Income questions

Pat_Fleming

kidmugsy wrote: »

There are various ways you could approach this that are likely to make better use of your money than the inefficient 4% rule. I like the sound of this:

(1) The paper by Sun and Webb that I've linked to below shows a rational approach, whereby the amount you drawdown is (a) linked to your remaining life expectancy (assuming average health), (b) the success or otherwise of your investing policy, and (c) the assumption that you'd probably like to have a higher income early in retirement than at the end. The authors report that under assumptions that they think reasonable this is far more efficient than the 4% rule nonsense. It's also easy to see how you might adapt it for your desire to keep some capital back (presumably for bequests?).

(2) Here's what Sun and Webb recommend. Each year, at most:
(i) Draw all the dividends and interest from your portfolio, but not the capital gains.
(ii) In addition draw a proportion of the capital value of the portfolio. Amusingly, a table of percentages drawn up by the US tax authorities for a rather different purpose tells you how much to take of the capital each year. Thus you'll see that the table in the Appendix reports that at age 65, for example, you should withdraw 3.13% of the capital, with that percentage increasing each year, but of course the actual cash flow perhaps decreasing as you slowly deplete the pot.

(3) Now, you tell us that you'll get a slight "pay rise" when your SRP begins. Fine: if that pay rise were to be (say) £1k p.a. you could supplement the Sun and Webb rules by taking an extra £1k p.a. (inflation-linked if you like) until your SRP begins, and then stop. Adapt the rest of the calculation accordingly.

(4) Look at Sun and Webb's measure of merit - or rather de-merit - called Strategy-Equivalent Wealth (SEW). The way it works is that they compute (mathematical details not shown) an optimal strategy. Suppose a couple starts with, say, $100,000. The optimal strategy gives them benefits in the most efficient possible way. They report that their simple rule of thumb, the one I've described in (2), gives the same benefit for a starting sum of $103,000. (See their figure 3.) Given the radical uncertainty of the future that 3% difference is trifling; in other words, their rule of thumb is awfully good. They also report that for the couple to get the same benefits with the 4% rule they'd have had to start with $149,000. That 49% difference is not trifling; the 4% rule is - as many other authors have concluded, by a variety of calculation methods - an awfully expensive way to fund your retirement. Moreover, if it doesn't succeed you end up penniless; if it over-succeeds you end up with heaps of capital when you don't need it i.e. are decrepit or dead.

Judging by what I've read the conclusion that the 4% rule is a poor thing is not tied to the idiosyncrasies of the US tax system - it's intrinsic to the foolish project of trying to take a fixed income from a fluctuating portfolio while ignoring the life expectancy of the pensioner(s).


http://crr.bc.edu/wp-content/uploads/2012/10/IB_12-19-508.pdf



P.S. I predict that this post will be "answered" by further posts that will show the poster has either

(i) Failed to grasp the point, or

(ii) Is outraged at the very idea that something he's never heard of could possibly be better than whatever he does at the moment, or

(ii) Makes an objection that is factually reasonable but betrays a complete absence of a sense of proportion i.e. that worries away at a trivial detail.

Betcha!

Many Thanks for the first part of this reply. I'll take some time studying the material as you suggest.


However, I'm not sure what has prompted the end part. The only thing I can think of is that you have extrapolated this from my statement that "Guyton Klinger makes my head ache" which could possibly explain (i) but leaves (ii) & (iii) making one of us look petty. Has this won your bet?

kidmugsy

Pat_Fleming wrote: »

Many Thanks for the first part of this reply. I'll take some time studying the material as you suggest.

However, I'm not sure what has prompted the end part.

What prompted it is a deep weariness at the folly and pig-headedness of many of the participants in such discussions on this forum - it's nothing to do with you.

People on this forum know many things, and keep repeating them, that are plain wrong. For example: cash always earns less than inflation, equities practically always return more than cash, equities practically always return more than bonds, equities will always protect you from inflation, you must always buy and hold, time in the market is more important than timing the market, and on and on and on. Given that people can't even get history right, and given the utter unknowability of whether history will be a good guide to the future, many people are absurdly overconfident about the future. In fact the future is entirely uncertain, and uncertain in a way that means that attaching probabilities to various outcomes is a vacuous exercise.

One symptom of the folly is the poor silly sods who announce that their equities "should" return 4%, or 6%, or whatever, above inflation. Whereas "should" has nothing to do with it. Nobody knows. Nobody can know.

You have to do something with your money; decisions must be made. But spreadsheeting obsessively will not reduce the uncertainty a jot or tittle. And if the returns on your investments are uncertain, the same may be even more so of your future expenditures.

So by all means let the pensioner amuse himself with a spreadsheet; used sparingly and reflectively it might be time well spent. It might helpfully exclude various options he's been turning over in his mind. But used in combination with a blinkered misunderstanding of the past, and perhaps a ludicrous faith in Monte Carlo simulations, he might both waste his time and do himself a mischief. "Garbage In, Garbage Out" might be trite but it's a pretty good rule of thumb.

kidmugsy

OP, back to your position. Two things you must check:

(i) The official estimate of the size of your future State Retirement Pension. Because you retired early, and because you presumably spent years "contracted out" of SERPS/S2P, it's unlikely that you'll receive the full new-style pension unless you make extra National Insurance Contributions. It's likely that such contributions would be a wonderfully profitable investment. You might like to search for old threads that discuss this matter.

(ii) I suggest you read the rules of your DB pension carefully. When will the early boost cease? Will it be at the old State Pension Age, will it be at your own State Pension Age, or will it be when you start to draw your State Pension? Because if it should happen to be the latter you'd have an opportunity for an absurdly profitable investment. You'd simply defer drawing your State Pension, so extending the period for which you get the boost. Meantime your State Pension would grow by 5.8% for each year of deferral (plus inflation-protection). This would be a wonderful way to eventually get yourself more inflation-protected income. You'd need to alert your DB pension scheme that you intended to defer your State Pension a few months before the relevant age.