Justin Fitzpatrick: 'Retirees Have a Superpower'
The co-founder of retirement-software provider Income Lab says that older adults can take a few simple steps to ensure that their assets last throughout their lifetimes.
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Our guest on the podcast today is Justin Fitzpatrick. Justin is the co-founder and chief innovation officer at Income Lab, which provides retirement planning software. Before co-founding Income Lab, Justin spent over 15 years in financial services, leading teams in advanced financial planning and portfolio strategy and managing the development of financial technology tools. Prior to his work in financial services, Justin spent seven years in academia. He has taught at the Massachusetts Institute of Technology; Harvard University; Queen Mary, University of London; and the University of California, Los Angeles. Justin is a Chartered Financial Analyst charterholder and a Certified Financial Planner professional.
Sequence Risk and Spending Rules
"Will Higher Inflation Harm Retirees?" by Justin Fitzpatrick, advisorperspectives.com, Feb. 14, 2022.
"How the 4% Rule Undermines Advisors and Clients," by Johnny Poulsen, advisorperspectives.com, Oct. 25, 2021.
"Rethinking Risk in Retirement Planning," by Justin Fitzpatrick, thinkadvisor.com, Oct. 1, 2021.
"Retirement Withdrawal Rates Alone Are Misleading. Here's Why," by Justin Fitzpatrick, financial-planning.com, Jan. 21, 2022.
"Reducing Retirement 'Outrage' Risk With Adjustment-Based Planning and Communication," by Justin Fitzpatrick, kitces.com, May 19, 2021.
"How to Use Economic Context in Retirement Income Decision-Making," by Justin Fitzpatrick, kitces.com, June 1, 2022.
"Exploring the Retirement Consumption Puzzle," by David Blanchett, financialplanningassociation.com, May 2014.
"The Retirement Distribution 'Hatchet': Using Risk-Based Guardrails to Project Sustainable Cash Flows," by Derek Tharp and Justin Fitzpatrick, kitces.com, Nov. 24, 2021.
"The Transformative Value of Retirement Planning as an Ongoing Service," by Justin Fitzpatrick, incomelaboratory.com, 2020.
"The State of Retirement Income: Safe Withdrawal Rates," by Christine Benz, Jeff Ptak, and John Rekenthaler, Morningstar.com.
"A Dynamic Approach to Decumulation Planning," Fintech Impact podcast with Jason Pereira, incomelaboratory.com, July 6, 2022.
Portfolio Construction, Housing, and Annuities
"'Next-Gen' Retirement Planning Tool for Advisors Launched by Income Lab," by Brian Anderson, thewealthadvisor.com, June 29, 2022.
"The Bucket Approach to Retirement Allocation," by Christine Benz, Morningstar.com, Jan. 25, 2021.
Reverse Mortgages: How to Use Reverse Mortgages to Secure Your Retirement, by Wade Pfau
"David Lau: Taking High Commissions Out of Annuities," The Long View podcast, Morningstar.com, June 21, 2022.
Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance and retirement planning for Morningstar.
Jeff Ptak: And I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.
Benz: Our guest on the podcast today is Justin Fitzpatrick. Justin is the co-founder and chief innovation officer at Income Lab, which provides retirement planning software. Before co-founding Income Lab, Justin spent over 15 years in financial services, leading teams in advanced financial planning and portfolio strategy and managing the development of financial technology tools. Prior to his work in financial services, Justin spent seven years in academia. He has taught at the Massachusetts Institute of Technology (MIT); Harvard University; Queen Mary, University of London; and the University of California, Los Angeles. Justin is a Chartered Financial Analyst (CFA) Charterholder and a Certified Financial Planner (CFP) professional.
Justin, welcome to The Long View.
Justin Fitzpatrick: Thanks so much, Christine and Jeff. Nice to talk with you.
Benz: It's great to have you here. We wanted to start by discussing retirement planning in the context of the current moment. Given the current market environment and inflation, there is a lot of doomsaying going on in the retirement planning space. But your message is generally more optimistic. You think most people will probably be OK and not run out of money during their lifetimes. Can you discuss the key principles behind why you're relatively sanguine?
