof. (It would not likely be advisable to use all of the ESP to purchase annuities, even if they included an inflation rider, since 'lumpy' ES needs may come along that need larger amounts of capital than the monthly annuity payment.) And all of this would be in addition to whatever Social Security benefits were available to the retirees.

For the DSP, which would consist of whatever remains after the ESP is funded, income strategies could be more aggressive in terms of both asset allocation (e.g. more stock heavy) and withdrawal rate than the common recommendations. I envision a percentage-of-portfolio withdrawal method with 6% annual withdrawals potentially being useful for a 65 year old couple. Using FIRECalc, a 70/30 portfolio with 6% annual withdrawals for 20 years would have left 31% of the original portfolio intact in real dollars in the worst case; the average ending portfolio balance would have been 89% of the starting balance. By the time they reach 85, most retirees' discretionary spending is finished, so depleting the majority of the DSP would not be a problem (it could almost be viewed as a goal). But in the majority of historical periods at least, a large portion of the DSP would remain intact, leaving the retirees with a bequest and/or funds for long-term care or other significant expenses later in life.

Before I start discussing models as to how this might play out with real numbers, I'd like to get feedback regarding what pros/cons you see of this strategy.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: A different take on retirement income: time segmentation

Post by Sandtrap » Sun Jul 15, 2018 6:36 pm

Thanks for taking the time and "work" to post this.
Always enjoy your "educational posts".

1. I think that retirees that I know take this "hybrid" approach intuitively (without really understanding the financial concepts at work). ES (essential spending) is mentally "bucketed" from established long term income streams such as SS, Annuities, Pensions, etc. And, DS (discretionary spending) from an investment portfolio.

2. The idea of having the ES generating portion of the portfolio to last through the entire retirement to life end time period, in fixed assets is similar to the LBM (liability matching) portfolio where "safe assets" fund the entire retirement, and equities make up the remaining percentage of total assets. Is this so?

3. As for a retiree withdrawing 6% from a 70/30 portfolio, risk tolerance comes into play. I'm to sure if a retiree able to understand the "big picture" would be able to sleep at night with this. The more that "age 65" fades in the rear view mirror, the more potentially terrifying the costs of long term medical needs come into play.

You've presented a lot of "high fiber" concepts to chew on. I'm having a hard time with the cashews.

thanks, :D
j

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Re: A different take on retirement income: time segmentation

Post by WanderingDoc » Sun Jul 15, 2018 7:12 pm

Very well thought out and interesting idea. Good thoughts from Sandtrap as well.

I tend to think we shouldn't be so rigid in assuming lower spending in retirement. It should be more at an individual (and year by year) basis.

For example, there have been years where I spent $120K and years where I spend $12K, perhaps both intentionally and unintentionally. Was perfectly content doing both. Why are we assuming that retired people just want to sit home all day, or not fly first class, or not eat in nice restaurants? I think people are unique and life is not that simple.

Someone could be 50 years old and spend $50K/yr. until their 55th birthday. Then they may want to open a restaurant or start a business, and want to make a $300K lump sum withdrawal without relying on outside investors yet. This is a very plausible scenario.

I think an even more intelligent "hybrid" approach would be a mix of portfolios of stocks/bonds and real estate. You have your real estate which pays you say $5K/mo. consistently. When the mortgages are payed off (by your tenants by the way), this will jump to $11-12K/mo. in income, in your 50s-60s, depending on when you started purchasing properties. This will also allow you to be more aggressive in your equity allocations, which could be used to fund further business and charitable pursuits.
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Re: A different take on retirement income: time segmentation

Post by petulant » Sun Jul 15, 2018 7:32 pm

It seems likely that discretionary spending will be higher and concentrated in younger years of retirement, while essential spending will be spread out and rising as inflation and healthcare take their toll. As a corollary, it seems likely that reductions in real spending by retirees come from the reduction in discretionary spending, while essential spending might actually increase.

The result is that the need for discretionary funding may be highest the early years, while essential spending has a decades-long horizon that must be able to grow with inflation. That means the appropriate asset allocation for the two segments of the portfolio might be counterintuitive for a retiree who is actually in the withdrawal period. Discretionary spending might more appropriately be less aggressive since it will be shorter-term, while essential spending may appropriately have a substantial stock component to ensure inflation-resistant growth into the later years.

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Re: A different take on retirement income: time segmentation

Post by Snowjob » Sun Jul 15, 2018 9:03 pm

While I understand that there is a natural decline I wonder how much of these surveys are skewed by people who are actually worried about running out of money.

Nonetheless. I think if you plan on having some SPIA income the natural decline in spending is a reason one might opt for an annuity contract that is NOT inflation adjusted.

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Re: A different take on retirement income: time segmentation

Post by 9-5 Suited » Sun Jul 15, 2018 9:13 pm

After reading twice, I’m still not sure how this isn’t just mental accounting. Why wouldn’t a standard asset allocation approach that takes account of the individual’s need, willingness, and ability for risk yield the same result? I can pick my stock/bond/cash allocation to ensure enough FI to meet basic needs and have that determine my equity allocation if that’s how my need/willingness/ability shake out.

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Sun Jul 15, 2018 10:26 pm

Sandtrap wrote:
Sun Jul 15, 2018 6:36 pm
Thanks for taking the time and "work" to post this.
Always enjoy your "educational posts".
Thanks! I'm glad that someone gets something out of ramblings!
Sandtrap wrote:
Sun Jul 15, 2018 6:36 pm
1. I think that retirees that I know take this "hybrid" approach intuitively (without really understanding the financial concepts at work). ES (essential spending) is mentally "bucketed" from established long term income streams such as SS, Annuities, Pensions, etc. And, DS (discretionary spending) from an investment portfolio.
I think that you may be right. However, I'm not sure that most retirees mentally separate how much of their portfolio is needed for ES versus DS. This approach would 'force' them to conduct such an evaluation, which is certainly helpful even if they don't adopt this withdrawal strategy.
Sandtrap wrote:
Sun Jul 15, 2018 6:36 pm
2. The idea of having the ES generating portion of the portfolio to last through the entire retirement to life end time period, in fixed assets is similar to the LBM (liability matching) portfolio where "safe assets" fund the entire retirement, and equities make up the remaining percentage of total assets. Is this so?
Possibly. To my knowledge, LMPs rely exclusively on fixed income investments (I could be completely wrong about that). Using this strategy, the ESP could be mostly or possibly even entirely fixed income, but that wouldn't be necessary. The ESP definitely needs some kind of inflation protection, and stocks could certainly represent at least one part of that, potentially in addition to a cost of living adjustment added to an annuity or TIPS, for instance. Recall Benjamin Graham's advice that even the most conservative investor have at least a 25% allocation to stocks.
Sandtrap wrote:
Sun Jul 15, 2018 6:36 pm
3. As for a retiree withdrawing 6% from a 70/30 portfolio, risk tolerance comes into play. I'm to sure if a retiree able to understand the "big picture" would be able to sleep at night with this. The more that "age 65" fades in the rear view mirror, the more potentially terrifying the costs of long term medical needs come into play.
I chose 70/30 for that example because that's historically been about the 'sweet spot' between maximizing fixed withdrawal rates (even though I believe that a flexible one would work better for the DSP) and ending portfolio balances. And 6% as an annual percentage of the portfolio over a 20 year period isn't as aggressive as many might think, especially if they're accustomed to something like the '4% rule of thumb', which was designed around 30 year periods and featured withdrawals that matched inflation every year. An investor could certainly be more conservative with regard to both the AA and the withdrawal rate, but even an more aggressive AA might be fine as well for aggressive investors. Discretionary spending can certainly be curbed if stocks do a repeat of 2008. If spending can be reduced in the bad times, even a 100% stock allocation is possible.
Sandtrap wrote:
Sun Jul 15, 2018 6:36 pm
You've presented a lot of "high fiber" concepts to chew on. I'm having a hard time with the cashews.
It's a complex topic to be sure. I've tried to simplify this strategy as much as possible, and I really think that implementation wouldn't be too bad. But the reasoning for its development and justification involves numerous concepts.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Sun Jul 15, 2018 10:52 pm

WanderingDoc wrote:
Sun Jul 15, 2018 7:12 pm
Very well thought out and interesting idea. Good thoughts from Sandtrap as well.
Thanks!
WanderingDoc wrote:
Sun Jul 15, 2018 7:12 pm
I tend to think we shouldn't be so rigid in assuming lower spending in retirement. It should be more at an individual (and year by year) basis.

