[CoachKandSportsguy]

Copied here from Barrons, I am a paying subscriber

Economist Wade Pfau has been thinking about retirement since he was in 20s. But not just his own retirement.

Pfau started studying Social Security for his dissertation while getting his Ph.D. at Princeton University in the early 2000s. At the time, Republicans wanted to divert part of the Social Security payroll tax into a 401(k)-style savings plan. Pfau concluded it might supply sufficient retirement income for retirees—but only if markets cooperated.

Today, Pfau is a professor of retirement income at the American College of Financial Services, a private college that trains financial professionals. His most recent book, “Retirement Planning Guidebook,” was published in September.

While many retirees are banking on a continuing rise in stocks to keep their portfolios growing, Pfau worries that markets will plunge and imperil this “overly optimistic” approach. He has embraced oft-criticized insurance products like variable annuities and whole-life insurance that will hold their value even if stocks crash, and he has done consulting work for insurers. He wrote another book, “Reverse Mortgages: How to Use Reverse Mortgages to Secure Your Retirement,” because these loans also can be used as “buffer assets” during market meltdowns.

Pfau, 44 years old, is already playing around with spreadsheets to analyze his own retirement plan. He recently built a model to determine when it is best to convert money from tax-deferred accounts to tax-free Roth accounts, partly because he wanted the answer for his own retirement accounts. We reached Pfau at his home north of Dallas. An edited version of our conversation follows:

Barron’s: The 4% rule says a retiree can safely withdraw that percentage annually from a portfolio, adjusted for inflation. Why don’t you think it will work?

Pfau: It’s not that I don’t think it will work. I think there is something like a 65% to 70% chance that the 4% rule works for today’s retirees rather than being a near certainty.

It’s a debate. Do you just stick with the historical data, or do you make the adjustment to say, ‘Wait a second. With low interest rates, you can’t have as high a bond return as we’ve had historically, and maybe you can’t predict as high a stock return as we’ve had historically either’?

What percent can people safely withdraw?

I think 3% would be a lot more realistic in terms of giving the same chance of success that we usually think about with the 4% rule.

Will people still have enough money to retire with a lower withdrawal rate?

One of the unrealistic assumptions of the 4% rule is that you don’t have any flexibility to adjust your spending over time. Someone could start retirement with a 4% withdrawal rate if they’re willing to cut back on spending somewhat if we do get into a bad market environment.

Anything else?

People need to be smart about their Social Security claiming decisions. It’s OK to spend down investment assets in the short term so you can delay Social Security benefits until age 70, at least for the high earner of a married couple. The boost you get from Social Security benefits by waiting will really reduce the need to take distributions from investments after age 70.

People also might look at ways to use home equity to support retirement spending, whether that’s downsizing the home or considering getting a line of credit through a reverse mortgage.

Isn’t tapping home equity to avoid selling stocks doubling down on a losing bet?

Using a buffer-based strategy such as home equity does buy into the idea that over long periods the stock market will perform at a reasonable level. If there’s no market recovery, it is going to be all the more harder to have any kind of sustainable retirement strategy.

Why are the first years of retirement most dangerous?

It’s the idea of sequence-of-return risk. I’ve estimated that if somebody is planning for a 30-year retirement, the market returns they experience in the first 10 years can explain 80% of the retirement outcome. If you get a market downturn early on, and markets recover later on, that doesn’t help all that much when you’re spending from that portfolio because you have less remaining to benefit from the subsequent market recovery.

What’s the solution?

There are four ways to manage the sequence-of-return risk. One, spend conservatively. Two, spend flexibly. If you can reduce your spending after a market downturn, that can manage sequence-of-return risk because you don’t have to sell as many shares to meet the spending need. A third option is to be strategic about volatility in your portfolio, even using the idea of a rising equity glide path. The fourth option is using buffer assets like cash, a reverse mortgage or whole life policy with cash value.

What is a rising equity glide path?

Start with a lower stock allocation at the beginning of retirement, and then work your way up. Later in retirement, market volatility doesn’t have as much impact on the sustainability of your spending path, and you can adjust by having a higher stock allocation later on.

Why do annuities make sense when interest rates and annuity payouts are low?

Well, because the fact that interest rates are low impacts every strategy. But the impact of low rates on annuities is less than the impact on a bond portfolio.

