Sustainable Withdrawal Rates

Preparing for life after work. RRSPs, RRIFs, TFSAs, annuities and meeting future financial and psychological needs.
steves
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Re: Sustainable Withdrawal Rates

Post by steves »

My standard two cents worth.... These SWR concepts assume that the investments that are being drawn down exist in a vacuum. Of course, they aren't.

Most retirees have other financial entities to consider.... many/most of them discontinuous. Entitlements which kick in at a future time (bridging), an expected one-time capital gain, loan payments which will cease..... If you consider that the point of the SWR is to maintain a constant, sustainable after tax lifestyle, then the investment withdrawal trajectory wanders all over the map.

Of course, if the nest egg is $10million, these other entities won't effect the SWR. For the rest of us however, the SWR can be subject to wild(ish) fluctuations.
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Re: Sustainable Withdrawal Rates

Post by AltaRed »

Steves, not sure I understand your point. SWR calculations do not have much meaning until one is actually into, about to enter, withdrawal mode, i.e. retirement. At that point, there are few unknowns. CPP is known, OAS is known and even RRIF withdrawals (percentages at least) are known. The primary unknown, other than health issues which can be a curve ball at any moment, is investment return.

I think most of us retirees can make a pretty good crack at what the SWR rate should be, and what it delivers. I do like Ghariton's methodology to characterize SWR depending on real rate of return. I've not seen it expressed that way before but my hunch was that the 'standard' 4% that has been used in the past is too rich, and would have guessed 3% without doing the math.
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Re: Sustainable Withdrawal Rates

Post by Shakespeare »

The primary unknown,
is your personal life expectancy. (Or your spouse's.)
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Re: Sustainable Withdrawal Rates

Post by AltaRed »

Shakespeare wrote:
The primary unknown,
is your personal life expectancy. (Or your spouse's.)
In reality yes, but for the purposes of making judgements in SWR calculations, I don't agree. At least most of us plan on living 25 years once we retire (at 65). The SWR is obviously less for those retiring before 65.
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Re: Sustainable Withdrawal Rates

Post by ghariton »

Shakespeare wrote:
The primary unknown,
is your personal life expectancy. (Or your spouse's.)
Yes. But I was trying to isolate just the impact of changes in returns. So I kept the horizon constant at 30 years, the traditional assumption in estimating SWR. But in fact average life expectancy is increasing, albeit slowly. That puts additional downward pressure on SWR.

George
Last edited by ghariton on 30 May 2012 23:46, edited 1 time in total.
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Re: Sustainable Withdrawal Rates

Post by Dejavu »

ghariton wrote:
Shakespeare wrote:
The primary unknown,
is your personal life expectancy. (Or your spouse's.)
Yes. But I was trying to isolate just the impact of changes in returns. So I kept the horizon constant at 30 years, the traditional assumption in estimating SWR. But in fact average life expectancy is increasing, albeit slowly. That puts additional downward pressure on SWR.

George
Yesterday on a CBC Radio interview,I believe I heard the author of "Boom Bust, Echo" say, longevivty is increasing at 2 yrs per decade.
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Re: Sustainable Withdrawal Rates

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ghariton wrote:Of course, decreasing real rates of return will lead to lower SWR. (I say real, because SWR is usually expressed in after-inflation terms. Thus, a 4% SWR is to be interpreted as withdrawing 4% the first year and indexing the amount to inflation thereafter.)

As a quick illustration of the impact of changing real return on the SWF, consider a thirty-year annuity certain, in real terms, with r the real rate of return throughout the thirty years. If r equals zero, pretty close to the situation today, the SWF is obviously 3.33%. (I note that such an annuity completely eliminates market risk, although credit risk remains.)

