The Relationship Between Guaranteed Income And Safe Withdrawal Rates

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The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by gaspr » 22 May 2017 10:02

Check out Mike Piper's latest blog entry.

http://www.obliviousinvestor.com/the-re ... wal-rates/

Seems like a common sense idea. Question for Longinvest...Perhaps the VPW could be tweeked to include this info, or is it already included?

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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by longinvest » 22 May 2017 11:12

gaspr wrote:
22 May 2017 10:02
Question for Longinvest...Perhaps the VPW could be tweeked to include this info, or is it already included?
The finiki entry already encourages the use of guaranteed base income:

finiki: Variable percentage withdrawal
VPW is best used in conjunction with guaranteed base income from Old Age Security (OAS), Canada Pension Plan (CPP) or Québec Pension Plan (QPP), pensions, and, if necessary, inflation-indexed Single Premium Immediate Annuity (SPIA).
The VPW backtesting spreadsheet has entries to enter a) OAS+CPP (called Social Security because of US users*) and b) pension. The spreadsheet assumes that OAS+CPP are indexed to inflation and that the pension is not.

* It might be a good idea to create a Canadian-specific version of the spreadsheet.

I know that this doesn't directly answer your question, but the VPW model is based on the idea that VPW cannot replace a lifelong inflation-indexed pension; that it complements it.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by longinvest » 22 May 2017 20:54

gaspr wrote:
22 May 2017 10:02
Check out Mike Piper's latest blog entry.

http://www.obliviousinvestor.com/the-re ... wal-rates/

Seems like a common sense idea.
OK, I read the article.

It's yet another variation on the so-called "Safe" Withdrawal Rate (SWR) method. Of course, when you add a lifelong annuity, you lower the risk of total ruin* due to premature portfolio depletion. Yet, you don't remove the risk of premature portfolio depletion.

* You're not totally ruined anymore as you still have the annuity when the portfolio gets prematurely depleted. Doh!

I don't know why people continue to write article after article about the brainless SWR method which leads most its retirees to die as the richest people in the graveyard while bankrupting most of the remaining ones. It just doesn't make any sense to set a withdrawal amount on the day of retirement and then keep taking yearly withdrawals of this same amount, adjusted for inflation, for the rest of one's life regardless of market returns.

I consider all such articles as retirement withdrawal porn. It's pretty easy to detect. You just have to look for one keyword: SWR.


Just to see how senseless SWR is, just consider the following situation. For simplicity, I will do all the calculations in inflation-adjusted dollars.

In year Y, person A, age 65, retires with a 50/50 stocks/bonds portfolio of $1,000,000. He sets his retirement withdrawal amount to 4% of his current portfolio, $40,000. He takes his $40,000 withdrawal and is left (after withdrawal) with a portfolio of $960,000. During year Y, the portfolio suffers a real 10% loss. At the beginning of year Y+1, person A has a portfolio of $864,000 and takes another withdrawal of $40,000.

In the same initial year Y, person B, age 65, has a 50/50 portfolio of $950,000 and decides to wait one more year before retiring. During year Y, the portfolio suffers a real 10% loss. But, person B is working and manages to save and contribute an additional $9,000 to his portfolio (at year end). As a result, at the beginning of year Y+1, person B has a portfolio of $855,000 + $9000 = $864,000. Person B decides to retire. But, unlike person A at retirement, person B's retirement horizon is not 30 years but 29 years. So, he sets his SWR withdrawal rate accordingly at 4.1128% of his portfolio (instead of 4%). In other words, he gets to withdraw $35,535 each year from his portfolio for the rest of his life.

Do you see how illogical this is? In year Y+1, both retirees are 66 years old, have identical 50/50 portfolios of $864,000, and have identical retirement horizons. Yet, person A has a lifelong constant withdrawal amount of $40,000 and person B has a lifelong constant withdrawal amount of $35,545. This makes no sense whatsoever.


That's even before considering that no sane retiree would continue taking an inflation-adjusted 4% of retirement-day-portfolio withdrawal during an extended bear market, while seeing his portfolio melt before his eyes, just because he hopes that the market will recover in time. The dumb hypothetical 1966 retiree who ignored market returns went bankrupt and had to eat cat food and live under a bridge for the rest of his life.