Most income annuities aren’t inflation-adjusted.

An income annuity is not going to be the source of inflation protection in the retirement strategy. That is going to have to come from the investment side. But the annuity will allow a lower rate of withdrawal from your investment portfolio early on to mitigate sequence risk. Most retirees naturally spend less as they age, and they may not need inflation protection

Medical costs go up as you age.

Right, that’s the one offsetting factor. The medical expenses increase but everything else tends to decrease at a fast enough pace so that overall spending still goes down until very late in life when people may need to pay for more care in home or a nursing home or other type of long-term care needs.

Is long-term care insurance a good idea?

When I look at traditional long-term care insurance, I struggle a bit because usually you use insurance for low-probability, high-cost events. And the problem with long-term care is that it’s a high probability, high-cost event.

There are other hybrid approaches where you can combine long-term care insurance with life insurance or an annuity, and that’s where most of the new business is going, and that has some potential.

How is your own money invested?

At my age level, I’m still primarily in equities.

Do you own annuities?

I’m interested in variable annuities with living benefits, but I’m still too young. Usually, we don’t talk about getting annuities until you’re in your mid-to-late 50s.

Variable annuities have a bad rep. You think it’s undeserved?

For a large part undeserved. They get a bad rep because they have a high fee drag, and I think about retirement not so much about the fee drag but about how much assets do you need to feel comfortable about retiring. Variable annuities mean you believe that markets will outperform but you also don’t want to stake your entire retirement on the market so you want some sort of backstop.

You’ve been a proponent of products sold by insurers such as annuities, and you’ve done consulting work for insurers. How can we be sure your research isn’t conflicted?

Whenever I do some sort of research paper, I outline the methodology completely to give people a full understanding. Nothing is in a black box. The assumptions are all listed, and if people want to try it with different assumptions, they can do so.

If I’m concluding that annuities may be helpful, I try to give the benefit of the doubt in my assumptions to not using the annuities and still find a strong case can be made for the annuities.

Social Security is more generous than annuities. Shouldn’t people max it out before buying an annuity?

Yes. Insurance companies have to live in the real world so when interest rates are low that impacts annuities. Indeed if you are thinking about annuities, step one is at least the high earner in a couple should defer Social Security until 70. And then if you want more annuity protection beyond that, fine. It wouldn’t generally make sense to claim Social Security early and then buy a commercial annuity at the same time.

Does it ever feel odd to be focused on an event that won’t occur for you for a couple of decades?

For the most part, no. It only comes up at times when somebody is saying why is this young person telling me how to do retirement.

For me it’s not so much retirement, as tracking the ability to be financially independent. It’s still relevant for me to think about when I may be able to retire, even if I’m not necessarily ready. I have a personal interest in it.

A personal interest in what?

In playing around with spreadsheets and analyzing my own retirement plan. That’s what primarily drove me to do this tax planning research so that I could specifically build in Roth conversion strategies into my own planning.

Thank you, Wade.

[manaboutown]

Wade Pfau is associated with the reverse mortgage and insurance industries so I find his recommendations nonobjective and indeed suspect. Wade Pfau: Retirement Planning Should Include Reverse Mortgages - Rethinking65

[Stu from NYC]

Would be interested in how much money he makes from the annuity and reverse mortgage industry.

Taking out 4% from your assets each year starting as you enter retirement has been a recommendation for many years.

[dewilson58]

3% discussion started 10 years ago................the young kid is just rewriting old information.

Good for first time readers.

[retiredguy123]

Originally Posted by Stu from NYC

Would be interested in how much money he makes from the annuity and reverse mortgage industry.

Taking out 4% from your assets each year starting as you enter retirement has been a recommendation for many years.

When I studied financial planning years ago, they would send me a financial planning trade magazine every month. The magazine always had several full page ads by insurance companies promising a 9-10 percent upfront commission for selling an annuity. I understood that they often recover most of that money from the 7-10 percent surrender fees from people who decide to cash in the annuity when they need the money after a few years. It takes a little longer to recover the commission from people who keep the annuity, but the annual fees eventually pay for the commission.

[manaboutown]

One or more of the recent guests on Consuelo Mack's Wealthtrack are recommending 3 - 3-1/2%.