If r increases to 0.5%, SWR increases to 3.66%

If r increases to 1%, SWR increases to 3.87%

If r increases to 2%, SWR increases to 4.46%

If r increases to 3%, SWR increases to 5.10%

Many of the studies of SWR were performed at a time when real returns were 2% or so. Now, real returns are closer to 0.5%. My simple analogy suggests a drop in SWR of 1.0%, to somewhere around 3%

Such numbers are approximations of course, and don't take into account transaction costs, which would lower the SWF somewhat.

George
Thanks for responding, I have always enjoyed your commonsense approach to most matters. I can live with 3% real returns, my limited reading and grasp of the literature I have come across, suggests that real returns in the first 10 years after retirement are very important, thereafter not so much.

Annuitizing early on (@ age 65yrs) will have to provide a floor income together with a small CPP, a small annuity from my birth country and the bonds that are in my CPP (I'm getting slaughtered by tax within the CPP = approx 45%) and again annuitizing at age 70yrs. At the moment the floor income, with a cash buffer and a flexible approach to the rest makes sense to me.

A few recent articles suggest that once a floor income has been established, real return can keep pace with inflation by keeping the EQ:FI ratio high at 70:30 or even higher. This seems to run contrary to prevailing advice. I remember reading an article a few years ago that came to the conclusion (after backtesting) that inflation beyond 6% had a detrimental effect on equity returns which on a commonsense level seems to make sense. There comes a point beyond which inflation can no longer be passed onto the consumer with impunity.

Edited to improve clarity.
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Re: Sustainable Withdrawal Rates

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vince2 wrote: Annuitizing early on (@ age 65yrs) will have to provide a floor income together with a small CPP, a small annuity from my birth country and the bonds that are in my CPP (I'm getting slaughtered by tax within the CPP = approx 45%) and again annuitizing at age 70yrs. At the moment the floor income, with a cash buffer and a flexible approach to the rest makes sense to me.
Makes sense to me too. I will likely adopt a similar approach, although I will be annuitizing later than you, as I am still working at 66.
I remember reading an article a few years ago that came to the conclusion (after backtesting) that inflation beyond 6% had a detrimental effect on equity returns which on a commonsense level seems to make sense. There comes a point beyond which inflation can no longer be passed onto the consumer with impunity.
I can't point to a specific article, but my impression from a whole bunch of articles read at different times and which have left a sediment in memory :wink: is that, in times of high inflation, equities suffer at first, but then catch up later. I guess that it takes time for things to settle down, and for price increases to work their way through to the end product. Unfortunately, we are talking in terms of a decade or more.

In the short run, high inflation can devastate equities, it seems to me. That's why a fixed income core seems so important (as long as the fixed income can somehow adjust to inflation, either through rolling over or through inflation indexing).

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Re: Sustainable Withdrawal Rates

Post by steves »

AltaRed wrote:Steves, not sure I understand your point. SWR calculations do not have much meaning until one is actually into, about to enter, withdrawal mode, i.e. retirement. At that point, there are few unknowns. CPP is known, OAS is known and even RRIF withdrawals (percentages at least) are known. The primary unknown, other than health issues which can be a curve ball at any moment, is investment return.

I think most of us retirees can make a pretty good crack at what the SWR rate should be, and what it delivers. I do like Ghariton's methodology to characterize SWR depending on real rate of return. I've not seen it expressed that way before but my hunch was that the 'standard' 4% that has been used in the past is too rich, and would have guessed 3% without doing the math.
I understand your point. I guess that the retirement planning process is too important an issue to relegate it to a simple rule of thumb. Granted, if you are a retiree with all your entitlements started, and nothing but a nest egg to worry about, a single SWR might make sense. (the SWR for a 65 yearold won't be the same as an SWR for a 94 yearold however)

An individual who is retired, but whose entitlements won't be kicking in for several years, or who is planning to downsize their home in 10 years or sell the family cottage should not be using an SWR approach IMHO.
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Re: Sustainable Withdrawal Rates

Post by Flights of Fancy »

The fastest-growing age group in the country is people ages 60-64 (says the Census data released two days ago). Did anyone check what the second-fastest group is? People over 100. :thumbsup:
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Re: Sustainable Withdrawal Rates

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Flights of Fancy wrote:Did anyone check what the second-fastest group is? People over 100. :thumbsup:
This sounds like a subtle promotion for annuities! :rofl:
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Re: Sustainable Withdrawal Rates

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Moshe Milevsky has a new book: Learn the art of retirement planning from the masters
Will Your Retirement Plan Work Out?