For example, there have been years where I spent $120K and years where I spend $12K, perhaps both intentionally and unintentionally. Was perfectly content doing both. Why are we assuming that retired people just want to sit home all day, or not fly first class, or not eat in nice restaurants? I think people are unique and life is not that simple.

Someone could be 50 years old and spend $50K/yr. until their 55th birthday. Then they may want to open a restaurant or start a business, and want to make a $300K lump sum withdrawal without relying on outside investors yet. This is a very plausible scenario.

I think an even more intelligent "hybrid" approach would be a mix of portfolios of stocks/bonds and real estate. You have your real estate which pays you say $5K/mo. consistently. When the mortgages are payed off (by your tenants by the way), this will jump to $11-12K/mo. in income, in your 50s-60s, depending on when you started purchasing properties. This will also allow you to be more aggressive in your equity allocations, which could be used to fund further business and charitable pursuits.
It's true that not all retirees' spending goes down by a consistent 1-2% in real terms. Kitces actually believes that it may be slightly more realistic to model spending drop by 10% or more every decade in one fail swoop rather than bit by bit from year to year. But data from both Morningstar's David Blanchett and over 30 years of data from the Bureau of Labor Statistics supports the idea that retirees' spending does go down over time, particularly their discretionary spending.

Image

Those who want to increase their likelihood of more discretionary spending should either allocate more to their DSP, reduce their DSP withdrawal rate, or both.

And yes, allocations from either the ESP or DSP could certainly include some real estate. Some retirees 'count' on some portion of their real estate rental income (e.g. 70%) as part of their income floor, like Social Security benefits.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Sun Jul 15, 2018 11:02 pm

petulant wrote:
Sun Jul 15, 2018 7:32 pm
It seems likely that discretionary spending will be higher and concentrated in younger years of retirement, while essential spending will be spread out and rising as inflation and healthcare take their toll. As a corollary, it seems likely that reductions in real spending by retirees come from the reduction in discretionary spending, while essential spending might actually increase.

The result is that the need for discretionary funding may be highest the early years, while essential spending has a decades-long horizon that must be able to grow with inflation.
Bingo!
petulant wrote:
Sun Jul 15, 2018 7:32 pm
That means the appropriate asset allocation for the two segments of the portfolio might be counterintuitive for a retiree who is actually in the withdrawal period. Discretionary spending might more appropriately be less aggressive since it will be shorter-term, while essential spending may appropriately have a substantial stock component to ensure inflation-resistant growth into the later years.
The essential spending portfolio (ESP) I've outlined in this strategy needs to have some components that are at least historically capable of keeping pace with inflation. This could come from an inflation-adjusted annuity, a TIPS ladder, and/or some allocation to stocks or real estate, for instance. This would be in addition to any Social Security benefits the retiree had as well, which are inflation-adjusted.

The discretionary spending portfolio (DSP) could be far more flexible because withdrawals from it are, by definition, not essential. Retirees that want to trade off growth in their DSP for assurance of smoother withdrawals over time should likely tilt their DSP towards fixed income, and vice versa for those who want to maximize spending over the longer-term at the expense of more volatility in withdrawals should tilt toward more volatile asset classes. It really comes down here almost entirely to their willingness to take on risk; there is little to no need to take on risk in their DSP since it is for discretionary spending only, but for that same reason they are certainly able to take on risk for a potential upside.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Sun Jul 15, 2018 11:06 pm

Snowjob wrote:
Sun Jul 15, 2018 9:03 pm
While I understand that there is a natural decline I wonder how much of these surveys are skewed by people who are actually worried about running out of money.
The data I referenced a couple of posts above shows that spending actually does decline for most retirees.
Snowjob wrote:
Sun Jul 15, 2018 9:03 pm
Nonetheless. I think if you plan on having some SPIA income the natural decline in spending is a reason one might opt for an annuity contract that is NOT inflation adjusted.
A SPIA without an inflation-adjustment could certainly be used for part of retiree's ESP. But 20-30 years of inflation are likely to take their toll on the spending power of the monthly payout, so a significant portion of the ESP should have components that have at least historically been capable of at least keeping pace with inflation, like TIPS, stocks, and real estate.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: A different take on retirement income: time segmentation

Post by Nate79 » Sun Jul 15, 2018 11:44 pm

willthrill81 wrote:
Sun Jul 15, 2018 10:52 pm
WanderingDoc wrote:
Sun Jul 15, 2018 7:12 pm
Very well thought out and interesting idea. Good thoughts from Sandtrap as well.
Thanks!
WanderingDoc wrote:
Sun Jul 15, 2018 7:12 pm
I tend to think we shouldn't be so rigid in assuming lower spending in retirement. It should be more at an individual (and year by year) basis.

For example, there have been years where I spent $120K and years where I spend $12K, perhaps both intentionally and unintentionally. Was perfectly content doing both. Why are we assuming that retired people just want to sit home all day, or not fly first class, or not eat in nice restaurants? I think people are unique and life is not that simple.

Someone could be 50 years old and spend $50K/yr. until their 55th birthday. Then they may want to open a restaurant or start a business, and want to make a $300K lump sum withdrawal without relying on outside investors yet. This is a very plausible scenario.

I think an even more intelligent "hybrid" approach would be a mix of portfolios of stocks/bonds and real estate. You have your real estate which pays you say $5K/mo. consistently. When the mortgages are payed off (by your tenants by the way), this will jump to $11-12K/mo. in income, in your 50s-60s, depending on when you started purchasing properties. This will also allow you to be more aggressive in your equity allocations, which could be used to fund further business and charitable pursuits.
It's true that not all retirees' spending goes down by a consistent 1-2% in real terms. Kitces actually believes that it may be slightly more realistic to model spending drop by 10% or more every decade in one fail swoop rather than bit by bit from year to year. But data from both Morningstar's David Blanchett and over 30 years of data from the Bureau of Labor Statistics supports the idea that retirees' spending does go down over time, particularly their discretionary spending.

Image

Those who want to increase their likelihood of more discretionary spending should either allocate more to their DSP, reduce their DSP withdrawal rate, or both.

And yes, allocations from either the ESP or DSP could certainly include some real estate. Some retirees 'count' on some portion of their real estate rental income (e.g. 70%) as part of their income floor, like Social Security benefits.
Do you know if that chart is adjusted for inflation or is in nominal dollars?

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Sun Jul 15, 2018 11:50 pm

9-5 Suited wrote:
Sun Jul 15, 2018 9:13 pm
After reading twice, I’m still not sure how this isn’t just mental accounting. Why wouldn’t a standard asset allocation approach that takes account of the individual’s need, willingness, and ability for risk yield the same result? I can pick my stock/bond/cash allocation to ensure enough FI to meet basic needs and have that determine my equity allocation if that’s how my need/willingness/ability shake out.
It's possible that you could do something like this with a standard approach, but I don't see how without going through the same process of identifying your essential spending needs versus your discretionary spending. And while depleting 80% of that portion of your portfolio needed to fund discretionary spending by the time you're age 85, for instance, is probably not a big deal, doing so with the portion of your portfolio needed to fund essential spending could be catastrophic (by 1st world standards at least).

The point of this disaggregation of retirees' portfolios would be to allow, if not encourage), them to spend more of their portfolio while they're younger, have higher spending desires, and better able to enjoy their nest egg, while still explicitly (attempting to) covering their essential spending needs for the rest of their lives. This is one of the big drawbacks of most retirement spending models: they provide either no spending increase over time beyond inflation (e.g. '4% rule') or even provide for increased spending over time due to the retirees' life expectancy going down (e.g. VPW method). This method is an attempt to address all of that as compactly as possible.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Sun Jul 15, 2018 11:52 pm

Nate79 wrote:
Sun Jul 15, 2018 11:44 pm
willthrill81 wrote:
Sun Jul 15, 2018 10:52 pm
WanderingDoc wrote:
Sun Jul 15, 2018 7:12 pm
Very well thought out and interesting idea. Good thoughts from Sandtrap as well.
Thanks!
WanderingDoc wrote:
Sun Jul 15, 2018 7:12 pm
I tend to think we shouldn't be so rigid in assuming lower spending in retirement. It should be more at an individual (and year by year) basis.

