Retirement Drawdown Strategies

Have you thought about how would you draw down on your assets when you retire?

Arguably, the most important financial-planning decision you’ll ever make is deciding when you can retire, i.e.: when to make that crossover from accumulating assets to de-accumulating your assets to pay for your monthly expenses throughout retirement.

As our clients enter the de-cumulation phase, their biggest questions are:

  • Have I built up sufficient Retirement Assets to retire?
  • How should I be budgeting for and spending my Retirement Assets, so that I would have enough for the rest of my life?

Instead of leaving Retirement Drawdown to chance and risk outliving your assets due to lack of planning, we would discuss and plan for a Retirement Drawdown Plan with clients, so that they can adopt a suitable plan to guide their spending during retirement. The benefits of such an exercise are powerful:

  • Clients know with better clarity how much can they spend every month.
  • And they stop losing sleep over wondering if their retirement assets are truly enough.

There are 4 common strategies which are well researched and commonly considered by financial planning professionals, and we discuss the pros and cons of each:

 

1) 4% Strategy (systematic withdrawals)

  • At the core, this strategy is about determining a certain % to withdraw from your Retirement Portfolio
  • 4% has been the typical rate endorsed by research based on numerous modelling based on historical data
  • Research results has shown that this is a relatively fail-safe withdrawal rate to have your money last for 30 years
  • Nuances in actual implementation:
    • The 4% method can come with variations: Fixed-rate OR Inflation-adjusted
    • E.g. of Inflation-adjusted:
      • Assume Retirement Savings of $750,000, withdrawal rate of 4% and inflation at 2%
      • Withdraw $30,000 in the first year, $30,600 in year 2, $31,212 in year 3, etc
  • Strength of this strategy:
    • Ease of implementation
  • Weakness of this strategy:
    • Invites the question: Is 4% indeed fail-safe? Or should I withdraw at a higher or lower rate?
    • Some critics argue the 4% rate is too high. They point to forward-looking Monte Carlo analysis and say things could get worse if future returns can’t live up to historical returns; pointing to the low-interest-rate environment (that will seemingly never come to an end (details here and here).
    • Others argue that 4% is too low. They argue that you can choose 5% or even 6% if you are willing to curtail spending when markets decline. They point to research that says that 4% will leave you with all of your money when you die, 96% of the time. And in many instances, you will die with more than you started with.

 

2) The bucket Strategy (time-based segmentation)

  • This strategy involves thinking of and setting up your Retirement Portfolio into distinct buckets:
    • Bucket 1: Savings/investments with lowest-risk instruments for the near-term expenses;
    • Bucket 2: Somewhat higher-return investments for the mid-term (therefore higher volatility);
    • Bucket 3: The highest growth asset-allocation (therefore highest volatility) for the long-term
  • Monthly income is drawn from Bucket 1, and Bucket 2 will replenish Bucket 1, and Bucket 3 will replenish Bucket 2
  • Nuances in actual implementation:
    • Duration of each bucket. E.g.:
      • Bucket 1: 5 years (i.e.: early stage of Retirement)
      • Bucket 2: next 10 years (i.e.: mid stage of Retirement)
      • Bucket 3: beyond first 15 years (i.e.: late stage of Retirement)
    • Emptying of the buckets: Some plan to empty bucket 1, then move on to bucket 2, then 3. Whereas some plan to not empty one bucket before they start the next one. The long-term bucket flows constantly to the mid-term bucket, which flows constantly to the short-term bucket.
    • Number of buckets: some plan for more than 3 buckets to micro-simulate the many phases of retirement.
  • Strength of this strategy:
    • Many clients find this intuitive and feel more confident to deal with the double whammy of inflation and longevity.
  • Weakness of this strategy:
    • Compared to the 4% Strategy, this will require more oversight and managing for implementation
    • Like the 4% Strategy, uncertainty of investment returns may leave you in a position of spending too little while still running the risk of running out of funds.

 

3) The Flooring Strategy (essential vs. discretionary spending)

  • This strategy involves setting a floor for your retirement expenses
  • Also called an “essential vs. discretionary” approach because you will classify your retirement expenses as essential or discretionary, in other words:
  • Essential, basic needs: food, housing, utilities, other monthly bills and regular activities
  • The “luxuries”, such as travel, additional hobbies, and other unanticipated expenses.
  • Low-risk investments or guaranteed income (such as CPF LIFE, Retirement Plans) are used to fund essential expenses.
  • And a mix of medium- and high-risk investments are selected to fund discretionary expenses.
  • Income is drawn from the respective pools to cover respective expenses.
  • Also, by annuitizing a portion of the portfolio to pay for everyday expenses, you can secure a perpetual fixed income for the necessities, regardless of longevity
  • Nuances in actual implementation:
    • This is a strategy with high level of customisation since this is expense driven and is determined by retirement lifestyle. Here is an example of how it might work for you.
    • Project how much will your essential expenses be. And then work backwards to determine the percentage of Retirement Assets to set aside for a perpetual income stream that pays for food, housing, utilities and other essential monthly bills.
  • Strength of this strategy:
    • Many clients also find this intuitive and helps them budget better
    • Clients can better visualise how does CPF LIFE fit into their Retirement Plan
    • Unlike the prior strategies, you don’t run the risk of running out of money at the end of retirement
  • Weakness of this strategy:
    • What percentage to annuitize? You do run the risk of under spending and living at a reduced lifestyle and running short on liquidity, if you annuitize a too much of your Retirement Assets
    • Are you willing to forfeit some money if you die younger than expected?
    • How will you handle inflation in your “flooring”?
    • Some Can you do better investing your Retirement Assets instead of locking up a portion into an annuity?

 

4) The interest-only strategy or the dividend strategy

  • Some people set out to pursue the straightforward strategy of leaving their Retirement Assets untouched and use only dividends or interest to provide their retirement income.
  • A derivation of this strategy is to buy rental property and live on the rental income.
  • Strength of this strategy:
    • No need to worry about outliving Retirement Assets
    • Meet objective of leaving legacy
  • Weakness of this strategy:
    • Obviously, a massive amount of Retirement Assets must be accumulated. In fact, only a small percentage of people will be able to afford to use this strategy.
    • Fluctuating monthly income, since income is dependent from interest rates, bond coupon rates, dividends rate, rental rate

 

Conclusion

When we talk about Retirement Drawdown Strategies or Retirement Withdrawal Strategies with our clients, we are basically guiding them to think about how best to convert their Retirement Assets into meaningful streams of income to meet their needs, as well as to have their Retirement Assets outlast them.

Since each strategy comes with respective strengths and weaknesses, we have to consider about how to adjust any of the above strategies to meet individual circumstances and concerns.

Finally, whichever Drawdown Strategy is adopted, the risk of under spending in retirement and yet still run of money is always present. For this reason, it is good practice to review your spending plan against your remaining Retirement Assets to adjust for the dynamic nature of your retirement. It is over 30 years after all.

Review which strategy works best for you

Want to start reviewing which Drawdown Strategy should you pursue? Contact us and our adviser can work with you to determine one that fits you.

By |2018-07-05T18:13:41+00:00November 5th, 2017|Retirement|

Leave A Comment