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Kindle Notes & Highlights
by
Wade Pfau
Read between
February 16 - March 19, 2022
We will see many examples that focus on building a better long-term plan. These include delaying Social Security benefits, purchasing annuities with lifetime income protections, building a diversified portfolio offering long-term prospects for growth, choosing lifetime income options for defined-benefit pensions, identifying reserve assets, strategically paying more taxes to enjoy substantial future tax reductions, making home renovations and living arrangements with the idea of aging in place, planning for the risk of cognitive decline that will make it harder to manage your finances with
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We start our careers with a huge amount of human capital. This is the value of our future lifetime earnings from work. Over the course of our working years, our human capital is converted into income to cover both our current expenses and to provide a source of savings to fund future goals.
Wealth management has traditionally focused on accumulating assets without applying further thought to the shifts that occur after retirement.
A mountain-climbing analogy is useful for clarifying the distinction between accumulation (the working years) and distribution (retirement). Ultimately, the goal of climbing a mountain is not just to make it to the top; it is also necessary to get back down safely. The skillset required to get down a mountain is not the same as that needed to reach the summit. In fact, an experienced mountain climber knows that it is more treacherous and dangerous to climb down a mountain. On the way down, climbers must deal with greater fatigue when facing a downslope compared to an upslope. Our bodies are
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The prevalent idea is that there is one objectively superior retirement income approach for everyone, and anyone suggesting otherwise must be guided by a conflict of interest. The reality is that there are competing viable approaches for retirement income. No one approach or retirement income product works best for everyone.
We found that two factors can best capture an individual’s retirement income style: Probability-Based vs Safety-First and Optionality vs Commitment Orientation. The other four factors play a secondary role through their correlations with the primary factors to help further identify retirement income strategies. These secondary factors include a Time-Based vs Perpetuity income floor, Accumulation vs Distribution, Front-Loading vs Back-Loading income, and True vs Technical Liquidity.
Probability-based income sources are dependent on the potential for market growth to continually provide a sustainable retirement income stream.
Safety-First income sources incorporate contractual obligations. The spending provided through these sources is less exposed to market swings. A safety-first approach may include protected sources of income common with defined-benefit pensions, annuities with lifetime income protections, and holding individual government bonds to maturity.
But insurance companies can pool these market and longevity risks across a large base of retirees—much like traditional defined-benefit pensions and Social Security—allowing for retirement spending that is more closely aligned with average, long-term, fixed-income returns and average longevity.
Essential spending needs, at least, should not be subject to market whims.
Safety-first advocates dismiss probability-based ideas about safe withdrawal rates by noting that there is no such constant safe spending from a volatile investment portfolio.
Lifestyle, longevity, legacy, and liquidity are the four Ls of retirement income.
I then describe reasons why the 4 percent rule may be too high for today’s retirees. Reasons include that it does not consider the international experience, that low interest rates and high market valuations create a situation that has not been tested in the historical data, and that retirees may deviate from its assumptions about earning the index market returns, maintaining an aggressive asset allocation, and using a total-return investing strategy.
It is vital to understand that the Social Security claiming decision should be made independently from the decision to leave the labor force.
Retirees need to identify their purpose and passion that will provide a reason to get out of bed each morning.
More importantly, the fundamental nature of risk for retirees is the threat that events take place (unexpectedly long life, poor market returns, spending shocks) that trigger a permanently lowered standard of living for subsequent years.
As noted, retirement risks generally fall into three categories: longevity risk, market risk, and spending shocks.
Higher income and wealth levels and more education each correlate with longer lifespans.
The American Academy of Actuaries and the Society of Actuaries created the Longevity Illustrator [www.longevityillustrator.org] to help users develop personalized estimates for their longevity based on a few questions about age, gender, smoking status, and overall health.
In fact, we can see that the 50th percentile of longevity for a non-smoking couple in excellent health is age 94. This means that 95 is much closer to a life expectancy than to a conservative planning age needed to reasonably reduce the chance of outliving the retirement plan.
Fortunately, this is now practical as the United States began issuing Treasury Inflation-Protected Securities (TIPS) in 1997.
It is important to emphasize that, as a retirement income tool, bonds of any type do not mitigate longevity risk. Creating a bond ladder to fund retirement expenses will eventually lead to the depletion of those assets. Low interest rates will cause this to happen sooner rather than later.
For instance, Vanguard’s study of Advisor’s Alpha identifies the most important factor explaining investor underperformance is a lack of behavioral coaching to help investors stay the course and stick with their plans. They estimate that having the wherewithal to stay the course in times of market stress could add 1.5 percent of additional annualized returns to the portfolios of typical investors. In other words, without behavioral coaching, the typical investor could expect to underperform the markets by 1.5 percent per year due to poor decision-making.
Assets can decrease with the loss of Social Security and pension benefits, taxes can increase as the survivor transitions to filing as single, and household expenses may not decrease by enough to offset these other impacts.
On the asset side, any pension or annuities that pay based on the single life of the deceased will end. As well, while Social Security has survivor benefits, the overall amount of benefits paid to the household will decrease by one-third to one-half. For single-earner households, benefits will drop by about 33 percent as the spousal benefit ends. If both spouses earned Social Security benefits based on their own records and had the same primary insurance amounts, the total benefits drop by 50 percent.
The EBRI Retirement Confidence Survey found that while 79 percent expected to engage in part-time work in retirement, only 29 percent of retirees did work.
