The Best Strategy For Retiring Without Adequate Savings
Most research on retirement strategies assumes that people have saved
adequately. But data on household savings shows that many households fall
short, and will need to call on relatives or other sources for support. This
raises questions about the best withdrawal or annuity strategies when savings
are insufficient. It turns out that which strategy works best is different than
for adequately funded retirements.
The motivation for this article came from an Advisor Perspectives
commentary by Don Bennyhoff of Vanguard on estimating the return needed to
achieve client retirement goals, and deciding on an appropriate asset
allocation. In the APViewpoint discussion of the commentary, Larry Swedroe
proposed an example of a financially constrained retirement and made the
argument for a higher equity allocation to best meet retirement goals. In this
article, I’ll use a slight variation of Swedroe’s example and test various
asset allocations, as well as options that utilize annuities.
The example
The particular example I use is for a 65-year-old female with a remaining
life expectancy of 25 years. I assume that she has $500,000 in retirementsavings and will be receiving $30,000 per year from Social Security. I assume
her living expenses are $60,000 per year. The analysis will be pre-tax and all
dollar figures are in 2017 dollars.
I have deliberately designed this example to have a high probability of
failure. I assume her savings are her only source for generating income – she
cannot utilize home equity and she doesn’t have options for generating
additional income or reducing expenses. An inflation-adjusted single-premium
immediate annuity would not provide enough income to fill the $30,000 gap
between Social Security and her living expenses, and we’ll see below that systematic
withdrawal approaches run a high risk of failure. So unlike most retirementresearch where we look for ideal solutions, here we will try to find the
“least-bad” alternative. I’ll assume that retirement shortfalls will need to be
funded by relatives. This will broaden our focus beyond the retiree, since we
need to evaluate financial consequences for the contributing relatives.
Stock allocation
If we assume that future stock returns will exceed bond returns, a solution
might be able to tilt the asset allocation significantly to stocks. This
relates to a required-return approach, as discussed in the Bennyhoff article
mentioned above. But, in addition to average returns, the sequence of returns
is also important, and raising the stock allocation also increases the
volatility of outcomes. Another complicating consideration is that we don’t
know how long the retiree will live. Given this mix of factors, let’s evaluate
outcomes by doing some modeling.
The chart below shows projected outcomes at different stock allocations.
I’ve assumed that the individual in the example withdraws an inflation-adjusted
$30,000 per year to cover living expenses and that such withdrawals continue
until death or the funds run out. I ran 10,000 Monte Carlo projections for each
asset allocation assuming arithmetic-average real-returns for stocks of 5% and
0% for bonds. These are lower than historical averages, reflecting my
subjective assessment of current investment market conditions. (Standard
deviations of annual returns were assumed to be 20% for stocks and 7% for
bonds.) I also applied Monte Carlo analysis to longevity; the average age at
death is 90, but that varies for each of the Monte Carlo runs in accordance
with a mortality table.
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