Now, for most other historical retirement years, other than 1966, an identically dumb hypothetical retiree (who ignored market returns) had his portfolio double or triple, yet he kept only taking a $40,000 withdrawal per year. In the process, he deprived himself and people he loves of all kind of small luxuries and experiences that higher withdrawals would have allowed for. At death, his estate got so big and his heirs had been waiting so long for the money that they ended up fighting endlessly about it, making their lawyers rich in the process. Of course, the financial adviser/advisor was just happy to have endlessly growing AUMs (assets under management) all along**.

** Of course, the advis(e/o)r had recommended to take CPP as early as possible.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by NormR » 22 May 2017 22:25

I appreciate your passion for the topic!

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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by longinvest » 23 May 2017 00:32

I'm passionate about it because it's central to why we invest in the first place.

Many of us invest during our work years so that we can retire with dignity later. Keeping people anxious about retirement by telling them that they'll never have enough, because markets could be bad, harms them in multiple ways: it could discourage them from continuing to save for retirement (e.g. they start thinking they'll never retire, so why bother), or it could lead them to oversave, denying themselves and their loved one of pleasures during their younger and healthy years, and, lastly, anxiety is not good for health. The same fear mongers keep telling us that future returns are likely to be lower than historical ones. If we were to listen to them, we would end up living in poverty today in fear of living in poverty in our older days.

The reality is that we're lucky to live in a rich country with free healthcare and basic government pensions (CPP and OAS) for its elders. The average Canadian needs only to accumulate relatively modest savings, in addition to a paid-off modest home*, to afford a comfortable retirement at age 65. Those with higher than median salaries need to save more, if they wish to maintain their living standard, but they should be able to do so pretty easily as long as they don't spend all their money foolishly (e.g. getting into debt and not saving). If most people just used their RRSP and TFSA to regularly invest new money into a boring balanced portfolio, they would accumulate more than enough. There's really no need for all the anxiety.

* One could rent and invest the difference, too.

Knowing about how to establish a robust lifelong inflation-indexed retirement income base by simply delaying CPP and OAS and bridging the gap with a GIC ladder not exposed to market risk, and about how to sensibly withdraw money from a portfolio of risky assets (stocks and bonds) using something like VPW is key to avoiding this anxiety. Safely generating an income, during retirement, doesn't have to be more difficult than this.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by gaspr » 23 May 2017 07:53

longinvest wrote:
23 May 2017 00:32


Knowing about how to establish a robust lifelong inflation-indexed retirement income base by simply delaying CPP and OAS and bridging the gap with a GIC ladder not exposed to market risk, and about how to sensibly withdraw money from a portfolio of risky assets (stocks and bonds) using something like VPW is key to avoiding this anxiety. Safely generating an income, during retirement, doesn't have to be more difficult than this.
I agree totally with this and I too want to thank you for all your efforts. But just to play devil's advocate for a bit...

VPW results in year to year income variability that many retirees without a very good understanding of the method, would find uncomfortable. They might actually prefer to be able to withdraw an equal, inflation adjusted amount each and every year for as long as they live...

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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by SQRT » 23 May 2017 08:28

Good posts Long. I am also surprised at the apparent lack of common sense surrounding withdrawal rates. Many people (even on this site) seem to be proud of their low WR's. The idea that somebody would set a WR at retirement then stick to it for decades seems ludicrous. It's only a rule of thumb and then only useful during the accumulation period.

Another pet peeve I have is the apparent prevalence of forecasting of future real returns. Makes some sense during the accumulation phase but once retired we have better data, ie the actuals. This coupled with flexibility of withdrawals seems just too obvious to me.

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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by kcowan » 23 May 2017 09:47

Over on ER.org, many of the SWR proponents who are retired actually withdraw their amount from the portfolio and put it in a savings account because they don't need it! Makes no sense to me.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by longinvest » 23 May 2017 09:55

Gaspr,
gaspr wrote:
23 May 2017 07:53
I agree totally with this and I too want to thank you for all your efforts. But just to play devil's advocate for a bit...

VPW results in year to year income variability that many retirees without a very good understanding of the method, would find uncomfortable. They might actually prefer to be able to withdraw an equal, inflation adjusted amount each and every year for as long as they live...
A look at historical backtests shows that the volatility of VPW withdrawals is determined by portfolio volatility. In other words, retirees applying VPW on a balanced portfolio (e.g. with at least 50% bonds) won't suffer through much withdrawal volatility. Adding a lifelong non-portfolio income base further reduces total income volatility.

