Will I Run Out of Money?

Today’s post looks at a new guide to sustainable retirement income from Finalytiq.

Finalytiq

We’ve come across Finalytiq several times before.

• They’re run by Abraham Okusanya, who I regard as the leading UK researcher into decumulation (retirement spending).

We’ve previously looked at Abraham,’s work on sequencing risk, and last year I attended the Science of Retirement Conference (SORC) that Abraham organises.

Here are some of the articles from that conference:¹

• Science of Retirement Conference 2018
• Vanguard Dynamic Spending
• Morningstar and the 4% Rule

Will I Run Out of Money

Finalytiq’s new guide is a white label offering, designed to be handed to clients by their IFAs, but Abraham kindly agreed to let me write about it anyway.

• So remember, if you do have an adviser, please ask them for a copy.

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The big financial question in retirement is:

How much money can I take out of my pension every year, without running out of money?

This is not easy to answer, largely because we don’t know when we are going to die.

Safe withdrawal rates

The conclusion from our many posts on drawdown is that a withdrawal rate of 3% to 3.25% should be safe.

• That is based on historical returns and a 100% target success rate.

If you can tolerate a greater risk of failure, you might be able to withdraw more, but:

• Don’t blindly follow the 4% rule.

Bengen’s original 4% rule research used a 60/40 US stock / bond portfolio, ignored fees and taxes, and only looked at a 30-year retirement horizon.

A number of approaches to dynamic withdrawal levels (and hence dynamic spending) are available, but you won’t need them if you stick to a “failsafe” level of 3% pa.

• There are also dynamic asset allocation rules – like a rising equity glidepath – that can help.

Getting down the mountain

Finalytiq use the same analogy that I have employed in my own presentations on decumulation.

• Building up your pension pot (accumulation) is just the first half of the journey.

Getting back down again is the tricky part.

Financial planners are like mountain guides – financial Sherpas if you like.

We believe that everyone benefits from having a retirement Sherpa, a financial planner who applies robust and empirical evidence to retirement income planning.

I wouldn’t go that far – some people can work out what to do on their own – but it’s probably a good idea to know what the best Sherpas are thinking.

Any mountain guide worth their salt will tell you that the skills needed to reach the summit are quite different to those for getting back down.

Most climbers who die on Mount Everest do so above 8000m, usually while descending the upper slope, in the area called the ‘Death Zone.’

Committed vs involved

Retirement is the stage when your pension pot transitions from a chicken into a pig. It becomes a lot more than just a number on a statement. When you’re retired, you have more skin in the game.

They key point here is that without an income (other than the drawdown from your pension), you have a diminished capacity to recover from any investment mistakes.

Other issues include:

• longevity risk (unknown time horizon)
• sequence risk (especially at the start of retirement)
• inflation
• diminishing cognitive abilities

Withdrawal policy statement

Finalytiq sell decumulation modelling software called Timeline, and the brochure includes a sample withdrawal policy statement.

• I think it’s very good, and instructive for a private investor – so let’s take a look at the highlights.

The statement begins with a summary of:

1. the pot size
2. the required income, and
3. the annual fees

The SnapShot section shows:

• likely longevity
• the success rate of the portfolio to that age
• the likely legacy (at age 95 in this case)
• the lifetime income that will be withdrawn

The Withdrawal Strategy section covers:

• the tax treatment of drawdown sources
• the legacy goal
• the inflation and other adjustments to annual withdrawals

The investment strategy shows:

• the asset allocation
• the rebalancing rule, and
• the withdrawal order

There’s also a handy section on the guiding principles behind the retirement investing plan.

Charts

The final section of the report is  a series of charts (projections and illustrations), beginning with the sustainable withdrawal rate.

• This compares the SWR to the target withdrawal income.

The running portfolio balance shows the median (50th percentile) and the “best” and “worst” (each undefined) scenarios.

• The shading covers the 30th to 70th percentiles in the centre.
• The middle band is 10th to 30th and 70th to 90th percentiles.
• The outer band is 1st to 10th and 90th to 100th percentiles.

The income chart follows the same format.

The longevity chart shows the chances of the client surviving to a given age, and the chances of the portfolio lasting that long.

• In this case the client is safe until age 88, but has only an 80% change of not running out of money by age 100.

The green line is a longevity adjusted failure rate.

• Since the client’s chances of surviving to 100 are small, the actual likelihood of failure is also small (never more than a few percent).

Conclusions

The switch from accumulation into decumulation is tricky, and this brochure makes a good fist of introducing the key concepts.

• If you have a financial advisor, you should ask for a copy.

I also like the format of the withdrawal policy statement, and think that private investors (without an advisor) should adopt something similar.

• Until next time.

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1. I realised when writing this post that I have forgotten to publish Abraham’s presentation, so look out for that soon [↩]