Thirst for Advice Lasts Beyond Retirement

Michael Falcon, managing director and head of retirement for J.P. Morgan Asset Management, tells PLANADVISER that the long-familiar 4% withdrawal strategy—which, as the name suggests, urges retirees to spend no more than 4% of their assets per year to minimize longevity risk—simply doesn’t cut it in today’s volatile and complex economic reality.

“A rule of thumb is fine during the accumulation stage, when you’re aiming for something way in the distance,” Falcon says. “But as you get closer, and certainly once you’re there in retirement, you need to know how to actually make spending decisions. Sticking to the 4% rule, or the required minimum distributions, which is another way that people do this, those methods are really easy, but they ignore all the important things.”

Falcon says important considerations that should factor into spending plans include such questions as, how healthy is the retiree? What is the housing and home equity situation like? What’s the health of a spouse or other dependents? And on the other side of the equation—what do these considerations mean for portfolio asset allocations and market exposures?

“It’s not so rare today to see retirees or near-retirees who have to take care of elderly parents,” he says. “All of these are dynamics to consider in planning retirement income, and of course you should consider the things that are going on in the markets. How has performance been? What are interest rates like? What are annuity rates like? Do you have other sources of income? What have you done about claiming or deferring Social Security?”

Interestingly, Falcon points out the risk of adhering to the 4% withdrawal is not the familiar worry that a retiree will run out of money too soon after leaving the work force. Instead, retirees often risk being too conservative in their spending—leaving large amounts of assets until they’re too sick or old to actually enjoy the money. Of course, some retirees may wish to leave as much as possible to younger generations, but in any case, Falcon says a more personalized withdrawal strategy is preferable to an inflexible, percentage-based rule that ignores such factors.

“I can’t tell you, even as your long-term financial adviser, how you are going to weigh the risk of having less in the future versus the pleasure of having more now,” Falcon explains. “How you experience that is very different from how I might view it. And your health and the health of a spouse or a parent or child, that’s a very personalized component that varies widely across retiree populations.”

One trend in aggregate J.P. Morgan spending and investing data, Falcon says, is health care costs seem to be the one expense that reliably grows in retirement—a fact that can challenge retirees with lackluster health benefits and those relying on federal programs to subsidize medical costs. Interestingly, the increasing health care costs don’t necessarily translate to greater overall spending in retirement for most retirees, Falcon says, as nearly all other expenses fall through time, compensating for the expanding health expense burden.

Falcon says from J.P. Morgan’s perspective, health costs are to be considered like any other recurring expense in retirement, so long as retirees and their advisers are aware the expense will grow rather than shrink through time. The biggest consideration, he says, is making sure retirees will be able to meet expenses as health costs continue to surge. 

“If you look at a typical retirement income model, you’re going to pick some confidence level and run that against a Monte Carlo simulation—so I want to be 90% sure that I’m not going to run out of money before I’m 95, and you set that trajectory,” he explains. “We’re seeing that, by definition, 90% of your outcomes are going to be favorable to that, and you’re almost guaranteed to end up with more money than you expected.”

That’s great to protect against bad returns and poor market conditions later on, Falcon says. But what about the cases where a retiree ends up with more money than he expected or wanted or needed? Is that a successful outcome?

“We’re asking, would that money have been more useful to you in your early 70s rather than in your late 80s?” Falcon says. “That’s a hard thing for people to get comfortable with, because running out of money is a very real and serious fear, and not inappropriately. But how do you balance that fear against the fact that, if I had resources now, I could do more things?”

Researchers at J.P. Morgan have come up with a phrase to summarize considerations of this nature, “calculating lifetime utility.” The term lifetime utility comes from a research paper published recently by the firm, called “Breaking the 4% Rule” (see “Rethinking the 4% Withdrawal Rule”).

In the paper, researchers argue that retirees—and the service providers supporting them—should take a more dynamic approach to managing retirement account withdrawals. The study finds more rigid, percentage-based rules can expose retirees both to an increased chance of outliving their retirement assets or leaving too much wealth untapped, mainly because these strategies ignore the specifics of a retiree’s financial situation.

“Health goes hand in hand with utility,” Falcon says. “We’ve seen that people tend to want to spend more when they’re healthy, in the earlier years of retirement. Then their spending naturally goes down over time. This fact was one of the driving motivations to start to do the research and think about this space more deeply.”

Falcon is quick to explain that the dynamic withdrawal strategy his firm is recommending—and working diligently to commoditize—does not just recommend retirees live it up in their earlier years.

“We’re talking about doing things for children or grandchildren that you get to see and participate in—enjoy, if you will. So that’s the whole idea of utility. That’s the big impetus about this,” Falcon says. 

For retirees, the application of a dynamic withdrawal strategy would require an ongoing relationship with a financial adviser. Falcon says the pair would have to make regular updates to asset allocations and portfolio strategies while also communicating regularly about what retirees hope to accomplish in their golden years and how their personal life is unfolding.

As providers grow more sensitive to demand for retirement income strategies—both inside and outside qualified retirement plans—Falcon says he expects the Department of Labor will eventually throw its hat into the ring as well.

“The pick up and adoption of those income products that are in-plan is very, very low, in the low percentages,” Falcon says. “The reason, we think, is that it’s hard for sponsors to get people out of the target-date and the default options without exposing themselves to fiduciary risk because there is no safe harbor—yet—relative to plan sponsors directing money into an income product. My guess is that the Department of Labor will look at it and offer guidance, much in the way the [Pension Protection Act] established safe harbors for the [qualified default investment alternative].”