For example, there have been years where I spent $120K and years where I spend $12K, perhaps both intentionally and unintentionally. Was perfectly content doing both. Why are we assuming that retired people just want to sit home all day, or not fly first class, or not eat in nice restaurants? I think people are unique and life is not that simple.

Someone could be 50 years old and spend $50K/yr. until their 55th birthday. Then they may want to open a restaurant or start a business, and want to make a $300K lump sum withdrawal without relying on outside investors yet. This is a very plausible scenario.

I think an even more intelligent "hybrid" approach would be a mix of portfolios of stocks/bonds and real estate. You have your real estate which pays you say $5K/mo. consistently. When the mortgages are payed off (by your tenants by the way), this will jump to $11-12K/mo. in income, in your 50s-60s, depending on when you started purchasing properties. This will also allow you to be more aggressive in your equity allocations, which could be used to fund further business and charitable pursuits.
It's true that not all retirees' spending goes down by a consistent 1-2% in real terms. Kitces actually believes that it may be slightly more realistic to model spending drop by 10% or more every decade in one fail swoop rather than bit by bit from year to year. But data from both Morningstar's David Blanchett and over 30 years of data from the Bureau of Labor Statistics supports the idea that retirees' spending does go down over time, particularly their discretionary spending.

Image

Those who want to increase their likelihood of more discretionary spending should either allocate more to their DSP, reduce their DSP withdrawal rate, or both.

And yes, allocations from either the ESP or DSP could certainly include some real estate. Some retirees 'count' on some portion of their real estate rental income (e.g. 70%) as part of their income floor, like Social Security benefits.
Do you know if that chart is adjusted for inflation or is in nominal dollars?
The data used to produce that chart were cross-sectional and not longitudinal (i.e. they were collected at one point in time) by the BLS. So they are all in today's dollars.

I think that a few people may be thinking that if a particular retirees' spending doesn't go down that this method would somehow 'fail them'. I do not believe that is the case. First, using the method outlined for the DSP, it is mathematically impossible to completely deplete that portfolio, so there will always be something there to draw upon later if needed. Second, if there is at least a small (e.g. 25%) allocation to stocks in the ESP, there is a strong historical likelihood that that portfolio will at least remain fairly stable in real dollars over time. Third, it will truly take a "series of unfortunate events" to stress the ESP, deplete the DSP, and then have the retiree experience an extended period of long-term care that they could not cover. It's certainly possible, but the likelihood would be small.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: A different take on retirement income: time segmentation

Post by AlohaJoe » Mon Jul 16, 2018 2:07 am

willthrill81 wrote:
Sun Jul 15, 2018 5:36 pm
Potentially combining these two approaches may offset some of the disadvantages of the common withdrawal methods. The basic gist of what I propose is this: split retirees' portfolio into two, one for essential spending (ES portfolio) and another for discretionary spending (DS portfolio). Then, apply different withdrawal methods for the two portfolios, based on your need, willingness, and ability to take on risk for both ES and DS. Income strategies involving use of the ESP should logically be more conservative than those involving the DSP. And while the primary purpose of the DSP would be to fund discretionary spending, which typically declines as retirees' age, a secondary purpose could be to at least partially fund significant essential spending needs that might arise, such as long-term care.
Michael Zwecher's book Retirement Portfolios: Theory, Construction, and Management is a good deep-dive into this kind of "floor & upside" approach to retirement income.

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Re: A different take on retirement income: time segmentation

Post by The Wizard » Mon Jul 16, 2018 4:03 am

willthrill81 wrote:
Sun Jul 15, 2018 11:06 pm

...A SPIA without an inflation-adjustment could certainly be used for part of retiree's ESP. But 20-30 years of inflation are likely to take their toll on the spending power of the monthly payout, so a significant portion of the ESP should have components that have at least historically been capable of at least keeping pace with inflation, like TIPS, stocks, and real estate.
Correct, which is why my Immediate Annuties with TIAA contain a percentage of CREF Stock and TIAA Real Estate Account along with TIAA Traditional.
My annuity income has increased nicely over the past five years...
Attempted new signature...

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Re: A different take on retirement income: time segmentation

Post by The Wizard » Mon Jul 16, 2018 4:17 am

Theory is that retirees overall spending tends to decline with age.
How much of this is because they spent much of their modest nest eggs early on, unwisely perhaps, and now don't really have enough remaining to spend more?

On the other hand, we have people with larger portfolios who simply lose interest in doing stuff as they age and their portfolios grow significantly.

I know we have examples of both cases above, but I suspect that, in the general public, retirees who run low on money are more common.
What does the data show on this?
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Re: A different take on retirement income: time segmentation

Post by SGM » Mon Jul 16, 2018 4:29 am

I don't divide my portfolio between essential vs. discretionary spending. Our essential spending is covered by various income streams. The portfolio dividends make up a part of the total spending. I do have a hierarchy of spending and at the top regular deposits that come in from rental income, annuitized income including a spousal SS benefit, pension and a good variable and fixed annuity through previous employment. Next are dividends that we are forced to take and then selling of equities or bond funds. Roth accounts will not be spent from unless absolutely necessary and probably not until age 90 or never.

I feel we do some mental accounting, but not to the point where it has been harmful. I will soon start my delayed SS and will see if our spending increases. I hope to find something fun to spend it on.

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Re: A different take on retirement income: time segmentation

Post by Snowjob » Mon Jul 16, 2018 5:55 am

The Wizard wrote:
Mon Jul 16, 2018 4:17 am
Theory is that retirees overall spending tends to decline with age.
How much of this is because they spent much of their modest nest eggs early on, unwisely perhaps, and now don't really have enough remaining to spend more?

On the other hand, we have people with larger portfolios who simply lose interest in doing stuff as they age and their portfolios grow significantly.

I know we have examples of both cases above, but I suspect that, in the general public, retirees who run low on money are more common.
What does the data show on this?
That was my initial concern.

A chart below shows that this was spending for affluent households so on the surface it leads you to believe this is people with larger portfolios losing interest. I have not seen the study directly but I browsed the link to the Kitces site that was posted as well. There are several studies and while I am sure there is some truth to this I am more sceptical.

Anecdotally I have not seen my parents slow down at all (now late 70's) and their spending has been capped by smaller portfolio balances due to some poor investment decisions not any sort of natural decline. Frankly between mortgage repayment, projects and other various items they could probably spend another 50% of their portfolio (which they don't have / can't afford) today just on that. The only thing that will slow them down is early death or severe health decline.

My grandmother whom I only really knew in her mid 80's -> early 90's seemed to watch jeopardy and wheel of fortune every day. Read the paper to see the obituaries. Yelled at my grandfather for eating icecream for breakfast and not turning on his hearing aids. That seemed to be her routine. But life was different back then. Depression era kids, pre-internet. Simple life, never spent much. They worked for 50 years at a low to middle wages and passed on in the same small house they had their whole lives. Seemed to travel a little in their 70s from the family photos I found.

My grandparents both lived to their 90s and their actual spending pattern may have fit the spending decline that this data shows. My parents (if one does die early) will show a chart that has spending continuing to grow as much as their portfolio allows and then at some point when that death occurs, there will be a one time dramatic reset. There will be a reduction of income as well though (small pension, soc. sec. etc are likely reduced) and there is one less person consuming, so the decline will not be as extraordinary on a per head basis. Further, this really only helps if your modeling a couple who is married where one dies. What if the retiree is single? Death is simply the end point.

I prefer to think of any natural spending decline as an additional layer of safety. Even if you end with extra money at the end, this is simply additional funds to distribute to charity or leave some for your kids, help out with grand kids college etc. I think the only risk would be the risk of regret that you didn't spend enough during the early years on the bucket list trips. To that end, instead of a 2 portfolio split that models a larger decline in spending, a solution might be to model a decline in your vacation budget on its own -- Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.

