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  • Optimizing Retirement Income by Integrating Retirement Plans, IRAs, and Home Equity A Framework for Eva luat ing Ret i rement Income Decis ions

    Summary Report , Pract ica l Appl icat ions, and Technica l D iscuss ion

    November 2017

  • Optimizing Retirement Income by Integrating Retirement Plans, IRAs, and Home Equity A Framework for Eva luat ing Ret i rement Income Decis ions

    Summary Report , Pract ica l Appl icat ions, and Technica l D iscuss ion

    AUTHORS Wade Pfau, Ph.D. , CFA Joe Toml inson, FSA, CFP® Steve Vernon, FSA

    SPONSORS Committee on Post- Ret i rement Needs and R isks

    Pens ion Sect ion

    1

    Caveat and Disclaimer

    The opinions expressed and conclusions reached by the authors are their own and do not represent any official position or opinion of the collaborating organizations or their members. The collaborating organizations make no representation or warranty to the accuracy of the information.

    Copyright © 2017, Leland Stanford Junior University. All rights reserved.

  • In this report, the authors present a framework of analyses and methods that financial advisers, financial institutions, plan sponsors, and retirees can use to compare and assess strategies for developing lifetime retirement income. We recommend that financial advisers, plan sponsors, and financial institutions use disciplined analyses to demonstrate they are acting in the best interests of their clients who are approaching and entering retirement.

    We also recommend that stakeholders use rigorous analyses for supporting retirement income decisions instead of using intuition, a gut feeling, or “winging it.” Our analyses project that many middle-income workers will fall short of retirement income goals commonly advocated by financial planners. As a result, retirees will need to make the most effective decisions when deploying their constrained resources. In addition, they may want to consider applying their home equity to supplement their financial resources and Social Security benefits. For many such people, their most important retirement income planning decisions might be when and how to leave the paid workforce, when to claim Social Security benefits, how to manage and reduce living expenses, and whether to deploy home equity.

    The authors recommend a portfolio approach for retirement income strategies that integrates Social Security claiming decisions, investing and deploying retirement savings, and utilizing home equity if necessary. Social Security benefits, pensions, annuities, and tenure payments or lines of credit from reverse mortgages can be considered the “bond” or “guaranteed” part of a retirement income portfolio. If retirees achieve sufficient secure income from these sources, our analyses justify investing remaining savings significantly in equities, which are more volatile but have the potential for growth. We acknowledge there can be behavioral constraints regarding this conclusion.

    For most middle-income retirees, Social Security is the foundation of retirement income, providing anywhere from half to more than three-fourths of total retirement income. Social Security has several desirable features that, in aggregate, aren’t available with any other retirement income solution. As such, optimizing Social Security benefits through delayed claiming is often an important component of a retirement income strategy. Risk-averse retirees should consider drawing from savings in order to optimize Social Security benefits, before purchasing an annuity or investing in bonds. When middle-income retirees optimize Social Security benefits, they might have all the “annuity” income they need, particularly if they reduce their living expenses.

    The authors also identified one straightforward strategy that can be reasonably implemented in virtually any IRA or 401(k) plan without purchasing an annuity. This strategy helps retirees delay Social Security benefits as long as possible, uses the IRS required minimum distribution to determine income from savings, and invests in common target date or balanced funds. Using our metrics, this strategy compares favorably to many other strategies that are more complicated.

    Financial advisers and institutions may need new business models to implement many of the strategies and retirement income solutions outlined in this report. While the analysis in this report focuses on middle- income retirees, the approach to comparing options and the methodology can also be used for higher- income retirees.

    Abstract and Overview

    2

  • Building retirement income portfolios is a complex yet critical topic for most older workers and retirees, and the advisers, plan sponsors, and financial institutions who assist them. Adequately addressing this task involves complex analyses. As a result, this report is long – the text covers more than 80 pages, and the entire report, including graphs and tables, is over 150 pages.

    To address this issue, we structured this report so readers can selectively read according to their interests and capacity for detail, as follows:

    • The “Report Summary” covers the main results and conclusions. We included just enough technical details to help readers understand these results and conclusions.

    • The “Practical Applications” section discusses issues that should interest retirees and their advisers, plan sponsors, and financial institutions.

    • The “Technical Discussion” section goes into detail on the results and conclusion of our analyses, and provides supporting documentation for the first two sections of the report, as described above.

    • The “Figures and Tables” and “Appendices” sections provide additional details on our results, assumptions, and methods.

    We acknowledge that this is not a report that can be read and absorbed quickly in one sitting of an hour or two. Professionals who want to help older workers and retirees make effective decisions about retirement income planning will need to devote many hours to understanding the various issues. This report is one resource that can provide valuable insights and will complement other books and materials that address these critical topics.

    A Guide to Reading This Report

    3

  • Table of Contents

    Section 1: Acknowledgments.........................................................................................

    Summary Report Section 2: Background and Project Scope…………………………………………….... Section 3: Subproject A – Assessing the Impact of Performance for Financial Solutions……………………………………………………………….............................. Section 4: Subproject B – Metrics for Assessing Retirement Income Solutions.......... Section 5: Subproject C – Utilizing Home Equity for Retirement Income……............ Section 6: Additional Observations and Conclusions……….......................................

    Practical Applications Section 7: Implications of Inadequate Retirement Resources..................................... Section 8: Integrating In-Plan and Out-of-Plan Resources........................................... Section 9: How Plan Sponsors Can Use These Analyses............................................... Section 10: How Retirees and Advisers Can Use These Analyses................................. Section 11: How Financial Institutions and Advisers Can Use These Analyses...........

    Technical Discussion Section 12: Subproject A – Assessing the Impact of Performance for Financial Solutions……………………………………………......... Section 13: Subproject B – Metrics for Assessing Retirement Income Solutions ........................................................................................ Section 14: Subproject C – Utilizing Home Equity for Retirement Income……………………………………….................................................

    References....………………………………………...........................................................

    6

    8

    12 18 22 24

    29 32 35 39 46

    49

    58

    67

    70

    71 73 75 78 79 80

    4

    Appendices on Methods and Assumptions Appendix A: Assumptions for Hypothetical Retirees..................................................... Appendix B: Investment Return and Mortality Assumptions ....................................... Appendix C: General Investment and Annuity Product Assumptions........................... Appendix D: Assumptions Regarding Reverse Mortgages ............................................ Appendix E: Withdrawal Percentages from the IRS Required Minimum Distribution.................................................................................................................... Appendix F: Federal Income Tax Rates and Standard Deductions in 2017..................

  • 82 89 96 103 116 129

    133 141

    This report is the product of a research project and is not intended to provide advice to any person, plan sponsor, adviser, or financial institution.

    The results and conclusions are based on the methods and assumptions used for the analyses. There are other methods and assumptions that are reasonable and could produce different results and conclusions. The results are for defined case studies; individual situations can be significantly different than the case studies.

    The analyses consider actuarial, investment, and economic fac