Fitzpatrick: I think this is an area where the messaging, as you say, the doomsaying for retirees is I think a little misleading. Retirees kind of have a superpower. The fact is, they're not running hedge funds. Living through retirement, funding retirement is not like investing for the short term. You're really funding relatively small expenses relative to the overall decades of spending. So, you're funding those slowly over time. And then, the other part of the superpower is the ability to adjust and adjust not just your current spending but maybe make changes to other goals, legacy goals, specific spending goals for the future, and then continue adjusting as you learn over time. Those two things together, the fact that those liabilities are slow and often steady, and the fact that retirees can adjust, actually makes risk in retirement very different from the kinds of things that retirees might hear day to day, short-term news cycle about bear markets and spikes in inflation, and so on. Not that those things are never important, but they have a really different level of importance for retirees than they would for people with a shorter-term horizon.
Ptak: I think we wanted to talk about some of those adaptations, if you will, that current retirees might make in view of the current circumstances. But before we get to that, I wanted to go back a bit to the '60s and '70s, which are kind of held out as the modern Armageddon, if you will, for retirees and a reference point for the current period. That earlier period also featured rising bond yields, falling equity prices, and inflation. What are the similarities and differences with our current environment?
Fitzpatrick: As you say, this is a famous period really from the '90s on, it's where we get this current concept of the 4% rule from. It's the period, starting in about basically the mid-'60s on, where a combination of sideways markets and rising inflation into the '70s really affected how much somebody could have withdrawn from their portfolio. And in the worst case, famously, that was about 4%. But there's really a lot more going on in a typical retirees' situation. Most people aren't funding their spending entirely from portfolio withdrawals. So, many people will have sources of income that are not so tied to returns or not so tied to inflation, so things like Social Security, are of course really important for the vast majority of Americans.
And it's also interesting, the mid-‘60s really didn't seem like a bad time at the time. So, inflation was relatively low going into that period, returns weren't particularly awful coming out of it. It was really the high inflation and bad returns of the ‘70s that would have hurt somebody retiring in the ‘60s. So. that's a lesson of like, it's not necessarily what's happening now, it's what will happen in the future. And predictions are really hard, especially about the future, as Yogi Berra tells us. And so, that's why I definitely think it's not necessarily true that what we're seeing right now is an exact analogy to the to the mid-‘60s. If it is analogous to anything, it might be analogous to the ‘70s. We'll see. And if that's true, though, the patterns we've seen in history have typically provided a cushion for retirees, which is, in those periods of bad returns, or really high inflation, they have often been followed by good returns and lower inflation. So, we now know in retrospect, that actually retirees in the mid-‘70s could have afforded quite a bit of withdrawals from their portfolios. It may not have felt like that at the time. Living through that probably would have been a little unsettling. But because the ‘80s, particularly the mid- to late-‘80s, were so good for returns and inflation, there was light at the end of the tunnel for those folks.
Benz: One big theme for retirement researchers like yourself is sequencing risk, sequence of return risk. If retirees today, new retirees or pre-retirees, perhaps are pondering the prospect of a weak market environment and potentially above-average inflation over their retirement years, which seems realistic to me. What are the key items that they have in their toolkits? You mentioned previously this idea of adjusting withdrawal rates. But as you survey the whole suite of tools that new retirees or pre-retirees might have, what are the things that they should be thinking about?
Fitzpatrick: I think generally people may sleep better at night if they have a diversification of income sources. So, we talk a lot about diversification and investing, but as I mentioned, the income sources, the way people are funding retirement, that's typically not the equivalent of holding a single stock. People have Social Security, which is adjusted for inflation and not affected by market moves. Others might have pensions. You could have income from rental properties; there are people doing part-time work. Even the concept of retirement as an all-or-nothing phase is probably mistaken. So, the more diversification of income sources you have, the less any particular risk when it actually materializes will rob you of sleep.
It's also worth noting—and again, this is maybe a little harder to feel great about—but it's worth noting that once bear markets have arrived, at least historically, risk isn't the same as it was before the bear market. We have throughout history seen that though people may have had lower portfolio values after bear markets, in bear markets, they have—we now know with the benefit of hindsight—actually been able to take larger withdrawals from those portfolios. So, it's not that someone who could have taken 4% when they were riding high, still has to take 4% if they've lost 20% of their portfolio. Working carefully at this, looking at the specific situation, people may be able to take more.
Ptak: Shifting to retirement spending. In the realm of retirement spending, I think you've argued that the idea of retirement failure—such as, the possibility of literally running out of funds before the end of life—is it realistic or helpful? You think a better approach is to discuss what you call the probability of adjustment to alert the retiree that maybe his or her plan will require downward spending adjustments. Can you expand on that idea a bit?