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Re: A different take on retirement income: time segmentation

Post by dknightd » Mon Jul 16, 2018 7:02 am

Sandtrap wrote:
Sun Jul 15, 2018 6:36 pm
Thanks for taking the time and "work" to post this.
Always enjoy your "educational posts".
Yes, thanks.
Sandtrap wrote:
Sun Jul 15, 2018 6:36 pm
1. I think that retirees that I know take this "hybrid" approach intuitively (without really understanding the financial concepts at work). ES (essential spending) is mentally "bucketed" from established long term income streams such as SS, Annuities, Pensions, etc. And, DS (discretionary spending) from an investment portfolio.
I think my plan is in line with this.

I'll identify what I consider ES. Not an easy thing to do, since what is essential might change with time. 15 years ago I would not have considered internet and cell phone essential, but now I do. Who knows what I might consider essential in 20 years. I also consider at least some money for hobbies and entertainment "essential". So I guess everybody has a different idea about how you define ES. Anyway, lets pretend I have decided what my ES is (currently I'm planning $72k for two people, $54 for one, before taxes).

When I claim SS, I want my ES covered by SS, a small pension, and annuities. I'll annualize some when I retire, and some when I claim SS. I want to make sure our ES is covered for as long as one of us might live. Pension and annuities will be 100% left to survivor to help cover the loss of one SS check.
So between when I retire, and when I claim SS, I have enough funds invested conservatively to cover what SS will provide in the future.

The rest goes in a discretionary bucket, which I'll keep at about 50/50. My plan is to retire when this bucket (combined with our ES bucket) approximately matches our current spending (assume 4% withdrawal for planning purposes). In reality I expect we will want to spend more in our first few years of retirement than we spend now, then will probably slow down. Likely it will be lumpy, depending in part on what we want to do, and in part on how investments have been doing. We'll have the flexibility to do this since our ES are covered.

A lot of mental budgeting and accounting, which will eventually get put in a spreadsheet. To me this makes sense. A combination of separating essential expenses from discretionary expenses, and using imaginary "buckets" to cover different time horizons and needs/wants. I'm not sure it is better than any other approach from a theoretical or practical standpoint, but, it helps me feel more confident as I consider giving up a regular paycheck (it will still be hard to transition from saver to spender !)

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Re: A different take on retirement income: time segmentation

Post by dknightd » Mon Jul 16, 2018 7:23 am

The Wizard wrote:
Mon Jul 16, 2018 4:03 am

Correct, which is why my Immediate Annuties with TIAA contain a percentage of CREF Stock and TIAA Real Estate Account along with TIAA Traditional.
My annuity income has increased nicely over the past five years...
I'm also with TIAA. You were perhaps lucky your variable annuity has done so well over the last few years. I'll probably take some variable annuity, but mostly "fixed". I have some old TIAA traditional accumulations. I plan to take them on the "graded" payout schedule. Looks like those payments will increase at about 1.5%/year. Not enough to keep up with inflation, but at least it will put a dent in it (and is not likely to go down).

It is difficult to plan for 30 years with any kind of certainty. Even planning for 5 years is not easy.

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Re: A different take on retirement income: time segmentation

Post by AlohaJoe » Mon Jul 16, 2018 8:05 am

The Wizard wrote:
Mon Jul 16, 2018 4:17 am
How much of this is because they spent much of their modest nest eggs early on, unwisely perhaps, and now don't really have enough remaining to spend more?

[...]

I know we have examples of both cases above, but I suspect that, in the general public, retirees who run low on money are more common.
What does the data show on this?
Blanchett tested whether it was due to people who spent their modest nest egg early on by also looking at spending patterns relative to wealth levels; that doesn't look like the reason. Actually, people with low levels of wealth are the ones least likely to reduce spending significantly. Note also that the same effect -- spending reductions -- happens in in countries other than the US -- that is countries that don't rely on defined contribution retirement plans, where things like "portfolios" aren't really a factor.

For that matter, there is quite a bit of evidence that the vast majority of retirees -- even ones with comparatively tiny portfolios -- don't spend them down. There was a thread on Bogleheads just last week about the research on it: viewtopic.php?f=10&t=253471
The researchers found that after 18 years of retirement [...] those with less than $200,000 retained 80% [of their initial wealth].
The data seems pretty clear that the spending reductions aren't being caused by portfolios running out and retirees rarely run low on money.

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Re: A different take on retirement income: time segmentation

Post by SGM » Mon Jul 16, 2018 8:25 am

TIAA-CREF annuity payout has risen considerably over the last several years. It is mostly in CREF. Expenses are very low to the insurance company because as an annuitant we take the risk of mortality credits. Apparently our cohort has been disappearing. The payout could go up or down, but I expect it will continue to go up as the cohort ages. There is no guarantee that the payout will continue to rise, but we are including it in our income streams that covers both essential and non-essential expenses. I am discounting the risk that the cohort is going to start living longer or that the underlying funds are going to do very poorly. Fortunately it is one of several income streams.

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Mon Jul 16, 2018 8:44 am

Snowjob wrote:
Mon Jul 16, 2018 5:55 am
The Wizard wrote:
Mon Jul 16, 2018 4:17 am
Theory is that retirees overall spending tends to decline with age.
How much of this is because they spent much of their modest nest eggs early on, unwisely perhaps, and now don't really have enough remaining to spend more?

On the other hand, we have people with larger portfolios who simply lose interest in doing stuff as they age and their portfolios grow significantly.

I know we have examples of both cases above, but I suspect that, in the general public, retirees who run low on money are more common.
What does the data show on this?
That was my initial concern.

A chart below shows that this was spending for affluent households so on the surface it leads you to believe this is people with larger portfolios losing interest. I have not seen the study directly but I browsed the link to the Kitces site that was posted as well. There are several studies and while I am sure there is some truth to this I am more sceptical.

Anecdotally I have not seen my parents slow down at all (now late 70's) and their spending has been capped by smaller portfolio balances due to some poor investment decisions not any sort of natural decline. Frankly between mortgage repayment, projects and other various items they could probably spend another 50% of their portfolio (which they don't have / can't afford) today just on that. The only thing that will slow them down is early death or severe health decline.

My grandmother whom I only really knew in her mid 80's -> early 90's seemed to watch jeopardy and wheel of fortune every day. Read the paper to see the obituaries. Yelled at my grandfather for eating icecream for breakfast and not turning on his hearing aids. That seemed to be her routine. But life was different back then. Depression era kids, pre-internet. Simple life, never spent much. They worked for 50 years at a low to middle wages and passed on in the same small house they had their whole lives. Seemed to travel a little in their 70s from the family photos I found.

My grandparents both lived to their 90s and their actual spending pattern may have fit the spending decline that this data shows. My parents (if one does die early) will show a chart that has spending continuing to grow as much as their portfolio allows and then at some point when that death occurs, there will be a one time dramatic reset. There will be a reduction of income as well though (small pension, soc. sec. etc are likely reduced) and there is one less person consuming, so the decline will not be as extraordinary on a per head basis. Further, this really only helps if your modeling a couple who is married where one dies. What if the retiree is single? Death is simply the end point.

I prefer to think of any natural spending decline as an additional layer of safety. Even if you end with extra money at the end, this is simply additional funds to distribute to charity or leave some for your kids, help out with grand kids college etc. I think the only risk would be the risk of regret that you didn't spend enough during the early years on the bucket list trips. To that end, instead of a 2 portfolio split that models a larger decline in spending, a solution might be to model a decline in your vacation budget on its own -- Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.
Thanks for sharing your parents' and grandparents' experiences.

My parents are just about to enter retirement (father will be 70, and mother will be 65). It's looking like they will do a lot of traveling over the next 5-10 years, but it's doubtful beyond that. My father has some health issues that are minor now but could become very restrictive to their lifestyle down the road. My mother says that she's planning on them having "five good years" to do what's left on their bucket list. While their discretionary spending decreases will probably be lumpy, I think that they are quite likely to occur.

I believe it was Kitces who noted from working with clients directly and indirectly through other advisors that it seemed very common for health issues in retirees' mid- to late-70s to lead to them slowing down and spending less on travel, restaurants, clothing, etc. Someone would get a hip replacement but could no longer walk as far they could before, eyesight would decline to the point that they could not drive anymore, etc. Without good mobility, it's harder to go on pricey vacations or even dine out often.