Here’s the current state of your retirement affairs. In Chapter One you learned how to link your fixed spending rate in dollars together with the fixed interest rate you earn on the invested money to the number of years the money will actually last. A simple tradeoff was quantified. In reality, of course, nothing is fixed - especially the number of years you spend in retirement. That’s why in Chapter Two you learned about the randomness of human life and how that can be quantified. With a knowledge of longevity risk in hand, in Chapter Three you learned about the value of a pension annuity, which should - I argued - serve as the foundation of any retirement income plan. In Chapter Four you had a chance to ponder your patience and prioritize whether you want a constant spending rate for the rest of your life or are willing to trade off and accept some longevity risk. Chapter Five discussed the stock market and how to “think” about your asset allocation as a function of age and time. Then, Chapter Six discussed the value of a death benefit and how much is it worth today? Finally, in this definitive chapter, we bring it all together and ask: Assuming you have set a plan in motion - taking all the above uncertainties into account - what is the probability your retirement plan is sustainable?
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Re: Sustainable Withdrawal Rates

Post by steves »

Interesting tidbit from his 'how long will your savings last?' table. A $100K nest egg will last exactly 2.0 years when drawn down at $50K per year. Who knew?
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Re: Sustainable Withdrawal Rates

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steves wrote:Who knew?
Those who've heard of the concept of triviality.
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Re: Sustainable Withdrawal Rates

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steves wrote:Interesting tidbit from his 'how long will your savings last?' table. A $100K nest egg will last exactly 2.0 years when drawn down at $50K per year. Who knew?
I didn't. Taking interest into account, I fully expected the nest egg to last slightly more than two years. (But then I'm not a famous professor of finance.)

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Re: Sustainable Withdrawal Rates

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ghariton wrote:Taking interest into account, I fully expected the nest egg to last slightly more than two years.
At 1.5% that's $1,500 per year. That's only slightly non-trivial ;)
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Re: Sustainable Withdrawal Rates

Post by steves »

I am certain I am missing something, but wouldn't the solution to this "how long" question be part of a question at the end of chapter three of a grade 10 textbook called "Introduction to Spreadsheet Programming". Just sayin.
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Re: Sustainable Withdrawal Rates

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“Can We Predict the Sustainable Withdrawal Rate for New Retirees?” by Wade D. Pfau, Journal of Financial Planning, August 2011. This second paper follows the theme of the first, bringing into focus the importance of incorporating contemporaneous market metrics, concluding (persuasively) that “market valuations and yield measures at retirement may provide a tool to help predict how much retirees can sustainably withdraw from their portfolio.” Based on this conclusion Pfau warns that the estimated “MWR for the 2000 retiree is 2.7 percent, but further declines continue until 2008 when the estimated MWR reaches 1.5 percent. For 2010 retirees it rises back to only 1.8 percent.”
http://www.fpanet.org/journal/CurrentIs ... fulin2011/

OH OH, I'm starting at 2 % with a max of 3 % at least till I'm 65 and old enough to buy an annuity. Trying to keep the portfolio growing or at least breaking even.
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Re: Sustainable Withdrawal Rates

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Re: Sustainable Withdrawal Rates

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Logic dictates that retirement income solutions should leverage the best features of both investments and insurance. Given the many competing goals and the complex nature of
the risks, the timing of the “invest or annuitize” decision is important to the overall success of any retiree’s financial plan. The use of annuitization hurdles helps frame the problem in simple terms.
http://www.schulmerichandassoc.com/Mode ... lation.pdf

I found this interesting.
Systematic withdrawals take place as long as wealth stays above this cost, which provides retirees with the benefits of maintaining control over their assets for as long as possible; plus, there is a quantifiable benefit in delaying the decision to annuitize. But should wealth fall too much, annuitization triggers to lock in the lifestyle floor.
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Re: Sustainable Withdrawal Rates

Post by Shakespeare »

I found this interesting.
Funnily enough, it's confirmation of the strategy I decided on some years back. I think Georges arrived at a similar conclusion.