Fitzpatrick: I think most people get this intuitively. So, in your working years—again, sticking to that idea that retirement is on or off, which is probably not the case—but in our normal working years, people are adjusting all the time. If we run into some roadblocks in life, maybe lose a job or something, people adjust. And then, vice versa, if things are going really well, I've never seen someone fail to live a little, spend a little when things are going well. So, that's exactly the kind of adjustment that I'm talking about in retirement. It's not like we reach retirement and suddenly we've lost all ability to react to circumstances as we learn more about the world we're actually traveling through. And the data is very clear. At least to the extent that we can find that data, people are not running out of money in retirement, at least not in droves.
Retirees are the least likely to file for bankruptcy of any age group, although there could be other reasons for that, such as the fact they may have less debt. And it is just intuitive that people change their behavior over time. During the pandemic, people were changing their behavior maybe not because they wanted to, but I know a lot of people spent a lot less on vacations or going out to eat, at least for a while. So, those things happen. And a really dynamic approach to retirement spending planning takes all that into account. So, it's not just, OK, let's make a plan at the beginning of retirement and then we will follow it to the letter as time goes on. A much better way to approach it is to make a provisional plan, include adjustments in that plan, so know when you would make a change, and then keep updating it, keep track of where things are. The great thing about that is, not only will it help people adjust if things are looking a little worse than we'd hoped, but it will also let people know if actually things are better than hoped and they could actually afford to spend a bit more.
Benz: It does seem like a lot of the retirement research that's been done over the past couple of decades, looking specifically at withdrawal rates, has pointed to the value of being able to be flexible, variable. The question in my mind is, in an inflationary environment, could a retiree have the best of intentions to try to reduce spending during a period of down markets, down portfolios but simply have difficulty doing that because actual spending on real necessities have increased?
Fitzpatrick: It's a really good question. I know when I fill up my gas tank it is a shock these days. I think it's worth noting that pretty much all of the work that you're referring to on retirement income and withdrawal rates is done with real returns and real spending in mind. So, that means that course corrections, plans for spending, maybe plans for spending that might change as you age. I know you've discussed in the past on the podcast the retirement smile, the idea that people might spend more earlier in retirement and then slow down later. All of that is net of inflation. In other words, any adjustments, they could in a high-inflation period not actually involve a reduction in spending at all. It may just be not keeping up entirely with inflation. And plans might have other levers as well. Like I mentioned, retirees have this superpower. Well, maybe it's adjusting your goals. Maybe you had a really lofty legacy goal and that could be adjusted. Or there were some kind of aspirational plans for future spending, and that big trip that you planned a few years from now, well, we could potentially, if things are still bad then, we could take a trip closer to home. Maybe it's a changing in the timing of Social Security. So, there are often many levers people can pull if they can't currently absorb a cut in real spending.
Ptak: You may have addressed this previously in your comments, but I think you have been critical of withdrawal rate systems like the 4% guideline, which assume fixed real rates of spending for every year over the retiree's life cycle. Though you might have alluded to it earlier, maybe you could expand a bit on what you think that 4% guideline and fixed spending guidelines like it get wrong?
Fitzpatrick: I'm an academic by training. So, I appreciate the need to simplify when doing research and the guidelines like the 4% guideline or other things you might hear, they're typically based on very simplified scenarios that can help us learn something. But in the real world, things are messy. Different people will have different mixes of cash flows, investments, longevity assumptions, spending plans, like I mentioned—maybe they're planning to spend more now and less later, or maybe even vice versa. And so, that makes applying rules of thumb almost never possible. And so, that's my main critique of rules of thumb like that, is that be careful applying them to a specific situation.
I've done some work talking about how if someone, naively took that 4% guideline and said, “OK, well, that's what I need to do.” But maybe they're delaying Social Security for five years. Well, in fact, they may have to withdraw quite a bit more than that in the interim in order to fund their lifestyle knowing that there will be an increase in these outside cash flows. Portfolio withdrawals have to be this leveling force. I was just in Florida a few months ago with my kids and wife, and there was a pool that had a shallow area and then it suddenly drops down for the bigger kids to go there. Well, that's essentially what people experience early in retirement sometimes. They have to fill in this big deep area with withdrawals and then some other things will come along and make the pool shallower and then they don't have to stress their portfolios as much. Situations like that, which are really common, make applying a withdrawal-rate guideline not very useful.
Benz: I wanted to talk about the role of life stage in influencing someone's retirement spending plan. You referenced David Blanchett's great research looking at spending across the retirement life cycle. But can you talk about how retirees should think about that, should think about potential changes in their own spending, and also factor in the fact that they could be an outlier? How worried should we be about something like that? Well, maybe I'll be the person who just wants to keep on spending and taking expensive trips into my late 80s. How do I know when I'm 65? How should people approach that?