But nonetheless, I believe that using a percentage-of-portfolio approach to retirees' discretionary spending portfolios is better than just amortizing it over a certain period. By doing so, retirees cannot exhaust their discretionary portfolios, leaving them the options of either continued discretionary spending later in retirement or paying for medical costs like long-term care.

Those who are really concerned about long-term care expenses or other expenses that tend to occur near the end of one's life might want to allocate some additional funds for that purpose to their essential spending portfolio or maybe even a third portfolio just for that.
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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Mon Jul 16, 2018 8:45 am

AlohaJoe wrote:
Mon Jul 16, 2018 2:07 am
willthrill81 wrote:
Sun Jul 15, 2018 5:36 pm
Potentially combining these two approaches may offset some of the disadvantages of the common withdrawal methods. The basic gist of what I propose is this: split retirees' portfolio into two, one for essential spending (ES portfolio) and another for discretionary spending (DS portfolio). Then, apply different withdrawal methods for the two portfolios, based on your need, willingness, and ability to take on risk for both ES and DS. Income strategies involving use of the ESP should logically be more conservative than those involving the DSP. And while the primary purpose of the DSP would be to fund discretionary spending, which typically declines as retirees' age, a secondary purpose could be to at least partially fund significant essential spending needs that might arise, such as long-term care.
Michael Zwecher's book Retirement Portfolios: Theory, Construction, and Management is a good deep-dive into this kind of "floor & upside" approach to retirement income.
Thanks for the recommendation. I've heard of it, and the approaches sound similar.
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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Mon Jul 16, 2018 8:50 am

SGM wrote:
Mon Jul 16, 2018 8:25 am
TIAA-CREF annuity payout has risen considerably over the last several years. It is mostly in CREF. Expenses are very low to the insurance company because as an annuitant we take the risk of mortality credits. Apparently our cohort has been disappearing. The payout could go up or down, but I expect it will continue to go up as the cohort ages. There is no guarantee that the payout will continue to rise, but we are including it in our income streams that covers both essential and non-essential expenses. I am discounting the risk that the cohort is going to start living longer or that the underlying funds are going to do very poorly. Fortunately it is one of several income streams.
I think that those employing some version of the approach I've outlined above might do well to have at least their essential spending come from multiple sources if for no other reason than helping them sleep well at night. Knowing that one has a Social Security, an annuity with an upside, and a balanced portfolio to all draw income from is probably more comforting than all of it coming from one source.
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Re: A different take on retirement income: time segmentation

Post by The Wizard » Mon Jul 16, 2018 8:52 am

AlohaJoe wrote:
Mon Jul 16, 2018 8:05 am

...For that matter, there is quite a bit of evidence that the vast majority of retirees -- even ones with comparatively tiny portfolios -- don't spend them down...
Ok, I think there are two related but distinct issues here.

One is the level of "spending" each year in retirement and the other is your portfolio balance and whether it's increasing or decreasing over the retirement years.

If a retiree has sufficient income from SS, variable annuities, and COLAd pensions, then it's possible for income and spending to increase year to year without need to withdraw from portfolio on a regular basis.

Similarly for people with "large" portfolios where a 2% withdrawal rate works.

In both cases, it's possible to have gradually increasing spending year to year concurrently with portfolio growing over those same years.
With any luck, I'll be in this situation...
Attempted new signature...

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Re: A different take on retirement income: time segmentation

Post by Walkure » Mon Jul 16, 2018 9:14 am

willthrill81 wrote:
Sun Jul 15, 2018 11:52 pm
Nate79 wrote:
Sun Jul 15, 2018 11:44 pm
willthrill81 wrote:
Sun Jul 15, 2018 10:52 pm
It's true that not all retirees' spending goes down by a consistent 1-2% in real terms. Kitces actually believes that it may be slightly more realistic to model spending drop by 10% or more every decade in one fail swoop rather than bit by bit from year to year. But data from both Morningstar's David Blanchett and over 30 years of data from the Bureau of Labor Statistics supports the idea that retirees' spending does go down over time, particularly their discretionary spending.

Image

Those who want to increase their likelihood of more discretionary spending should either allocate more to their DSP, reduce their DSP withdrawal rate, or both.

And yes, allocations from either the ESP or DSP could certainly include some real estate. Some retirees 'count' on some portion of their real estate rental income (e.g. 70%) as part of their income floor, like Social Security benefits.
Do you know if that chart is adjusted for inflation or is in nominal dollars?
The data used to produce that chart were cross-sectional and not longitudinal (i.e. they were collected at one point in time) by the BLS. So they are all in today's dollars.

I think that a few people may be thinking that if a particular retirees' spending doesn't go down that this method would somehow 'fail them'. I do not believe that is the case. First, using the method outlined for the DSP, it is mathematically impossible to completely deplete that portfolio, so there will always be something there to draw upon later if needed. Second, if there is at least a small (e.g. 25%) allocation to stocks in the ESP, there is a strong historical likelihood that that portfolio will at least remain fairly stable in real dollars over time. Third, it will truly take a "series of unfortunate events" to stress the ESP, deplete the DSP, and then have the retiree experience an extended period of long-term care that they could not cover. It's certainly possible, but the likelihood would be small.
I think the cross-sectional sample makes it a lot harder to draw any sort of "spending reduction" conclusion from the data. Most 85 year olds in 2015 (who grew up in the depression) probably had lifelong spending habits and expectations that were lower than the 65 year old baby boomers studied. And of course, the biggest problem is with the early retirement group aged 45-54 - it's presumably taken from the very small outlier group of people who were wealthy enough to afford to retire 10-20 years before the norm. It doesn't include the pre-retirement spending levels of working people in the same age bracket.

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Re: A different take on retirement income: time segmentation

Post by AlohaJoe » Mon Jul 16, 2018 9:35 am

Walkure wrote:
Mon Jul 16, 2018 9:14 am
I think the cross-sectional sample makes it a lot harder to draw any sort of "spending reduction" conclusion from the data.
Longitudinal samples show the same pattern and support the results from cross-sectional samples.

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Re: A different take on retirement income: time segmentation

Post by goodenyou » Mon Jul 16, 2018 10:15 am

Snowjob wrote
Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.
I like this idea. It’s akin to a retirement 529. One issue that is not brought up because it is controversial is the issue of an inheritance windfall. The notion of an inheritance has no place in my retirement planning, however, the reality is that it will happen. We have parents on both sides that are extremely frugal and have been prodigious savers. The potential will be significant, but not play any role in the decision on when to retire. It will likely be used in the DSP of our retirement portfolio. In all likelihood, it will be passed to the next generation since we have saved enough and don’t “need” it for our planned retirement. The interesting part is that it is invested heavily in equities because both side’s parents live so frugally that their ESP is met with SS, small pension and small fixed income. If, and when, there is an inheritance, there will be a disruption in the segmentation model of our portfolio.
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Re: A different take on retirement income: time segmentation

Post by dcabler » Mon Jul 16, 2018 10:21 am

Reminds me a little bit of Gummy's Sensible Withdrawal method from years past. A low initial % SWR rate for needs and a method for withdrawing "extras" for discretionary spending when portfolio returns warrant it.

http://www.financialwisdomforum.org/gum ... rawals.htm

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Mon Jul 16, 2018 10:32 am

goodenyou wrote:
Mon Jul 16, 2018 10:15 am
Snowjob wrote
Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.
I like this idea. It’s akin to a retirement 529. One issue that is not brought up because it is controversial is the issue of an inheritance windfall. The notion of an inheritance has no place in my retirement planning, however, the reality is that it will happen. We have parents on both sides that are extremely frugal and have been prodigious savers. The potential will be significant, but not play any role in the decision on when to retire. It will likely be used in the DSP of our retirement portfolio. In all likelihood, it will be passed to the next generation since we have saved enough and don’t “need” it for our planned retirement. The interesting part is that it is invested heavily in equities because both side’s parents live so frugally that their ESP is met with SS, small pension and small fixed income. If, and when, there is an inheritance, there will be a disruption in the segmentation model of our portfolio.
Yes, what I'm referring to as the DSP could be used for any expenses that aren't deemed essential to the retirees' needs, including a bequest.
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Re: A different take on retirement income: time segmentation

