Wade Pfau and Jeremy Cooper have co-authored an excellent paper called “The Yin and Yang of retirement income philosophies”. They argue that in building a retirement income plan, the opposing strategies can be identified as probability-based and safety first. I think the ideal plan is safety first of essential retirement income and probability-based management of the discretionary retirement income. For many Australians, the safety first layer is facilitated by the Centrelink Age Pension. A lucky few don’t need to think this way because their assets are sufficiently large that retirement income is not the central focus. The real challenge is how to assist the middle group faced with trade-off decisions between level of desired sustainable income and safety.
The paper sets out the usual challenges that retirees face in longevity, market, sequence and inflationary risks. It introduces a good point that this self-annuitisation can be threatened by the inevitable cognitive decline many retirees will face. I have seen this already in a number of cases I have worked on. There are sections that examine: safe withdrawal rates; the role of lifetime annuities; spending priorities of needs/wants/likes and wishes; asset-liability matching; variable spending strategies etc.
I read – with particular interest – the sections on three bucketing or time segmentation strategies – cash, bonds for income and equities for growth. The authors observe that “it provides a behavioural foundation for retirees to maintain their asset allocation and avoid panicking during market downturns, although this might not always be achieved in practice”.
Funded ratio management treats personal retirement planning in a similar manner as a corporate pension fund. While this may be useful in the accumulation period, in a practical sense I find with post retirement clients that it is more useful to focus on the trade-offs involved. The funding status has a danger of putting the emphasis on something driven by the assumptions rather than the trade-off between sustainable income levels and downside risks.
A paper like this is fantastic in setting out in a disciplined, academic manner the major issues facing retirees. I suggest that every financial planner should read it a number of times. I certainly will be! What doesn’t it do? It will not provide a solution as to how to implement an objective drawn retirement strategy for Bruce and Anne sitting in your client meeting room. To do that, one must be able to project levels of sustainable retirement income taking buffers and the Age Pension into account. Those models need to provide private income drawings, anticipated capital usage and the critical rate of return to be achieved. NetActuary has been working on the tools to do the heavy lifting of computations. We are now recasting our internal tools into consumer versions. Those retirement objectives can then be fed into an investment/economic scenario model to provide insights into risk ramifications. Currently, the market has an awkwardly low defensive asset return. You have to analyse all drawdown levels to optimise tax efficiency in a TTR strategy. One has to do the same here in setting the cash/defensive/growth asset allocation levels. At a practical level, we need to deal with existing client portfolios that may (for example) have a real property component. I will show worked examples of actual cases that have been changed to diligently eliminate identification possibilities. Have you seen how many of the examples have a 9th October birth date? Now you know when to send that bottle of wine!
The NetActuary Team