Fitzpatrick: I think that's another good example of a place where we probably shouldn't just make blanket assumptions about every household, every person and how they will behave. David's research is combining a lot of different households and seeing general patterns. I do think that that pattern makes sense to a lot of people. I have one grandmother who is in her late 80s. In her 60s she traveled around, seeing friends, and so on. She's slowed down quite a bit, but she still has a great life, but she does a lot more walking the dog, doing some gardening, watching college basketball, things that don't cost as much. Her expenses have gone down a lot. So, I think that general pattern that David and others have observed is, it's intuitively attractive to people.
The other thing is, you could begin planning that way, assuming that you'll slow down in your spending—typically, we see that people can have 15% or 20% more spending early in retirement if they adopt that spending plan. But it may turn out, if you've been fortunate that when your 70s and 80s come along, you actually still have plenty of resources to keep on spending. So, just because you make a particular plan doesn't mean you can never adjust that plan to react to facts on the ground. And if you have a very clear vision that you don't want to slow down, go ahead and plan that way. There's definitely no requirement that people apply the retirement smile to their own situation. We actually see people often run a couple of plans—one where they do slow down, one where they don't—and just get a feel for how much that would affect their current standard of living.
Ptak: I think you've also asserted in the past that variable methods like the Guyton-Klinger Guardrails method are an improvement, but they still fail to consider retiree spending over the life cycle, how spending is often at its highest early on and then tapers off, something you call the retirement distribution hatchet. Can you walk us through that?
Fitzpatrick: I really like, and we've benefited a lot from, at this point, decades of research on dynamic withdrawals, dynamic retirement income. But one of the issues with just a focus on the withdrawal portion or specifying particular rates of withdrawals, both that you would take and withdrawal rates at which you would adjust, is that those don't scale really well across households, across different situations, and they don't scale really well over time. So, if we have two different households, they could have very different withdrawal rates at roughly the same risk level depending on their plan, depending on timing of Social Security, for example, or other cash flows.
As I mentioned with the pool analogy or what we've referred to as the hatchet—think of the blade of the hatchet is this period early in retirement where many people will be waiting to take Social Security in order to benefit from the increases that come with delaying Social Security, and that means that they have to fund more of their spending from their portfolio. Well, those withdrawal rates are going to be quite a bit higher than rules of thumb, and the change in withdrawals that comes when Social Security comes along, that's a plan to change. So, those planned changes in withdrawals, they're extremely difficult to apply withdrawal-rate guardrails to the plan. That doesn't mean the concept of guardrails is a bad one; I think it's incredibly useful. We just need something that takes a broader context into account for a particular person or household situation. I like to talk about this as total-risk guardrails or holistic guardrails. Basically, we need to look at the entire situation for this person, this retiree, and get a feel for when an adjustment is prudent for them rather than trying to apply, idealize withdrawal rates that we get from research papers, which are really useful, but they're hard to apply to particular situations.
Benz: If someone wants to approach withdrawal rates in a holistic way that incorporates some of these things that you've talked about—market performance, market environment and portfolio performance, their own spending patterns based on their life stage, and their own longevity— where should they begin with that? I know you run a sophisticated software program that incorporates those factors. But can you give us the outlines of how it works?
Fitzpatrick: I think that you're right. It's not an easy question, and so, I do think that some sophisticated tools are really needed to get customized plans for retirement. But a great way to start is really taking an inventory of all of the things that are going to help fund your spending in retirement. Like I said, diversifying income sources can be a great thing for retirees. And then, I like to think of it as doing A/B testing. Should I take Social Security soon? Should I delay? What are the different levers that I have? Let me explore the space of plans that might work for me and then see which ones match, ideally, my desired lifestyle. If there's a mismatch, what kinds of things can I do? And applying things like the retirement smile and so on can lead to better news than people might have thought. That being said, this is not kind of back-of-the-napkin-type math. And so, probably you need to seek out some advisor tools that can go beyond just the surface level.
Ptak: Related to longevity, which is obviously a key factor, how should people go about forecasting their own longevity at the start of retirement?