It means that the base value for annuity purchase should be kept in bonds, preferably RRBs. The remaining part of the portfolio can be placed in equities.
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Re: Sustainable Withdrawal Rates

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This article on "How Spending Declines With Age" provides some interesting food for thought. The article cites a number of studies which show that wealth declines with age until about age 70, and then wealth starts increasing again after 70.

"This is happening because older retirees save more than younger retirees. ...It appears the primary reason for saving more is that the very elderly have fewer opportunities to spend. ....while spending per capita on health rises modestly with age, spending on transportation, travel, clothing and durable goods drops dramatically."

The article concludes that "there is a strong argument to be made that retirement income derived from RRSPs does not have to increase to cover inflation. Hence, there is little or no reason to think about buying an indexed annuity with one’s RRSP balance."
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Re: Sustainable Withdrawal Rates

Post by Shakespeare »

Hence, there is little or no reason to think about buying an indexed annuity with one’s RRSP balance."
Yes, that also seems a reasonable conclusion. Also, CPP/OAS are indexed so a blend with an unindexed annuity will be partly indexed.
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Re: Sustainable Withdrawal Rates

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Arby wrote:This article on "How Spending Declines With Age" provides some interesting food for thought. The article cites a number of studies which show that wealth declines with age until about age 70, and then wealth starts increasing again after 70.
The first study cited is German, from 1992. It does show savings rate increasing in old age. However, I'm not sure how applicable it is to Canada twenty years later. Anecdotal evidence suggests that the average German is tighter with his money than the stereotypical Scot, neither of them representative of the average Canadian. As well, a retiree twenty years ago would still have been conditioned by the Great Depression to save for a very rainy day. And the fear of hyperinflation still looms over the German imagination.

The second study cited is a current U.S. study, which is good. Unfortunately, the study shows declines in spending as people get older, and is silent on what happens to the savings rate. It may be that spending goes down with age because people save more. But it is also possible, and IMHO much more likely in the U.S., that spending goes down because previous generations saved less and so have less money to spend. (I'll google the study later just to check. In passing, I find it deplorable that the author gives neither the titles nor the authors of the studies that he relies on.)

The third study is a 1997 Statistics Canada survey. It apparently shows that 85-year-old Canadians (in 1997) saved or gave away as gifts 18.6% of net income. And that raises an interesting question: When calculating spending needs in retirement, does one include planned gifts? (I do, and I have taken on some significant commitments.) Again, this evidence is 15 years old and very limited.

All of this isn't to say that Mr. Vettese is wrong. He may well be right. But his "evidence" is embarrassingly weak.

FWIW, I agree that, as many on this forum have said, the main financial burden in old age is likely to be extended health care. That includes home care, extra nursing in hospitals,. and so on. But I think that many other services, currently covered by government health care insurance, may no longer be so in ten or fifteen years (or even in five years in Ontario). Combine that with the availability of new but increasingly expensive treatments, which are unlikely to be paid for by government, and the health care burden in old age may well become huge.

Rather than extra savings, the rational solution is long term extended health care insurance -- insurance with no cap, or a very high one, and preferably with benefits linked to inflation. Unfortunately that market is very under-developed currently. As far as I can see, precautionary savings, beyond what needs are expected, are the only way to go.

YMMV

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Re: Sustainable Withdrawal Rates

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ghariton wrote:Rather than extra savings, the rational solution is long term extended health care insurance
What's wrong with dying? I still think we need assisted suicide in this country. At least I know I don't have to save for a retirement home.

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