WealthTrack

[davem4616]

Money, money, money

moving from that chapter in life where for decades the focus was on accumulating wealth, into that chapter of finally being able to enjoy your wealth is different for everyone...and difficult for some to make the transition

Most of the financial advisors that I've met were pretty much 'doom and gloom' personalities (they want to manage you money, because that's how they support themselves...yes, it's about your retirement, but it's just as much about them)

In my mind, there is no single magical percentage point...it's going to vary each year, based on what my plan is

there's a lot of non-financial considerations that investment advisors seldom, if ever, talk about during their 'free lunches' that individuals need to factor in and consider....

yeah the big push now is...wait until you're 70 to collect social security....that works if your parents died in their 90's, but is questionable if they barely made 70...(and who is behind this anyway?? Someone with my best interests in mind, or is there another motive)

no one wants to out live their money and, as my dad would say, 'end up in the poor house'....so having a plan is important

on the other hand....I'm not about to deny myself in my retirement either....just to conform to some percentage number, based on a mathematical algorithm developed using forecasting tools

My mother's advice to me was, 'have fun, but live within your means'

[Boomer]

I did some Roth conversions before RMD age. I regret not doing more of them.

Now we are at the point where the RMD has to come out before a conversion. I have not done any more conversions since — thought about it — but have not. . .

One reason is that I am not clear on how the 5-year rule works when converting from a traditional IRA to add to a long-standing Roth. From what I can decipher, I think it would work against me if I wanted to get to the newly converted money sooner than 5 years. . .

Does anybody here know if I am right? (And — for some of my fellow posters — for the sake of behaving in a gentlemanly manner, and not looking like grouchy cliches, please do not go into that condescending “look it up” litany that we see around this place all the time.)

For the record. . .

Investopedia gave me 3 applications of the 5 year rule but did not clarify separating newly converted money or stocks from the old money in the same long-existing account. And I will not make what could be an additionally taxable move without knowing, for sure, what I am doing. . .

I am advising myself against any further Roth conversions at this point because it looks like if I would want the newer money back before 5 years, I would get slammed. I think I am right. Damn!

Boomer

[CoachKandSportsguy]

Originally Posted by Boomer

I did some Roth conversions before RMD age. I regret not doing more of them.

Now we are at the point where the RMD has to come out before a conversion. I have not done any more conversions since — thought about it — but have not. . .

One reason is that I am not clear on how the 5-year rule works when converting from a traditional IRA to add to a long-standing Roth. From what I can decipher, I think it would work against me if I wanted to get to the newly converted money sooner than 5 years. . .

Does anybody here know if I am right? (And — for some of my fellow posters — for the sake of behaving in a gentlemanly manner, and not looking like grouchy cliches, please do not go into that condescending “look it up” litany that we see around this place all the time.)

For the record. . .

Investopedia gave me 3 applications of the 5 year rule but did not clarify separating newly converted money or stocks from the old money in the same long-existing account. And I will not make what could be an additionally taxable move without knowing, for sure, what I am doing. . .

I am advising myself against any further Roth conversions at this point because it looks like if I would want the newer money back before 5 years, I would get slammed. I think I am right. Damn!

Boomer

So I can't answer your question at the moment as far as taxes, and its a great question,

but the first question is: when or why will you take money from a roth?

My initial intuitive answer, which is about 1/1000th of a second of deep thought, is that you would live on SS and RMDs, and take money out of Roth ONLY when you need money more than SS and RMD, such as buying a new car, etc, where you would incur significantly higher taxes with additional RMD, and zero incremental from the ROTH. .

If that makes sense, that is the best use case I have thought about to diversify into a ROTH. . .

What's your thoughts on that logic about when to consider a ROTH distribution?

[retiredguy123]

I would feel comfortable using the 4 percent rule, especially if it is supplemented by a pension or Social Security income, and it is adjusted for inflation. I think using the CPI to adjust the payouts for inflation is too conservative because you can usually modify your spending to reduce the inflation impact. For example, if the cost of beef goes up, then you can eat more chicken. My conservative diversified portfolio has an average return of about 6 percent over the past 30 years or so.

[coralway]

Originally Posted by retiredguy123

I would feel comfortable using the 4 percent rule, especially if it is supplemented by a pension or Social Security income, and it is adjusted for inflation. I think using the CPI to adjust the payouts for inflation is too conservative because you can usually modify your spending to reduce the inflation impact. For example, if the cost of beef goes up, then you can eat more chicken. My conservative diversified portfolio has an average return of about 6 percent over the past 30 years or so.