Fitzpatrick: This is probably one of the things that makes retirement so difficult. I think Bill Sharpe called it something like the hardest, nastiest problem he's ever worked on, and I think partly that's because longevity is an unknowable. Or it's a known unknown. I think, Christine, you called it that. I think that's a great term. And so, this is another one where I think updating your plan over time is crucial. But even at the start, rather than going for gut level—"Maybe I should plan to live to 100 or 105 or something, because I really don't want to run out of money"—I think using some of the tools that are out there to help you zero in on reasonable longevity assumptions is a good one. We happen to use full actuarial models to help people come to plan lengths that are reasonable, but also, over time things change. At the very least, as you age, your plan length will get lower, and it's important to keep that in mind because that can do a lot to cushion the blow of bad periods. But people could get diagnosis. There's a lot that happens where it's really important to be dynamic, not just on the amount that we're withdrawing or the amount we're spending, but even looking at the length of your plan over time has to be updated pretty regularly.
Benz: One other consideration that doesn't seem to get too much play in the academic literature—you referenced it earlier, Justin—is legacy goals. One thing Jeff and I and John Rekenthaler found when we were working on our retirement research last year was that the most efficient withdrawal systems basically encourage retirees to consume what they have without consideration for those legacy goals for leaving money behind for loved ones or charity. So, how should retirees approach their spending plans and their portfolio positioning if they do have legacy goals?
Fitzpatrick: I think legacy goal is, it's really the other side of the scale in retirement planning. So, there's these two main categories of goals. There's what I would think of as standard of living goals and legacy goals. And there's no particular reason that those can't be balanced throughout retirement. So, when we do our analysis of retirement plans, legacy goal is always a part of it, and that legacy goal could be anything, and sometimes it is zero. We have people say, "I want my last check to bounce," but sometimes it's more substantial. I think the other thing that we've seen with a lot of retirees, clients, or the advisors we work with, is that there's an appetite for gifting, and donations, and active charity, or like I said, maybe helping out the next generation while you're alive. So, rather than a terminal legacy goal, people are thinking about, well maybe my situation actually supports more spending than I need or that I thought I needed, rather than lifestyle creep and increasing our baseline spending, maybe we can include some gifting, some donations, more active charity along the way. And so, I think it's not just a matter of legacy goal but really a lifelong approach to what kind of impact do you want to have in the lives of people other than other than yourself.
Ptak: Wanted to shift and talk about another key dimension to retirement success, which is portfolio construction. So far, in 2022, a 60/40 portfolio has encountered significant stress. It would have lost about 16% for the year to date through early July. What other assets belong in retiree portfolios, in your opinion?
Fitzpatrick: In the business that we're in, I try not to have much of an opinion there. A lot of it we work with financial advisors and try to accommodate any kind of philosophy on retirement portfolios. That being said, I think that the research shows that inflation really is one of the biggest risks to retirees. And not fleeting inflation; we won't know whether the current bout of inflation is going to be short-lived or not for a while. But because inflation is such an important consideration—at least for retirees who are not fortunate enough to have lots and lots of inflation-adjusted income streams—stocks and equities really are one of the few places that have historically provided good inflation-adjusted returns. Although I know often it's tempting for people who are invested in stocks to really get nervous at times like these, I think that history shows—and history is the only data we have—that fleeing equities in a bear market typically does a lot more harm than good. I think that there's a good case to be made for ownership of equities by retirees.
Benz: I know you just said that you leave the investment management decisions to your advisor clients, but I'm curious, do you have a take on the bucket approach? And something I've written a lot about, but I'm curious whether you have any impression of whether it's something that advisors should be using or that resonates with clients?
Fitzpatrick: I think it really does. I think that my approach or my thoughts on the bucketing are that we can look at behavioral finance and say, look at these ways that we are irrational creatures and so on. And one of the things that you'll see talked about as irrational is mental accounting. But in fact, I think that we can turn that to our advantage by accepting that mental accounting. People like to think of different buckets of money as doing different things. And so, I think in communicating with clients or on their own, people can look at, OK maybe I'm looking at my bonds or my cash and understanding how much time of spending that could fund is really important.
That being said, I don't know that there's any research that supports just on a purely analytical side, an advantage of keeping large cash holdings. So, if the bucketing approach is used to increase cash up to outsize levels, I think actually it can do a lot of harm. I think possibly it's better as a visualization or as a communication technique rather than something that actually affects the overall asset allocation, for example.
Ptak: Does Income Lab provide an advisor's retired clients with guidance on how to source their distributions each year, which accounts they should be tapping for their cash flow needs, for instance? And if so, are there any overarching principles you could share?