Post by goodenyou » Mon Jul 16, 2018 10:39 am

willthrill81 wrote:
Mon Jul 16, 2018 10:32 am
goodenyou wrote:
Mon Jul 16, 2018 10:15 am
Snowjob wrote
Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.
I like this idea. It’s akin to a retirement 529. One issue that is not brought up because it is controversial is the issue of an inheritance windfall. The notion of an inheritance has no place in my retirement planning, however, the reality is that it will happen. We have parents on both sides that are extremely frugal and have been prodigious savers. The potential will be significant, but not play any role in the decision on when to retire. It will likely be used in the DSP of our retirement portfolio. In all likelihood, it will be passed to the next generation since we have saved enough and don’t “need” it for our planned retirement. The interesting part is that it is invested heavily in equities because both side’s parents live so frugally that their ESP is met with SS, small pension and small fixed income. If, and when, there is an inheritance, there will be a disruption in the segmentation model of our portfolio.
Yes, what I'm referring to as the DSP could be used for any expenses that aren't deemed essential to the retirees' needs, including a bequest.
I recently listened to Wade Pfau on a Podcast discuss retirement investing strategies. He advocates SPIAs in lieu of bonds in retirement. He believes bonds have NO place in retirement asset allocation. He calles SPIAs “super bonds”. What’s your take on that strategy? It was new to me.
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Re: A different take on retirement income: time segmentation

Post by dknightd » Mon Jul 16, 2018 10:51 am

goodenyou wrote:
Mon Jul 16, 2018 10:15 am
Snowjob wrote
Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.
I like this idea. It’s akin to a retirement 529. One issue that is not brought up because it is controversial is the issue of an inheritance windfall. The notion of an inheritance has no place in my retirement planning, however, the reality is that it will happen. We have parents on both sides that are extremely frugal and have been prodigious savers. The potential will be significant, but not play any role in the decision on when to retire. It will likely be used in the DSP of our retirement portfolio. In all likelihood, it will be passed to the next generation since we have saved enough and don’t “need” it for our planned retirement. The interesting part is that it is invested heavily in equities because both side’s parents live so frugally that their ESP is met with SS, small pension and small fixed income. If, and when, there is an inheritance, there will be a disruption in the segmentation model of our portfolio.
I would not rely on a potential inheritance. I hope my kids are not. I'll be happy if they do not have to help take care of me, or their mother.

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Re: A different take on retirement income: time segmentation

Post by dknightd » Mon Jul 16, 2018 11:01 am

goodenyou wrote:
Mon Jul 16, 2018 10:39 am

I recently listened to Wade Pfau on a Podcast discuss retirement investing strategies. He advocates SPIAs in lieu of bonds in retirement. He believes bonds have NO place in retirement asset allocation. He calles SPIAs “super bonds”. What’s your take on that strategy? It was new to me.
I have not heard that podcast. Right now SPIA are paying more than bonds. YMMV

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Mon Jul 16, 2018 11:01 am

goodenyou wrote:
Mon Jul 16, 2018 10:39 am
willthrill81 wrote:
Mon Jul 16, 2018 10:32 am
goodenyou wrote:
Mon Jul 16, 2018 10:15 am
Snowjob wrote
Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.
I like this idea. It’s akin to a retirement 529. One issue that is not brought up because it is controversial is the issue of an inheritance windfall. The notion of an inheritance has no place in my retirement planning, however, the reality is that it will happen. We have parents on both sides that are extremely frugal and have been prodigious savers. The potential will be significant, but not play any role in the decision on when to retire. It will likely be used in the DSP of our retirement portfolio. In all likelihood, it will be passed to the next generation since we have saved enough and don’t “need” it for our planned retirement. The interesting part is that it is invested heavily in equities because both side’s parents live so frugally that their ESP is met with SS, small pension and small fixed income. If, and when, there is an inheritance, there will be a disruption in the segmentation model of our portfolio.
Yes, what I'm referring to as the DSP could be used for any expenses that aren't deemed essential to the retirees' needs, including a bequest.
I recently listened to Wade Pfau on a Podcast discuss retirement investing strategies. He advocates SPIAs in lieu of bonds in retirement. He believes bonds have NO place in retirement asset allocation. He calles SPIAs “super bonds”. What’s your take on that strategy? It was new to me.
Pfau has been a big fan of SPIAs for a while, but the truth is that retirees don't tend to like them. Part of the reason for their distaste stems from the fact that they must permanently surrender the annuitized assets in return for future income of an unknown duration. This can make good sense on paper, but it doesn't sit well with most folks, even those cognizant of the math involved.

Part of Pfau's liking of SPIAs is his very bearish stance on the '4% rule of thumb'. He has even said in the recent past that 2% is the 'new 4%', which most here rightly view as ludicrous for a 30 year retirement.

There are other reasons, though, why I think that SPIAs are not a one-size-fits-all approach for even essential spending for retirees. For one, getting one with a real inflation adjustment isn't easy because very few firms offer them. You can get one a decent variable annuity like those referred to by others above that may help you to keep pace with inflation, but there are no guarantees (fees can be high too), and that's what Pfau really wants. And even when you can get an inflation-adjusted SPIA, the payout ratio for a couple in their mid 60s will be about the same as the '4% rule of thumb'. So retirees must decide whether they want to hang on to their assets (which they want to do anyway), have the high historic probability of being able to withdraw even more as time goes on, and have a high historic probability of also passing down a big chunk of the starting balance to heirs/charity or give up all of that for the security of lifetime income. Most don't like that trade-off, and I frankly wouldn't either.

I think that SPIAs, whether inflation-adjusted or not, can have a place in retirees' ESP, but I don't think that they should be the bulk of it and certainly not all of it. Vanguard doesn't recommend that retirees annuitize more than 20% of their overall portfolios (they obviously aren't dissecting essential and discretionary spending), and I think that's pretty good advice.
dknightd wrote:
Mon Jul 16, 2018 11:01 am
I have not heard that podcast. Right now SPIA are paying more than bonds. YMMV
They always 'should' because the insurance company is going to turn around and invest your single premium to buy bonds for themselves. They can afford to pay you a higher payout than the bonds' yield because of mortality credits (i.e. they know about when you'll die on average). But you cannot take advantage of mortality credits on your own because you are not an average.
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Re: A different take on retirement income: time segmentation

Post by goodenyou » Mon Jul 16, 2018 11:06 am

dknightd wrote:
Mon Jul 16, 2018 10:51 am
goodenyou wrote:
Mon Jul 16, 2018 10:15 am
Snowjob wrote
Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.
I like this idea. It’s akin to a retirement 529. One issue that is not brought up because it is controversial is the issue of an inheritance windfall. The notion of an inheritance has no place in my retirement planning, however, the reality is that it will happen. We have parents on both sides that are extremely frugal and have been prodigious savers. The potential will be significant, but not play any role in the decision on when to retire. It will likely be used in the DSP of our retirement portfolio. In all likelihood, it will be passed to the next generation since we have saved enough and don’t “need” it for our planned retirement. The interesting part is that it is invested heavily in equities because both side’s parents live so frugally that their ESP is met with SS, small pension and small fixed income. If, and when, there is an inheritance, there will be a disruption in the segmentation model of our portfolio.
I would not rely on a potential inheritance. I hope my kids are not. I'll be happy if they do not have to help take care of me, or their mother.
That’s what I said in my text. I am not. I have far exceeded my retirement needs and have no need for it. It will likely be a generational skipping inheritance.
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Re: A different take on retirement income: time segmentation

Post by goodenyou » Mon Jul 16, 2018 11:17 am

willthrill81 wrote:
Mon Jul 16, 2018 11:01 am
goodenyou wrote:
Mon Jul 16, 2018 10:39 am
willthrill81 wrote:
Mon Jul 16, 2018 10:32 am
goodenyou wrote:
Mon Jul 16, 2018 10:15 am
Snowjob wrote
Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.
I like this idea. It’s akin to a retirement 529. One issue that is not brought up because it is controversial is the issue of an inheritance windfall. The notion of an inheritance has no place in my retirement planning, however, the reality is that it will happen. We have parents on both sides that are extremely frugal and have been prodigious savers. The potential will be significant, but not play any role in the decision on when to retire. It will likely be used in the DSP of our retirement portfolio. In all likelihood, it will be passed to the next generation since we have saved enough and don’t “need” it for our planned retirement. The interesting part is that it is invested heavily in equities because both side’s parents live so frugally that their ESP is met with SS, small pension and small fixed income. If, and when, there is an inheritance, there will be a disruption in the segmentation model of our portfolio.
Yes, what I'm referring to as the DSP could be used for any expenses that aren't deemed essential to the retirees' needs, including a bequest.
I recently listened to Wade Pfau on a Podcast discuss retirement investing strategies. He advocates SPIAs in lieu of bonds in retirement. He believes bonds have NO place in retirement asset allocation. He calles SPIAs “super bonds”. What’s your take on that strategy? It was new to me.
Pfau has been a big fan of SPIAs for a while, but the truth is that retirees don't tend to like them. Part of the reason for their distaste stems from the fact that they must permanently surrender the annuitized assets in return for future income of an unknown duration. This can make good sense on paper, but it doesn't sit well with most folks, even those cognizant of the math involved.

