Portfolio Income & Withdrawals
Dr K C Gupta, YBB Personal Finance
PORTFOLIO INCOME is important for many investors & retirees now that old defined-benefit (DB) pensions have almost disappeared. Portfolio WITHDRAWALS (decumulations) need to cover only the income-gap that is the difference between basic expenses & income from other streams such as pension, annuities, Social Security, RMDs, etc.
Younger people may use 72T/SEPP (substantially equal periodic payments) for tax-deferred accounts for penalty-free (but taxable) withdrawals before 59.5.
BENGEN (1994) suggested 4% SWR (safe withdrawal rate) with COLA from portfolios with allocations that ranged from 30-70 to 70-30 (stocks-bonds); the withdrawal period was assumed to be 30 years. The withdrawals were set at 4% of initial portfolio values ($300 lump-sum per $1/month withdrawal) & then were inflation-adjusted annually regardless of portfolio performance. Studies based on Monte Carlo simulations (computer-generated random data trials) also lead to similar results. Bengen’s SWR took into account the worst 30 year stretches & the subsequent experience has been that his 4% SWR with COLA may leave large balances at the end of the period (instead of $0 balance).
REVIEW & RESET is an alternate strategy to use 4-5% withdrawal from initial balance that is not adjusted for inflation. But every 5 years, if the portfolio balance is higher than that in the previous review, reset to 4-5% withdrawal of the higher balance; otherwise keep the withdrawal the same for another 5 years. This method conditionally adjusts withdrawals up only when the portfolios can support them & keeps withdrawals level when the portfolio values are down to allow portfolios to recuperate. Use conservative or moderate allocation for portfolios.
WITHDRAWAL STUDIES take into account the regular withdrawals & the SOR (sequence of return) risks. There are two ways to address the SOR risks: 1) appropriate allocations, 2) withdrawal adjustments. The combination of regular withdrawals & sharp market downturns (1987 crash, 2000 dot. com burst, GFC 2008-09, 2020 pandemic, 2022 when both stocks & bonds fell) is a portfolio killer.
The SOR risk exists for fixed or variable dollar-amounts of withdrawals, but not for a defined percentage of withdrawals (but those fluctuate a lot). Note that total return (point to point TR; also called TWRR) isn’t affected by the SOR because of the geometric-averaging involved, so that makes people complacent. In particular, using withdrawal rates that are 2-4% below the historical TRs often fail. The flip side is the DCA (dollar cost averaging) benefit during accumulation.
Many withdrawal studies on SWR assume exhaustion of the portfolio at the end of the design period (typically 30-40 years). Some newer studies find SWRM (SWR-Modified) that leaves the inflation-adjusted initial principal at the end. This eliminates the worry of prematurely running out of money & allows shorter design periods after which another withdrawal program may be started, if needed.
A portfolio that generates income higher than SWR or SWRM is also a solution, but such an income-first approach may lead to ROCs & higher portfolio volatility.
ANNUITIES from insurance companies may anchor parts of the income stream. Types range from basic single premium immediate annuities (SPIAs) to fancy with guaranteed minimum withdrawal benefits (GMWB). Annuities with many bells & whistles are expensive, more profitable for the insurance companies & more lucrative to the selling agents. Many brokers & insurance agents push annuities because these have the highest commissions among the products they sell. Some annuity prospectuses may run 100-200 pages.
Most workplace 403b plans & some 401k plans also offer annuitization options. Qualified longevity annuity contracts (QLACs) are allowed for limited amounts from IRA/ 401k/ 403b; these are deferred-income annuities & the amounts used are exempt from RMDs. Stick with highly rated insurance companies (by A.M. Best, S&P, Moody’s, & Fitch); beware that state insurance guarantee programs are unfunded & only work to find some industry solution for the failed insurer & that takes time. You can also switch annuities with 1035 exchange.
LUMP-SUM vs PENSION decisions may be faced at retirement. Partial lump-sum & pensions may be available, but some have only all-or-none options. An attraction for early retirees for pensions may be the continued availability of retiree group health insurance. These offers should be evaluated on a case-by-case basis. Generally, the pensions offered are better than what you can buy on your own in the commercial annuity market. Companies often use insurance companies or other 3rd parties to provide these annuity benefits, but these no longer have PBGC guarantees. Offering lump-sum buyouts for pensions of existing retirees is now illegal except in special situations.
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