©2013, College for Financial Planning, all rights reserved.

Module 12Retirement Cash Flow Considerations

Chartered Retirement Planning CounselorSM Professional Designation Program

Learning Objectives

12–1: Describe key factors impacting the decision to retire.

12–2: Describe issues impacting retirement needs analysis.

12–3: Analyze a situation to determine how much money will be needed for retirement.

12–4: Identify issues related to determining a safe initial withdrawal rate.

12–5: Evaluate an individual’s situation to determine a basic retirement cash flow portfolio.

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Questions to Get Us Warmed Up

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Learning Objectives

12–1: Describe key factors impacting the decision to retire.

12–2: Describe issues impacting retirement needs analysis.

12–3: Analyze a situation to determine how much money will be needed for retirement.

12–4: Identify issues related to determining a safe initial withdrawal rate.

12–5: Evaluate an individual’s situation to determine a basic retirement cash flow portfolio.

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Factors Impacting the Decision to Retire

The decision to retire involves much

more than monetary issues.

Additional considerations are:

• Social

• Cultural

• Interpersonal/relational

• Life fulfillment

The planner needs to uncover what will make retirement meaningful to the client • May or may not be retirement

in the traditional sense

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Retirement Funding Decisions

• Social Security: Does it make more sense to wait for full retirement age or to start benefits at age 62?o Healtho Lifestyle choiceso Financial differentialo Additional sources

of income• Medicare eligibility• Employer-sponsored

retirement income plans12-612-6

Behavioral Finance

• Anchoring• Confirmation bias• Paralysis by analysis• Mental accounting• Herd mentality• Wealth effect

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Learning Objectives

12–1: Describe key factors impacting the decision to retire.

12–2: Describe issues impacting retirement needs analysis.

12–3: Analyze a situation to determine how much money will be needed for retirement.

12–4: Identify issues related to determining a safe initial withdrawal rate.

12–5: Evaluate an individual’s situation to determine a basic retirement cash flow portfolio.

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Retirement Needs Analysis

Analyze expenses to determine a budget• Consider additional

discretionary expenses, such as travel

• Dream fulfillment costs money

Inflation• At 3.5% inflation, purchasing

power of $100 reduces to about half in 20 years

Health care issues• 65-year-old couple may have

$240,000 unreimbursed medical expenses throughout retirement

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How Much Money Will Be Needed?

After reviewing the underlying issues and areas of concern, two primary questions

mustbe addressed1. How much money will be needed to fund the

retirement budget?2. How much of the retirement nest egg can

safely be withdrawn year-by-year?

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Variability in Retirement Planning Assumptions

• Traditional planning uses straight-line returnso i.e., the same rate

continues throughout the retirement period

• Two significant areas of variabilityo Inflationo Investment return

• Monte Carlo analysis can help gauge variability of investment returns

• Stress testing adds greater reality to the process

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Stress Testing

1. Help the clients create a picture of their goals.

2. Create a base plan using average returns.

3. Stress test their plan for return-sequence risk and unsystematic risks.

4. Repeat steps 2 and 3 as required to create the plan that works for them.

5. Use Monte Carlo to compare relative results (if helpful for that client).

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Learning Objectives

12–1: Describe key factors impacting the decision to retire.

12–2: Describe issues impacting retirement needs analysis.

12–3: Analyze a situation to determine how much money will be needed for retirement.

12–4: Identify issues related to determining a safe initial withdrawal rate.

12–5: Evaluate an individual’s situation to determine a basic retirement cash flow portfolio.

12-13

Safe Initial Withdrawal Rates—Bengen

• Bengen’s original work = 4% initial withdrawal rate (IWR)

• Bengen’s Layer Cake: o Withdrawal scheme (foundation layer)o Asset allocationo Success rateo Rebalancing intervalo Super-investor (normally

capable of better-than-average returns)

o Desire to leave a legacyo Time horizon o Plus portfolio tax status

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Safe Initial Withdrawal Rates—Guyton

Safe IWR defined as

• never requiring a reduction in withdrawals from any previous year.

• allowing for systematic increases to offset inflation.

• maintaining the portfolio for at least 40 years.

Increasing portfolio equity percentages (to a point) has a significantly positive impact on • initial withdrawal rates.

• subsequent withdrawals.

• overall portfolio sustainability.

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Guyton’s Results

At the 99% Confidence Standard, Max IWR is:• 4.5%–4.6% with 50% equities• 5.2%–5.3% with 65% equities• 4.7%–5.6% with 80% equities

At the 95% Confidence Standard, Max IWR is:• 4.8% with 50% equities• 5.5%–5.7% with 65% equities• 5.6%–6.2% with 80% equities

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Income vs. Cash Flow

• Cash flow involves structuring a total return portfolio to fund a retirement budget on a year-by-year basis. o Money for the budget may come from many sources

• Cash flow portfolio o Tries to balance income generationo While maximizing growtho Within reasonable safety parameterso So as to provide the highest levels of

inflation-adjusted funding for as long as needed

• Income portfolios primarily invested in income-producing investments such as bondso Biggest problem is

maintaining purchasing power.

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Retirement Income Pyramid

Roth IRA

Other Real

Estate

Illiquid Investments

IRAs Life Insurance

Home

Social Security

Company Pension Annuity Job Reverse

MortgageRMDs

Rollover IRAs

Building a Cash Flow Portfolio

• Start by allocating about a year’s worth of withdrawals to cash/cash equivalentso Do the same with an amount for

an emergency fund• Initial allocation of 65% equities

o Should be balanced at the lowest end of the risk spectrum, while still providing sufficient growth to meet long-term objectives

• Initial allocation should change over time to reflect the result of getting oldero Eventual allocation may be

close to 100% cash• Building in a safety net will help

deal with increased longevity12-19

Question 1

Going along with the consensus is an area of behavioral finance known as:

a. anchoring.b. herd mentality.c. overconfidence.

d. mental accounting.

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Question 2

An individual who wants to start receiving Social Security at age 62 instead of waiting until full retirement age should answer some questions relative to the decreased benefit. Which of the following are areas that should be considered?

I. Are they in good or poor health?

II. Will an eventual pension benefit make up any income deficit?

III. Do they need the income?

IV. What is the frequency of Social Security benefit payments?

a. I and II onlyb. III and IV onlyc. I, II, and III onlyd. II, III, and IV only

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Question 3

Which sequence of returns would be most advantageous to a new retiree in a 4% inflationary environment with a $70,000 inflation adjusted annual withdrawal rate?

a. -15% the first five years of retirement, +6% the next five years, and +15% the next five years.

b. +15% the first five years of retirement, +6% the next five years, and -15% the next five years.

c. +15% the first five years of retirement, +6% the next five years, and -30% the next five years.

d. -30% the first five years of retirement, +6% the next five years, and -15% the next five years.

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Question 4

In a 3.5% inflation-rate environment, approximately how many years will it take for the purchasing power of $5,000 to be cut in half?

a. 5b. 10c. 15d. 20

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Question 5

Which of the following assets will typically be the last to supply income during retirement?

a. traditional IRAb. qualified retirement planc. taxable brokerage accountd. home

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©2013, College for Financial Planning, all rights reserved.

Module 12End of Slides

Chartered Retirement Planning CounselorSM Professional Designation Program