During my entire life, my income has been variable. I am sure that this is true of most FWF members, too. Some years, we get higher bonuses than others, for example. In bad periods, like 2008-2009, we're just happy if we get to keep our job, so we don't care if our income is indexed to the CPI or not, or if our bonus is cut. We adapt.

Why should we assume that suddenly, as soon as people retire, they lose all their senses and stop being able to manage any variation in income or, more precisely, any variation in CPI-adjusted income? This simply makes no sense. Let me ask you this: When was the last time that you checked if your net paycheck matched the increase in CPI over the last month or the last year? I don't know about you, by my own net income varies throughout the year because of how EI and QPP contributions are deducted. I don't freak out because of it, and I'm perfectly able to survive. Doh!

Didn't you know that CPI is often more volatile than bonds? CPI is just an indirect measure of inflation; its volatility is not something one notices in real life. It can be quite misleading to look at inflation-adjusted charts without taking into account this fact. Actually, our governments are so aware that people live a nominal world that they don't dare reducing CPP and OAS pensions when CPI takes a dip. They keep the pensions level until CPI recovers.

So, with this information in mind, let's look at a plausible retirement scenario for an average single Canadian. Let's assume that he had a variable income in his 20s that more or less stabilized around $50,000 (in inflation-adjusted terms) by the time he reached age 35. He continues to work until age 65. This person did not start saving for retirement before age 35, because he was mostly concerned with paying his student debts, accumulating a down payment for a small house, and spending money on the house (repairs, landscape, etc).

Let's estimate his age 65 CPP pension by simply accounting for his CPP contributions from age 35 to 65. That's 30 years of contribution out of (65-18) - 17% = 39.01. So at age 65, he could get $9,613. Delaying the pension until age 70 increases this to $13,650 (without accounting for the fact that wage inflation is usually 1% higher than CPI inflation). OAS delayed to 70 would be an additional $9,355.

At age 35, he starts contributing 15% of his salary into his RRSP and puts the tax refund into his TFSA. He invests both into a 50/50 stocks/bonds portfolio delivering an average annualized real 3.5% return from age 35 to 65. That's a RRSP contribution of $7,500 and a TFSA contribution of $2,250 per year. This should thus grow to a little more than $500,000 at age 65, spread between RRSP (77%) and TFSA (23%).

In order to compensate for missing CPP and OAS payments between ages 65 and 70, he will need to put aside ($13,650 + $9355) X 5 = $115,000, 20% into a savings account (for the current year) and 80% into a 4-rung non-rolling GIC ladder. He will be left with a $385,000 portfolio on which he will apply VPW.

Let's assume that we're in January 2000, near the top of the tech bubble. Here's what would have happened, using the Canadian data set of the VPW spreadsheet (including 2016 data not yet in the web version of the spreadsheet):

Settings:
settings.png
settings.png (21.61 KiB) Viewed 1129 times
Chart:
chart.png
Details:
table.png
Let's look at the feared volatility of withdrawals in nominal terms. In 2000, the retiree withdrew $18,480 from his portfolio. Luckily, in 2000 the portfolio managed to deliver positive returns. In 2001, the retiree withdrew a little more, $18,804. Then, the bubble burst. How bad was the impact on withdrawals? In 2002, he managed to withdraw $17,558 merely $1,245 less than in 2001. In 2003, he got $16,440. That's merely $2,364 less than in 2001. And, that was it for the tech bubble*!

If we were to translate this $2,364 gross income difference into net income, we're talking of a variation of less than $2,000 dollar. One should be able to easily manage this on an approximate total gross income of $40,000 per year (including CPP and OAS). Don't you think?

* I'll let readers repeat the exercise for the 2008-2009 crisis. All the data (chart and detailed table) are displayed above.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by gaspr » 23 May 2017 10:50

@ Longinvest. Again, I totally agree with all you have written here. It is an excellent withdrawal method. My problem with those who cannot manage this on a DIY basis. They need help from someone to explain and to implement and manage this. Where do they go for this? Until fee for service advisers start to promote VPW, most people will remain helpless...

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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by longinvest » 23 May 2017 11:07

gaspr wrote:
23 May 2017 10:50
@ Longinvest. Again, I totally agree with all you have written here. It is an excellent withdrawal method. My problem with those who cannot manage this on a DIY basis. They need help from someone to explain and to implement and manage this. Where do they go for this? Until fee for service advisers start to promote VPW, most people will remain helpless...
One could easily put 100% of the portfolio into Tangerine's Balanced Income Portfolio (70% bonds, for extremely low volatility). As for managing VPW withdrawals, all one needs it to be able to lookup a percentage into a table and know how to multiply two numbers once a year. I don't know how it can get simpler than this.