Part of Pfau's liking of SPIAs is his very bearish stance on the '4% rule of thumb'. He has even said in the recent past that 2% is the 'new 4%', which most here rightly view as ludicrous for a 30 year retirement.

There are other reasons, though, why I think that SPIAs are not a one-size-fits-all approach for even essential spending for retirees. For one, getting one with a real inflation adjustment isn't easy because very few firms offer them. You can get one a decent variable annuity like those referred to by others above that may help you to keep pace with inflation, but there are no guarantees (fees can be high too), and that's what Pfau really wants. And even when you can get an inflation-adjusted SPIA, the payout ratio for a couple in their mid 60s will be about the same as the '4% rule of thumb'. So retirees must decide whether they want to hang on to their assets (which they want to do anyway), have the high historic probability of being able to withdraw even more as time goes on, and have a high historic probability of also passing down a big chunk of the starting balance to heirs/charity or give up all of that for the security of lifetime income. Most don't like that trade-off, and I frankly wouldn't either.

I think that SPIAs, whether inflation-adjusted or not, can have a place in retirees' ESP, but I don't think that they should be the bulk of it and certainly not all of it. Vanguard doesn't recommend that retirees annuitize more than 20% of their overall portfolios (they obviously aren't dissecting essential and discretionary spending), and I think that's pretty good advice.
dknightd wrote:
Mon Jul 16, 2018 11:01 am
I have not heard that podcast. Right now SPIA are paying more than bonds. YMMV
They always 'should' because the insurance company is going to turn around and invest your single premium to buy bonds for themselves. They can afford to pay you a higher payout than the bonds' yield because of mortality credits (i.e. they know about when you'll die on average). But you cannot take advantage of mortality credits on your own because you are not an average.

What do you think of the theory that the SPIA allows for a more aggressive equity portfolio that likely will lead to more growth and likely more legacy?
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Re: A different take on retirement income: time segmentation

Post by dknightd » Mon Jul 16, 2018 11:18 am

willthrill81 wrote:
Mon Jul 16, 2018 11:01 am
There are other reasons, though, why I think that SPIAs are not a one-size-fits-all approach for even essential spending for retirees.
I don't think there is a one-size-fits-all approach to this. Too many variables.

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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Mon Jul 16, 2018 11:38 am

goodenyou wrote:
Mon Jul 16, 2018 11:17 am
What do you think of the theory that the SPIA allows for a more aggressive equity portfolio that likely will lead to more growth and likely more legacy?
I don't buy it. Buying a SPIA is not likely to provide retirees with a meaningfully greater amount in their portfolio to allocate to equities. The payout ratio for a SPIA with an inflation-adjustment for a 65 year old couple is roughly 4% these days, which is close to the '4% rule of thumb'. Granted, the '4% rule' hasn't held with only nominal bonds in the past, but there's no need for a retiree to hold only nominal bonds any more. They can now buy TIPS, and with current real returns, they can guarantee about 27 years of inflation-adjusted spending, very close to the 30 year mark used with the '4% rule'. A small (e.g. 25%) allocation to stocks would historically be very prudent to add anyway to a ESP.

Yes, the SPIA is guaranteed for life, but that comes at the expense of giving up those assets forever, including any potential for growth and legacy that may come with retaining those assets.

So if a person who desires a 50/50 overall AA puts half of it in a SPIA instead of bonds, that doesn't enable them to be more 'aggressive' with the other half.
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Re: A different take on retirement income: time segmentation

Post by dknightd » Mon Jul 16, 2018 11:56 am

willthrill81 wrote:
Mon Jul 16, 2018 11:38 am
goodenyou wrote:
Mon Jul 16, 2018 11:17 am
What do you think of the theory that the SPIA allows for a more aggressive equity portfolio that likely will lead to more growth and likely more legacy?
I don't buy it. Buying a SPIA is not likely to provide retirees with a meaningfully greater amount in their portfolio to allocate to equities. The payout ratio for a SPIA with an inflation-adjustment for a 65 year old couple is roughly 4% these days, which is close to the '4% rule of thumb'. Granted, the '4% rule' hasn't held with only nominal bonds in the past, but there's no need for a retiree to hold only nominal bonds any more. They can now buy TIPS, and with current real returns, they can guarantee about 27 years of inflation-adjusted spending, very close to the 30 year mark used with the '4% rule'. A small (e.g. 25%) allocation to stocks would historically be very prudent to add anyway to a ESP.

Yes, the SPIA is guaranteed for life, but that comes at the expense of giving up those assets forever, including any potential for growth and legacy that may come with retaining those assets.

So if a person who desires a 50/50 overall AA puts half of it in a SPIA instead of bonds, that doesn't enable them to be more 'aggressive' with the other half.
As said - too may variables..

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Re: A different take on retirement income: time segmentation

Post by goodenyou » Mon Jul 16, 2018 11:59 am

willthrill81 wrote:
Mon Jul 16, 2018 11:38 am
goodenyou wrote:
Mon Jul 16, 2018 11:17 am
What do you think of the theory that the SPIA allows for a more aggressive equity portfolio that likely will lead to more growth and likely more legacy?
I don't buy it. Buying a SPIA is not likely to provide retirees with a meaningfully greater amount in their portfolio to allocate to equities. The payout ratio for a SPIA with an inflation-adjustment for a 65 year old couple is roughly 4% these days, which is close to the '4% rule of thumb'. Granted, the '4% rule' hasn't held with only nominal bonds in the past, but there's no need for a retiree to hold only nominal bonds any more. They can now buy TIPS, and with current real returns, they can guarantee about 27 years of inflation-adjusted spending, very close to the 30 year mark used with the '4% rule'. A small (e.g. 25%) allocation to stocks would historically be very prudent to add anyway to a ESP.

Yes, the SPIA is guaranteed for life, but that comes at the expense of giving up those assets forever, including any potential for growth and legacy that may come with retaining those assets.

So if a person who desires a 50/50 overall AA puts half of it in a SPIA instead of bonds, that doesn't enable them to be more 'aggressive' with the other half.
I agree. I assume also that there is a law of diminishing returns to a SPIA for retirees that have the ability to significantly reduce their withdrawal rate as well.
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Re: A different take on retirement income: time segmentation

Post by Snowjob » Mon Jul 16, 2018 12:15 pm

willthrill81 wrote:
Mon Jul 16, 2018 10:32 am
goodenyou wrote:
Mon Jul 16, 2018 10:15 am
Snowjob wrote
Put a sum of money into 70/30 balanced fund, call it the big vacation fund and take a healthy 6-7% a year out to cover big trips until its depleted. At that point your living more local anyway and hopefully any natural spending declines would free up enough money for a trip here or there if you did happen to experience that natural decline.
I like this idea. It’s akin to a retirement 529. One issue that is not brought up because it is controversial is the issue of an inheritance windfall. The notion of an inheritance has no place in my retirement planning, however, the reality is that it will happen. We have parents on both sides that are extremely frugal and have been prodigious savers. The potential will be significant, but not play any role in the decision on when to retire. It will likely be used in the DSP of our retirement portfolio. In all likelihood, it will be passed to the next generation since we have saved enough and don’t “need” it for our planned retirement. The interesting part is that it is invested heavily in equities because both side’s parents live so frugally that their ESP is met with SS, small pension and small fixed income. If, and when, there is an inheritance, there will be a disruption in the segmentation model of our portfolio.
Yes, what I'm referring to as the DSP could be used for any expenses that aren't deemed essential to the retirees' needs, including a bequest.
I think the only difference is I would limit my "DSP" to a vacation fund where as Will is looking at a much larger component of spending -- all discretionary.