To bring greater realism to the discussion of safe withdrawal rates in retirement, he focused his attention on what he later called the “SAFEMAX”—the highest sustainable withdrawal rate for the worst-case retirement scenario in the historical period. With a fixed 50/50 allocation for stocks and bonds, the SAFEMAX was 4.15 percent, and it occurred for a new hypothetical retiree in 1966 who experienced the 1966–1995 market returns. Searching for this “worst-case scenario” puts the focus on spending conservatively.
The 4 percent rule is based on a planning horizon of thirty years. In 1994, Bill Bengen considered thirty years to be a reasonable planning horizon for sixty-five-year-old couples, resulting in a planning age of ninety-five.
Buffer assets must be liquid and must not decline in value along with a general market downturn.
Income annuities are a form of insurance. They insure against outliving assets due to some combination of a long life and poor market returns.
In the same vein, someone who purchased automobile insurance might wish they had gone without if they never had an accident. But this misses the point of insurance. We use insurance to protect against low probability but costly events. In this case, an income annuity provides insurance against outliving assets and insufficient income late in retirement.
Mike Piper’s Open Social Security (https://opensocialsecurity.com/) is a free open-source online calculator.
As well, even if no action is taken, the inflows of new payroll taxes and taxes on benefits will be sufficient to cover more than 75 percent of benefits due. I discuss reform options further near the end of the chapter.
Exhibit 6.1 Social Security Benefit Adjustments by Age Adjustments by Age Claiming Age Full Retirement Age = 66 Full Retirement Age = 67 62 75% 70% 63 80% 75% 64 87% 80% 65 93% 87% 66 100% 93% 67 108% 100% 68 116% 108% 69 124% 116% 70 132% 124%
Information about how and when to sign up, as well as the available coverage and costs, is available at HealthCare.gov.
Using the Medicare Plan Finder Medicare provides the Plan Finder (Medicare.gov/plan-compare) to help participants learn more about the various options in their community for Part D prescription plans, Medicare Advantage plans, and Medicare supplements. The tool is probably the most useful for analyzing prescription drug costs, while it provides the least amount of information for Medicare supplements.
The major questions to answer are your comfort level with the company’s stability, the company’s customer experience and whether your health providers have relationships with the company such that they are willing to handle the billing and claims paperwork.
The most risk-averse action plan for retirement health care is generally to enroll in Original Medicare, choose a comprehensive Medicare supplement plan (Plan G for new enrollees), and choose a highly rated Plan D prescription drug plan with reasonable costs for your expected prescriptions.
Lifetime long-term care expenses for retirees are uncertain. About half of retirees may be able to make it through retirement without facing even $1 of long-term care expenses. But at the extreme, long-term care costs can exceed $1 million.
The default long-term care plan will be to self-fund expenses until assets are depleted and to then transition into Medicaid.
show the DHHS estimates that 51 percent of men and 61 percent of women in this age group will need long-term care at some point, and that the average lengths for care are 2.3 years for men and 3.2 years for women. They also estimated that 41 percent of men and 50 percent of women will require care for one year or longer, while 18 percent of men and 26 percent of women will need care for at least 5 years. Across the population, 56 percent will need care for an average of 2.8 years, with 22 percent of the population requiring care for at least 5 years.
Men Women Combined Percentage who will need care 51% 61% 56% Average number of years 2.3 3.2 2.8 Percentage needing no care 49% 39% 44% Percentage needing 1 year or less 10% 11% 10% Percentage needing 1-2 years 9% 9% 9% Percentage needing 2-5 years 14% 16% 15% Percentage needing 5+ years 18% 26% 22% Source: Department of Health and Human Services, January 2021
Long-term care planning is an especially important consideration for women. Wives tend to be younger than their husbands and tend to also live longer. Women are more likely to experience a period of widowhood. They are more likely to serve as long-term caregivers for the men in their lives, and they are then more likely to be widowed and alone by the time they need their own care.
Professionals can provide guidance about specific home renovations to better support aging in place. Universal design features and other characteristics that can lay a stronger foundation for aging in place include: · Walk-in showers, grab bars, and other bathroom safety features · Single-floor living with no stairs (kitchen, bathing facility, and bedroom are all on one floor), or an elevator allowing access to other floors · Wheelchair accessibility: ramps to the home, wide doors and hallways that can fit a wheelchair, and at least one wheelchair-accessible entrance to
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Therefore, it is a good idea to anticipate a larger tax burden in the future to fund the growing government debt.
Mutual fund owners may find that their tax forms include capital gains even when no shares were sold, because the underlying funds may be buying and selling securities throughout the year.
Single individuals may be eligible to exclude up to $250,000 of long-term capital gains on the sale of a home, and this can be up to $500,000 for couples. A surviving spouse may also receive the full couple’s exclusion for two years following a spouse’s death.
Starting at the top, tax-exempt bonds should always be held in a taxable account. They offer a lower yield because their tax advantages make them more equivalent to taxable bonds on a net-of-tax basis for those paying taxes on bond interest at higher tax rates.
disadvantage of having stocks in tax-deferred accounts is that their long-term capital gains and qualified dividends that would have been taxed at lower rates, end up being taxed as ordinary income. Instead, Roth accounts could be the place to hold less tax-efficient stocks with high growth prospects such as small value, emerging markets, and so forth.