For those who can't even manage that, I guess that the solution is to simply buy a 2% indexed life annuity. The current payout rate, for a joint 2% indexed life annuity, at age 65, is a bit over 4% (source).
Last edited by longinvest on 23 May 2017 11:51, edited 2 times in total.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by steves » 23 May 2017 11:10

gaspr wrote:
23 May 2017 10:50
Where do they go for this?
Beats me.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by NormR » 23 May 2017 11:23

kcowan wrote:
23 May 2017 09:47
Over on ER.org, many of the SWR proponents who are retired actually withdraw their amount from the portfolio and put it in a savings account because they don't need it! Makes no sense to me.
LOL!

There is something to be said in favour of simple rules even if they prove to be less than ideal in some scenarios. On the other hand, inflation-adjusting withdrawals might be too complicated for some people and spreadsheets could be mind boggling. Thus the persistence of rules like "spend your interest/dividends only", which works pretty well (with exceptions) on a reasonable portfolio.

However, the more complicated stuff is well suited to pros/numerate savers and can be good fun.

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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by longinvest » 23 May 2017 11:23

Note that insurance companies are able to include a 65-to-70 bridge, for delayed CPP and OAS, into the annuity.

Going back to my example, assuming that the annuity bridge price is identical to our DIY bridge ($115,000), this allows the retiree to buy an indexed $15,400 annuity. The sum of the annuity and CPP+OAS pensions would be $38,400 per year. It's a little less than what is usually delivered by VPW, and liquidity and bequest are lost. But, all worries about mismanagement of the portfolio by a rogue financial advisor are gone. Oh! And there's no need, anymore, for DIY management and multiplying numbers. Money keeps pouring in, monthly, into the bank account like clockwork.

It's not my preferred scenario, but it would be a solution for a spouse who is completely unable to manage money. I wouldn't dump 100% of the portfolio into an annuity, though; only what's necessary to provide a solid sufficient income. I would set the remaining portfolio on autopilot and tell the spouse to go dip into it when needed.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by adrian2 » 23 May 2017 13:50

NormR wrote:
22 May 2017 22:25
I appreciate your passion for the topic!
+1!
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by kcowan » 23 May 2017 15:17

longinvest wrote:
23 May 2017 09:55
During my entire life, my income has been variable. I am sure that this is true of most FWF members, too. Some years, we get higher bonuses than others, for example. In bad periods, like 2008-2009, we're just happy if we get to keep our job, so we don't care if our income is indexed to the CPI or not, or if our bonus is cut. We adapt.
When I went onto variable compensation after working as a process engineer for 3 years, I remember everyone being amazed at how I could handle the uncertainty. I told them I had made friends with my bank manager. He understood and advanced me credit, knowing the nature of the beast.

One of the big lessons early on was that dealing with uncertainty is well-rewarded. Ergo individual stocks rather than other safer vehicles. Not without work but well worth the work. And understanding that I just needed more winners than losers. And learned when to get out of both. Not rocket science. But also the role of "safe" investments in a portfolio to create stability.

Most of these threads deal with the search for certainty. How futile!
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by longinvest » 23 May 2017 20:15

Keith,
kcowan wrote:
23 May 2017 15:17
longinvest wrote:
23 May 2017 09:55
During my entire life, my income has been variable. I am sure that this is true of most FWF members, too. Some years, we get higher bonuses than others, for example. In bad periods, like 2008-2009, we're just happy if we get to keep our job, so we don't care if our income is indexed to the CPI or not, or if our bonus is cut. We adapt.
When I went onto variable compensation after working as a process engineer for 3 years, I remember everyone being amazed at how I could handle the uncertainty. I told them I had made friends with my bank manager. He understood and advanced me credit, knowing the nature of the beast.
To be fair, I didn't mean something as variable as your variable compensation.

My wife and I have a household budget. I just meant that various factors affected the household income almost every year. Things like variability in bonuses (or not getting one). One or the other of us changing job (and salary with it, sometimes up, sometimes down). One or the other being out of a job. etc. We managed to adapt every single time.

