Hi Stuart, I'm reading Wade Phau's new book "Retirement Planning Guidebook" and he describes the "funded ratio". I was wondering if this could be added to your program as all of the outputs that woud show up when running your program. He describes the funded ratio as just another way to look at the retiree's situation. Basically at the start of retirement, it puts all the assets on the same basis of contant year $'s (sums the investments and then adds to it the sum of the cash flows of the future soc security and pensions or annities, etc. Each of those future income cash flows are put in today's dollars). Then does the same thing for the expenses and sums everything and puts on the same contant years $'s. Finally, he divides the assets/expenses to get the funded ratio. He begins with a discount factor of 0 and if that gives a funded ratio >1, then you are good to go, he says with a very low risk retirement projection to meet all the future needs. If not and the funded ratio of below 1, then try with a higher discount factor and repeat....and depending on what discount factor relates to how risky the outlook appears....
I figured that your program has all of the inputs for this calculation and so it might be nice to have this funded ratio number show up (with discount factor of 0) as well as the discount factor needed to get a funded ratio of 1
Here's a link to one of Phau's articles about this.....
https://retirementresearcher.com/understanding-funded-ratio/
Thanks,
Bruce
Hi Bruce,
PRC Gold contained this calculation several years ago and it caused me nothing but grief in trying to answer questions about it. I finally concluded that it had been a mistake to implement it in the first place and ultimately removed it in the next model year. I don't recall the details, but I concluded this was a reasonable feature for low-end calculators but not appropriate for a high-fidelity tool like PRC Gold. With that said, though, I'll try to revisit the logic on this as I proceed with PRC2022 development and if I can find any merit in it I'll consider it for a future enhancement. Thanks!
Hi Stuart, I understand completely. Sounds like a non-starter if this caused that much grief previously.
Wade Pfau has been on quite the promotional tour lately! It's pretty common with a new book out. He always says "I don't sell annuities or life insurance." I hear him say in interviews, and find it very disingenuous. He's connected to NY Life and McLean and paid by them, so he's not exactly biased in terms of these insurance products.
Most annuities are a very bad deal. They're complex, expensive, and not insured. I've read through the contracts for clients and had them actually cry when they finally understood what they'd been sold. They're not easy to get out of, at least not without a lot of cost. Don't give your money to someone to invest and prosper from, and especially if you have to beg to get access to it.
Something like a simple single-payment immediate annuity late in life, when there's no long-haul investing returns to leverage, sure that might be ok. But these variable annuities, indexed annuities are bad. Sure, tied to investments - but *your* return is capped at a participant rate, so if the market goes up 30+% as it has in the past few years, you get your 'cap' return of 8% or even less. Guess who keeps the rest of the profit on investments on *your* money? And the hidden fees, always dipped into your pot for, can be egregious and hard to understand.
Invest simply, inexpensively. Find out your natural risk tolerance and combine that with your income needs and time horizon to determine a suitable asset allocation. Implement that with just a few (as few as two, but five at most) low-fee no-load index funds with a nice blend of US and international exposure. It's the formula that's shown to work again and again over time. It's what Warren Buffett and many others say to do. It works, and it's easy to manage.
I agree with Bill completely!
On a related note, a cool metric that would be good to build into PRC would be how much of your non-discretionary expenses are funded by guaranteed income flows such as Social Security, pensions, and annuities.
It really helps to give risk-averse folks the confidence that they're ok to retire and can support their "four walls" despite any economic circumstances in the stock market, at least. If you're relying on an optimistic market performance to sustain your basic lifestyle expenses, that can be a red flag.
Jim and Chris on the Retirement and IRA show podcast (excellent content) refer to this as the minimum dignity floor, so their followers look for this number whenever I'm doing retirement planning for them. I include it in client reports.
Many of the big fund companies are recommending a proportional withdrawal strategy that, once the expected income is determined, withdraw from accounts in proportion to the entire portfolio, instead of using a linear order. The reason is to avoid a tax bump that emerges later in retirement. As Fidelity describes it:
For most people with multiple retirement saving accounts and relatively even retirement income year over year, a better approach might be proportional withdrawals. Once a target amount is determined, an investor would withdraw from every account based on that account’s percentage of their overall savings.
PRC models withdrawals in a linear order. Is a proportional scenario possible in future iterations? I could do the math myself, but it would be interesting to compare this to the linear withdrawal order in the tool.
Peter
@hines202 I've found Michael McClung's Living Off Your Money in Retirement to be excellent. Detailed, heavily backtested, plenty of alternative scenarios.
Peter
@docfiddle I am very happy ???? someone other than me has actually read McClung's book. It's the bases for a lot of my retirement investing/managing decisions.
@docfiddle I'm not sure I see the justification in withdrawing from each account solely based on the account's percentage/proportion to the overall portfolio? It's simple, but could have profound consequences in terms of taxes. Each account is different usually, in terms of asset location (taxable, tax-deferred, never taxable, etc). Factors like that should drive withdrawals, and optimizing taxes and other factors (as Pralana does...), not primarily the size of the account. Unless I'm missing something, I haven't read the book.
@hines202 Follow the link in my message to Fidelity's explanation (Vanguard also suggests it). They're not recommending this for all retirees, just for those who fall into a particular segment -- have relatively consistent essential income from multiple retirement accounts. This is a tax-efficiency strategy, they argue:
To help get a clearer picture of how this could work, let's take a look at a hypothetical example: Joe is 62 and single. He has $200,000 in taxable accounts, $250,000 in traditional 401(k) accounts and IRAs, and $50,000 in a Roth IRA. He receives $25,000 per year in Social Security and has a total after-tax income need of $60,000 per year. Let's assume a 5% annual return.
If Joe takes a traditional approach, withdrawing from one account at a time, starting with taxable, then traditional and finally Roth, his savings will last slightly more than 22 years and he will pay an estimated $69,000 in taxes throughout his retirement.
Note that with the traditional approach, Joe hits an abrupt "tax bump" in year 8 where he pays over $5,000 in taxes for 11 years while paying nothing for the first 7 years and nothing when he starts to withdraw from his Roth account.
Proportional withdrawals
Now let's consider the proportional approach. This strategy spreads out and dramatically reduces the tax impact, thereby extending the life of the portfolio from slightly more than 22 years to slightly more than 23 years. "This approach provides Joe an extra year of retirement income and costs him only $43,000 in taxes over the course of his retirement. That's a reduction of almost 40% in total taxes paid on his income in retirement," explains Lyalko.
By spreading out taxable income more evenly over retirement, you may also be able to potentially reduce the taxes you pay on Social Security benefits and the premiums you pay on Medicare.
Read the article here.
I don't know if it's a good idea, but it'd be interesting to model it if possible.
Peter
