Article in Barrons behind Paywall about 4% Rule Might not work
 

Copied here from Barrons, I am a paying subscriber :welcome:

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.

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

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.

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

Good for first time readers.

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.

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

WealthTrack

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'

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?

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

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.

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. .

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

I agree with CPA #1. I never could justify a Roth conversion. But, my IRA assets have always been in bonds. I maintained my stock investments outside the IRA to take advantage of the lower capital gains rate. I had a friend who converted all of his IRA into a Roth so that his children could inherit his money tax free. It is also hassle free as compared to inheriting a traditional IRA.

Remember, that, if you ever have a huge medical bill, like assisted living, a nursing home, or home care, you can use money in your traditional IRA and take a medical tax deduction.

About those inherited IRAs, the tax law changes seem to have tripped up some of that for beneficiaries. I just went through re-visiting beneficiaries on IRAs in relation to the tax law and a trust. Some places limit the contingents that can fit on the IRA (traditional) online form, so you have to have an “on-file” added. I found that a little aggravating. I needed only one more contingent line but it took an extra hoop to jump through to get it.

Boomer

Why a ROTH conversion, of which you are proud of your decision versus a perceived professional, is not at all the question, nor the history . . remember, cpas and tax prep professionals have a current tax minimization today motivation. Tax minimization strategy is what you did, which is not their strength most of the time.. . . for that you need a planning professional, very different animal, one looks forward, the other looks backward. Very well done, and no criticism of your move to ROTH.

But now that the conversion is done, the question is for wealth maximization in conjunction with tax minimization, under what future scenarios for those two constraints or goals, does it make sense to take any money out of a Roth, versus using other sources of wealth. .

to be clear, the question is a future scenario question, one of which you are struggling for the constraints listed above. (which is the difference between finance and accounting) I am a finance professional, who only looks forward, as I can't change history, but I can influence the future towards wealth maximization and tax minimization, which is the point of the question.

looking forward to your thoughtfulness on your future decisions

Back in 2002 I had an anomalous extremely low income tax year and the market was off so I took a leap of faith and converted my entire IRA to a Roth. Glad I did!

Just got an email today from an investment guy (who I have listened to over the years)..................."Given the slump in the market, you should convert some traditional IRA dollars to Roth."

:read:

Only annuity I would consider is a life annuity which can be quoted through Immediate Annuities - Income Annuity Quote Calculator - ImmediateAnnuities.com . There are no commissions for the most part and that is why no one ever hears of them.

The life annuity is easy to understand. You get a quote on how much you will get monthly based upon the invested amount. Just divide the monthly quote into how much you invested and divide by 12 to see how many years it takes just to recover your investment.

To me it still makes no sense to buy even that annuity because they are based on bonds I believe. It just makes too much sense to stay in the stock market.

I would only ever consider it via the highest rated insurance company they offer.

what is the thought process behind that decision? just curious, is it to reduce future RMD in by creating a smaller IRA? but then if the market comes back, you are right back in the same situation. . . if your IRA was cut in half, would the mean to take out more? sounds like a tax minimization strategy of some sort.

just curious as i also look for hidden incentives. . and this one is a head scratcher for me. . so I must be missing something . .

“I yam what I yam”. . .
 

I understand everything we own. A professional might have been able to show a bigger return, but we’re OK with our own decisions and our returns.

My wiring is such that I like taking the responsibility for investment decisions. In fact, I really do think we are all wired in whatever way when it comes to money. I don’t know exactly why I am wired with an interest in investing, etc., but I am glad I am, and Mr. Boomer is happy about it, too.

Giving somebody one percent, annually, taken quarterly, whether the accounts are up or down is not something we are ready to do.

I have been at this for decades — in a sort of comfort zone. Maybe boring, but a comfort zone.

I do have a philosophy of investing. It is simple and categorized and forward-looking — and backward-looking — because I think many investors often suffer from amnesia. And I pay attention. No spreadsheets or formulas involved, just making sure I completely understand what we own — and what those companies do — and how they are doing at doing it, along with general awareness of things I might need to be aware of — like taxes — and have been getting tax advice along the way. I understand cap gains very well and play them carefully.

Mr. Boomer and I have a backup plan if I get to the point where I start investing in Franklin Mint plates or Pez dispensers or Beanie Babies. We have interviewed a few planners and know who we will see if we feel like we need or want to.

The main aggravation I have now is that there is no return on cash in that moat I maintain around the stocks. Our parents could always get returns on CDs. I don’t think we will ever see returns on CDs again. But, even so, I know to never get us into the position of having to sell stocks to pay taxes — thus, the moat will continue to be around.

All advisors can claim big returns right now. Bigger than mine, no doubt. But the old bull has been running for a long time. He must be getting awfully tired — and there sure seem to be a lot of picadors around these days. Whatever happens, I will stay swaddled in our comfort zone with my unsophisticated approach, still making our own decisions, while we can.

Btw, I am now over the idea of looking further into Roth conversions at RMD age. The existing Roth will be there already — and all ready — if we want it for a tax-advantaged expenditure. But I still regret not doing more conversion before RMD age. But that’s just me and my whole picture wiring.

Thanks for the conversation.

