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.

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history of the u.s market Safe Withdrawal Rates
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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 retirement savings 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 retirement research 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.

Retiring Without Adequate Savings

Read the full article here by Joe Tomlinson