That is veeeeeeeeeery conservative. You left a lot of $$ on the table

[Stu from NYC]

Originally Posted by retiredguy123

I would feel comfortable using the 4 percent rule, especially if it is supplemented by a pension or Social Security income, and it is adjusted for inflation. I think using the CPI to adjust the payouts for inflation is too conservative because you can usually modify your spending to reduce the inflation impact. For example, if the cost of beef goes up, then you can eat more chicken. My conservative diversified portfolio has an average return of about 6 percent over the past 30 years or so.

A return of 6% makes me think you might have been too conservative during this period.

We are all living longer and our money must last longer so a higher return is helpful. However we all have our own risk prefernces.

Notice nobody uses the rule of 100 anymore.

[retiredguy123]

Originally Posted by Stu from NYC

A return of 6% makes me think you might have been too conservative during this period.

We are all living longer and our money must last longer so a higher return is helpful. However we all have our own risk prefernces.

Notice nobody uses the rule of 100 anymore.

30 percent stock, 40 percent bonds, and 30 percent cash. Mostly Vanguard and Fidelity index funds. I was probably too conservative, but now I can't even spend my obscenely high Government pension.

[CoachKandSportsguy]

Originally Posted by retiredguy123

30 percent stock, 40 percent bonds, and 30 percent cash. Mostly Vanguard and Fidelity index funds. I was probably too conservative, but now I can't even spend my obscenely high Government pension.

So that is the ideal place to be. . . very well done. . .

And always remember, paying income taxes is a byproduct of success, the more successful you are, the more taxes you will pay. A tax minimization plan is secondary to a wealth maximization plan. .

[Boomer]

Originally Posted by CoachKandSportsguy

So I can't answer your question at the moment as far as taxes, and its a great question,

but the first question is: when or why will you take money from a roth?

My initial intuitive answer, which is about 1/1000th of a second of deep thought, is that you would live on SS and RMDs, and take money out of Roth ONLY when you need money more than SS and RMD, such as buying a new car, etc, where you would incur significantly higher taxes with additional RMD, and zero incremental from the ROTH. .

If that makes sense, that is the best use case I have thought about to diversify into a ROTH. . .

What's your thoughts on that logic about when to consider a ROTH distribution?

Many years ago I had a CPA I loved. He loved me, too. (Not real love, not hubba-hubba love, just the kind of love between a CPA and a multi-faceted woman who loved to pick his brain and always showed up prepared. But he retired. (sigh) I then found another CPA and I liked him a lot, but he retired on me, too. (Hmmmm, should I be taking these CPA retirements personally?)

And so, now, I have a wet-behind-the-ears CPA who is also a lawyer in the office of our regular lawyer. He’s fine, but I have to teach him a little something once in a while — like how the way I do our QCDs is OK because of where the IRAs are on deposit.

(Of course, I took him well-sourced documentation on the subject to make sure he knew that this retired high school English teacher knew what she was talking about. . .And about that English teacher thing, yes, I know in my posts I bastardize the hellouta punctuation, but I know I am doing that and it’s OK. And I will never correct anybody else, unless it is to share a laugh about a funny typo. We all have them. Although, I do wish some people would double-space longer posts into paragraphs to make them more readable — to make them look less like a manifesto — but I digress.)

Anyway, the new young CPA is coming along nicely and I don’t think he will retire any time soon.

Long story longer — CPA #1 used to tease me a little about doing those Roth conversions before RMD age. He always said, “Why do you want to pay your kids’ taxes?” I would explain that it was not about anybody else’s taxes, and that I had projected taxable income, found some room to take a little more hit, and took the opportunity. (It just seemed like a good idea at the time. And I was right. But as I said earlier, I regret not doing more of those conversions while I could.)

I still project taxable income and buffer our RMDs with QCDs, especially if I think the next year is not going to bring any need for extra income. And when I reach a point where there could be a reason to keep more of the RMDs for ourselves, I will do that. But, for now, I stay well-aware of thresholds and IRMAA.

But to answer your question, “Why now?” — it’s because sometime I might want a little extra ice cream on my cake.

Boomer