What you experienced is way more impressive.
kcowan wrote:
23 May 2017 15:17
One of the big lessons early on was that dealing with uncertainty is well-rewarded. Ergo individual stocks rather than other safer vehicles. Not without work but well worth the work. And understanding that I just needed more winners than losers. And learned when to get out of both. Not rocket science. But also the role of "safe" investments in a portfolio to create stability.
We might not share the exact same approach to investing, but we share this idea of having a stable basis combined with a variable layer. Delayed CPP and OAS (with a bridge) is the basis, and VPW applied on a balanced portfolio is the modestly variable layer, in the approach that I suggest.
kcowan wrote:
23 May 2017 15:17
Most of these threads deal with the search for certainty. How futile!
I agree that the search for total certainty is effectively futile.

But, this doesn't mean that we can't design sensible retirement plans, while keeping them simple. I did not consider the plan discussed in the article linked in the OP as a sensible one, due to its reliance on a broken model (SWR).
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by kcowan » 24 May 2017 09:43

I did not consider the plan discussed in the article linked in the OP as a sensible one, due to its reliance on a broken model (SWR).
Yes I agree that SWR is an obsolete model, but it does act as a useful surrogate for the numerically challenged.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by AltaRed » 24 May 2017 12:14

kcowan wrote:
24 May 2017 09:43
I did not consider the plan discussed in the article linked in the OP as a sensible one, due to its reliance on a broken model (SWR).
Yes I agree that SWR is an obsolete model, but it does act as a useful surrogate for the numerically challenged.
I agree it serves as a starting point for the financially challenged. Most? Majority? of people should have some intuitive common sense that even if they followed that model.... when there was a major reduction in the portfolio due to market events, they would intuitively cut back on their withdrawals. Indeed, based on some limited anecdotal evidence, I get the feeling some interpret 4% SWR as 4% of current portfolio, i.e. starting balance each year.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by kcowan » 24 May 2017 14:41

AltaRed wrote:
24 May 2017 12:14
Indeed, based on some limited anecdotal evidence, I get the feeling some interpret 4% SWR as 4% of current portfolio, i.e. starting balance each year.
The other common fallacy is to just withdraw dividends on the basis that the original portfolio is left intact. Of course, it is easy to be detached given the returns for the last decade.

What I also find humorous is the people that say the 3% is the new holy grail without any analytical backup. I have concluded that most people are numerically illiterate and so just grasp for handy ROTs.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by StuBee » 24 May 2017 15:06

kcowan wrote:
24 May 2017 14:41
The other common fallacy is to just withdraw dividends on the basis that the original portfolio is left intact. Of course, it is easy to be detached given the returns for the last decade.
Perhaps decade could be replaced by 20+ years... I am referring here to my anecdotal lifetime investment experience...

Whether or not it is a fallacy, I cannot say. But, it is working for me. OTOH, my portfolio has sufficient heft so that, at this time, I can sit back spend the income and watch the capital appreciate (which is the basis for the dividend growth...) For me, this is a handy rule of thumb and it allows me to have some room to maneuvre if times get tough.

Dividends are not my only source of funds. I am currently spending down FI that has been set aside for my bridge phase (between two years ago and age 65, I am now 55)
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by kcowan » 24 May 2017 15:40

Yes. I was referring to a general rule. If your financial plan calls for a particular spending pattern, any approach could be right. I am non-discriminant. I will spend bond interest, stock dividends, convertible debenture interest, and even proceeds from stock sales. I consider it all fungible. Twice a year I check asset allocation.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by steves » 24 May 2017 16:01

Lets see..... the rules of compound interest and inflation are known. Ditto income tax (clawbacks, tax credits, indexed brackets....) CPP and OAS rules. Current savings (reg/nonreg/tfsa amts) Max/min deposit factors for RSPs, RRIFS, LIFS.

Plug in future salary and retirement age estimates, current and future living expenses (after tax) and a maximum age horizon and estate target.

You would think some bright spark would have built a program which you could tweak and 'what-if' (or monte carlo). Oh well, I guess not.

Some day maybe.
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by kcowan » 24 May 2017 16:28

Steve
After 15 years of retirement, I would say that the desire for accuracy is a fool's game.

One can only be as good as one's guesses. They are better than nothing and I would encourage anyone 10 years away to get RRIFmetic. At least the guesses will be well-founded!
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Re: The Relationship Between Guaranteed Income And Safe Withdrawal Rates

Post by leoc2 » 24 May 2017 17:47

I too am a big believer and RRIFmetic. That's why I support it with my signature.

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