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Re: A different take on retirement income: time segmentation

Post by goodenyou » Mon Jul 16, 2018 1:11 pm

willthrill81 wrote:
Mon Jul 16, 2018 11:38 am
goodenyou wrote:
Mon Jul 16, 2018 11:17 am
What do you think of the theory that the SPIA allows for a more aggressive equity portfolio that likely will lead to more growth and likely more legacy?
I don't buy it. Buying a SPIA is not likely to provide retirees with a meaningfully greater amount in their portfolio to allocate to equities. The payout ratio for a SPIA with an inflation-adjustment for a 65 year old couple is roughly 4% these days, which is close to the '4% rule of thumb'. Granted, the '4% rule' hasn't held with only nominal bonds in the past, but there's no need for a retiree to hold only nominal bonds any more. They can now buy TIPS, and with current real returns, they can guarantee about 27 years of inflation-adjusted spending, very close to the 30 year mark used with the '4% rule'. A small (e.g. 25%) allocation to stocks would historically be very prudent to add anyway to a ESP.

Yes, the SPIA is guaranteed for life, but that comes at the expense of giving up those assets forever, including any potential for growth and legacy that may come with retaining those assets.

So if a person who desires a 50/50 overall AA puts half of it in a SPIA instead of bonds, that doesn't enable them to be more 'aggressive' with the other half.
Let’s do some mathematical modeling:

Given a $2,000,000 portfolio

If your ESP needs to generate $40k/year would that be:

$1,000,000

$750,000 in TIPS
$250,000 in TSM



DSP

$1,000,000

$500,000 TSM
$500,000 TBM

To combine each:

$750,000 TSM
$500,000 TBM
$750,000 TIPS


Do you “need” to invest more than $1,000,000 in the ESP to achieve a safe 4% withdrawal since less than a 50/50 portfolio?

Am I thinking of this correctly?

TIA
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Re: A different take on retirement income: time segmentation

Post by HomerJ » Mon Jul 16, 2018 1:52 pm

dknightd wrote:
Mon Jul 16, 2018 11:01 am
Right now SPIA are paying more than bonds. YMMV
What does that mean? Do you not understand the difference between the two? Or am I missing something?
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Re: A different take on retirement income: time segmentation

Post by HomerJ » Mon Jul 16, 2018 2:02 pm

willthrill81 wrote:
Mon Jul 16, 2018 11:38 am
The payout ratio for a SPIA with an inflation-adjustment for a 65 year old couple is roughly 4% these days, which is close to the '4% rule of thumb'.
Actually, it's about 5.6% for a 65-year old couple.

So one could put 50% of their money in a SPIA, and use a 5% withdrawal on the other 50% (assuming the first 50% SPIA and SS covers most of the essentials, so a 5% withdrawal on the second 50% isn't as scary), and end up with a 5.3% withdrawal rate with a very nice floor.

Edit: Oh wait, I did my SPIA without an inflation adjustment.

So never mind :)

(Although I personally think ignoring inflation, and then just revisiting your plan every 5 years works too. You can always buy supplemental SPIAs as you go).
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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Mon Jul 16, 2018 2:04 pm

Snowjob wrote:
Mon Jul 16, 2018 12:15 pm
I think the only difference is I would limit my "DSP" to a vacation fund where as Will is looking at a much larger component of spending -- all discretionary.
Any spending category that the retiree believes will decline over time as well as any categories that could be at least temporarily reduced in the event of a big market downturn, such as vacationing, dining out, or gifts could be included in the discretionary spending portfolio. At least some vehicle expenses could possibly be included as well; most 80 year olds aren't spending much on cars.
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Re: A different take on retirement income: time segmentation

Post by willthrill81 » Mon Jul 16, 2018 2:14 pm

goodenyou wrote:
Mon Jul 16, 2018 1:11 pm
willthrill81 wrote:
Mon Jul 16, 2018 11:38 am
goodenyou wrote:
Mon Jul 16, 2018 11:17 am
What do you think of the theory that the SPIA allows for a more aggressive equity portfolio that likely will lead to more growth and likely more legacy?
I don't buy it. Buying a SPIA is not likely to provide retirees with a meaningfully greater amount in their portfolio to allocate to equities. The payout ratio for a SPIA with an inflation-adjustment for a 65 year old couple is roughly 4% these days, which is close to the '4% rule of thumb'. Granted, the '4% rule' hasn't held with only nominal bonds in the past, but there's no need for a retiree to hold only nominal bonds any more. They can now buy TIPS, and with current real returns, they can guarantee about 27 years of inflation-adjusted spending, very close to the 30 year mark used with the '4% rule'. A small (e.g. 25%) allocation to stocks would historically be very prudent to add anyway to a ESP.

Yes, the SPIA is guaranteed for life, but that comes at the expense of giving up those assets forever, including any potential for growth and legacy that may come with retaining those assets.

So if a person who desires a 50/50 overall AA puts half of it in a SPIA instead of bonds, that doesn't enable them to be more 'aggressive' with the other half.
Let’s do some mathematical modeling:

Given a $2,000,000 portfolio

If your ESP needs to generate $40k/year would that be:

$1,000,000

$750,000 in TIPS
$250,000 in TSM



DSP

$1,000,000

$500,000 TSM
$500,000 TBM

To combine each:

$750,000 TSM
$500,000 TBM
$750,000 TIPS


Do you “need” to invest more than $1,000,000 in the ESP to achieve a safe 4% withdrawal since less than a 50/50 portfolio?

Am I thinking of this correctly?

TIA
I think you mean something along the lines of whether a 4% initial withdrawal rate plus inflation is reasonable for a portfolio with 25% TSM and 75% TIPS. I'd say yes. That might not be 'optimal', but I would call it reasonable. TIPS provide most of the real return needed for a 30 year retirement, and, historically, stocks would cover the rest and then some over that lengthy of a time frame.
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Re: A different take on retirement income: time segmentation

Post by The Wizard » Mon Jul 16, 2018 2:50 pm

Married couples would get higher income in retirement from SPIAs if each bought a single life SPIA for $500,000 rather than buying a joint life SPIA for $1M.

This also helps solve that nasty problem after the death of the first spouse where the survivor has excess income in a higher tax bracket.

We should have Wade take a look at this concept...
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Re: A different take on retirement income: time segmentation

Post by Peter Foley » Mon Jul 16, 2018 2:51 pm

The Wizard hit on something that occurred to me while I was reading the thread. We are really talking about an investment approach for a select cross section of retirees here. Snowjob followed up with an insightful anecdote about how different retirees spend their time in retirement. Both hit on the OP's premise that withdrawal methods are not a one size fits all formula.

My thought here is that we are talking about a group of people that have saved enough for retirement to cover the basics and have some ability to use discretionary spending to fund activities of interest that cost more than everyday living. Backtracking to the chart and applying a very rough 4% withdrawal to the early 60's age group, we are taking about people who have a minimum of $1,000,000 in retirement savings and perhaps closer to $2,000,000.* (A 4% withdrawal from $2M = $80,000, which when supplemented with $30K of SS benefits, is in the range shown on the chart.)

I think the concept of time segmentation is useful for this group. I'm inclined to agree that this group could be characterized as people with larger portfolios who gradually lose interest and perhaps the ability to pursue more expensive activities later in retirement.


*This of course could apply to individuals with greater savings who live in very high cost of living areas. It probably does not apply to individuals whose "lifestyle" choices are expensive. But that's another thread . . .

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Re: A different take on retirement income: time segmentation

Post by Dottie57 » Mon Jul 16, 2018 3:03 pm

I divy my portfolio by pre-SS and receiving SS. SS will cover most basic needs at age 70. So portfolio at that time should be 90% for non essential spending.

Between 62 and 70 , I need to fund all expenses from portfolio. Asset allocation is 50/50.
Last edited by Dottie57 on Mon Jul 16, 2018 3:07 pm, edited 2 times in total.

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