Boomer

Thoughts: Market will be back, able to convert more dollars today. & Convert to maximize "lower" tax brackets.

I just quoted myself on a Life Annuity and it would take 44 years to recoup just the money I paid in. Putting me at 101 before I start to eat into the insurance company's assets.

I bought a big chunk of Goldman Sachs stock today. I'll take my chances with that.

Wils, he might not have meant literal dollars. He might have meant that if you want to convert in-kind shares, you can get more shares out at a lesser gain in a down market and back into a Roth if you want to do that. Of course, if the share price then goes lower, the ROI might not happen for a while, especially when factoring in the face value of the committed shares that would be taxed on the way out of the traditional IRA.

At least, I think that’s what it means. I am pretty sure I am right about in-kind transfers so you don’t have to sell the stock. But it is entirely possible that I have no idea what I am talking about.

This is really a question for the OP. I just keep killing time today. (sigh). Besides, I think I must be the only one in this lineup who thinks conversion to Roth before RMD age — and only if the stars align — can be an excellent idea.

OP? In-kind is OK, right?

Boomer

Not cash dollars...............stock dollars, a/k/a current value.

You can transfer stock, depreciated or not, that you hold in a traditional individual retirement arrangement or qualified retirement account into a Roth IRA.

When you convert a qualified account to a Roth IRA, you create taxable income in the conversion year. The income is taxable at your marginal rate. The taxable amount is the current value of the assets transferred, excluding any nondeductible contributions. The IRS has you value the conversion equal to the amount of taxable income you would create had you simply withdrawn the proceeds rather than converting them into a Roth IRA.

Even on my favorite money show, WealthTrack on PBS, Christine Benz, Morningstar’s Director of Personal Finance, mentioned that some annuities are OK. If I am remembering correctly, she said that some annuities have more transparent language of in their contracts than others do. The reason I personally have avoided annuities is because I do not completely understand the various types and would rather just wing it with dividend stocks. But that’s just old buy-and-hold me. I know others who are comfortable with annuities though.

Christine Benz was interviewed on the January 14 episode which can be found on Consuelo Mack’s Wealthtrack YouTube stuff. That episode was a really good one. She also addressed withdrawal rates, along with alluding to the bumpy ride we could be facing until inflation calms down.

Boomer

I'm totally in the camp of enjoying the money we put aside

kids are fine with that (like that would influence me)

Don’t know how old you are. Not my business. But I do not regret having done it in my younger days. Having to get past RMDs and then add it on on top makes it not as much fun to do.

Boomer

And, like I have said before, “Fly first class or your kids will.”

(Geez. I gotta get outa here. I am turning into one of those people who hangs out on the internet all day. Today, I seem to be in need of an intervention. Maybe I should say something political or really mean and get into trouble and get benched. Might be a way out. :) )

Boomer

not sure I get why the price of equity has any relationship to the taxable bracket, etc.

Thinking about this more, the RMD is based upon the closing value of the IRA at the end of year. So if the market is ramped into the end of the year, and then sells off by 30%, you are taking a big hit on the total asset values by the calculation of the RMD, if you have to take a significant percentage out when the market is down 30%. . .

I still don't get the logic unless the increase is at a very low to zero tax rate, based upon social security and the taxable limit of tax free income. . so if the social security is $35K and you are allowed an extra $20K of income prior to taxation, and your RMD is $10K, then yes, taking an additional $10K out with very low taxes makes sense, as long as it then goes back into investments. . .

something like that makes sense, but many RMD put them over the limit. .

anyway, much more fun than corporate finance at 64

When I was doing those conversions to Roth, my aforementioned CPA#1 said I was trying to free my money from its prison long before its sentence was up.

That was exactly it.

Boomer

Left a lot of money on the table but he slept very soundly at night and it's well worth it

2% 3% 4%
 

If you live in The Villages then the odds are I you did pretty well in life. Further you probably saw the very expensive house up North and probably paid cash for the house year so you really do need a lot to live on and your Social Security probably pays most of what you really need so whatever Capital you really have just don't take a cruise every 3 months and you should do fine. If you can't afford to live the way you're living now it's really simple move 2 North Florida buy a $100,000 house and you're still has several hundred thousand Capital to live off of. Or have generous children like I do

I think recommended is a stretch. It WAS a recognized starting point for many folks to be used as a guideline, but updated thinking has changed to around 3%.

If these financial gurus are so smart why would there be a need to modify the 4% rule. Did not the rule accommodate economic changes over the long haul ? Every time there is a hiccup we need a new rule ? Not a very comforting feeling. Never forget fear and greed the world's two biggest motivators.

You are not the only one! I continue to Roth conversions up to my next tax bracket. Since I am still working, my 401k contributions go into my Roth account.

60 is in sight.
"Couldn't" convert in my working years ............... hate those tax brackets.
Finally not working, looking at maybe some conversions & bringing some funds a shore.
:shrug:

Thats the problem right there! It was never intended as a rule...more of a guideline. Over the years it became "a rule" that people viewed as inflexible and unchangeable, so thats why you literally see almost everyone questioning the 4%. Its kind of like the recommendation to walk 10,000 steps or drink 8 glasses of water, general guidelines that people now follow to the step...er...glass.