Fitzpatrick: We try to help people produce as realistic of a picture of their entire financial situation as possible and part of that is exactly what you said, estimates on how much money is coming from where. And it can get quite complicated, including issues around sourcing of withdrawals from different account types and so on. So, we do help advisors have visibility into that, seeing which accounts would be sources of withdrawals. Typically, we focus on the tax side there, so helping people understand if they're maybe doing Roth conversions early in retirement before Social Security-claiming. That's a common approach that we'll see people take because they want to reduce the taxability of Social Security in future years. So, we'll help them see where money has to come from in order to do those Roth conversions while at the same time funding their lifestyle. So, I would say, often that means moving money from one pocket to the other, from tax-deferred accounts into Roth accounts early in retirement and then funding actual spending from other accounts. Often those would be taxable accounts.
Benz: You referenced earlier on the value of coming into retirement with multiple sources of income. So, I wanted to ask about annuities and get your take on annuities. Should more retirees be thinking about them to help lift their lifetime income to help reduce the demands that they might be placing on their portfolio?
Fitzpatrick: I think this is a place where there's a lot of interest right now in the research community. I think that there's a lot of innovation on the product side that I'm definitely interested in seeing where that goes. I know academics for a long time have really loved the concept of annuities in their simplest form, which is just pooling of longevity risk. One of my biggest worries about annuities is actually related to inflation, which is definitely a hot topic right now. So, if inflation is elevated for a long time, to my knowledge, there are currently no annuities that are explicitly linked to inflation. And so, the baseline steady income that annuities can provide can really be eroded over time. That's my biggest concern.
That being said, like you mentioned, I think diversifying income sources, having sources of income that can provide a baseline, for some people, even providing for all of their nondiscretionary expenses can go a long way to helping people sleep better at night. I know Wade Pfau has done a lot of work on personalities of retirees and maybe what's your style. And so, I think there's probably not a one-size-fits all answer to that question. But for some people an allocation to annuities can make sense. That being said, there is such a broad range of annuities, I think it's important to look carefully and understand what they're doing.
Ptak: Do you think housing wealth is an underdiscussed piece of the retirement-funding puzzle? Should more retirees consider unlocking their housing wealth in retirement in some fashion, either by downsizing or by using a reverse mortgage?
Fitzpatrick: I definitely think it's an area that people need to look at more. Again, I think Wade Pfau wrote a book on reverse mortgages. It's not an area of expertise for me. But we do often see people include a downsize in their income plan. And any kind of influx of capital during a plan can go a long way to cushioning blows. In fact, I think Wade talks about assets that can be tapped, especially if they're needed. So, it may be that you're living through your retirement and things are going well, and so there might not be a need to tap these certain things. But if you have optionality in things like downsizing or accessing equity, that can actually go a long way to helping cushion those goals. I know Bob Merton at MIT is a big fan of this idea of tapping equity for basically annuity-type returns. I think the devil is in the detail. I know things like reverse mortgages have, in some quarters, a bad reputation. So, definitely important to understand exactly what the strategy would entail. But I think, in principle, that is an asset for a lot of people, often their largest asset, and if it works in the plan, being able to use that asset for funding your lifestyle could make sense.
Benz: We talked earlier on about how retiree expenses often trend down throughout the life cycle. But long-term-care expenses are a wild card for retiree plans—could cause a spike in cash flow needs later in life. So, how would you suggest that retirees, and especially pre-retirees, think about those potential costs and think about protecting themselves against that risk of very large costs late in life?
Fitzpatrick: This is a tough one. It's definitely a place where we see a lot of people explore different options. For example, in our software, sometimes people will create, again, this A/B testing. So, say, here's my baseline plan: I have all of my cash flows here and my baseline spending assumptions and so on. I understand when and how I'll adjust my spending. And then, in one plan, they will say, what if I plan to self-fund long-term care and I'll make some assumptions about the costs. Maybe it will be $5,000 a month for, in today's dollars, so whatever that is 20-30 years from now. And I'll put that in the final three or four years of the plan. And then, you can see, how much does it cost for me to self-insure? How much would my current spending have to be reduced if I were planning for that expense to come 20 years from now, for example. And often, that's a lot less than people would have expected, and you can compare that to any other ways—maybe you're offloading that risk to an insurance policy or something, and you can make those comparisons.
That being said, from people who are much more tapped into that world than I am, I know that there's been a lot of changes in availability of products specifically focused on long-term-care expenses. So, I think this is definitely an area where we're going to have to watch this space and see what other ideas come out, what other options come out for people to take advantage of.
Ptak: That's actually where we wanted to go next, whether there's any solutions in the long-term-care space that you find especially innovative and useful. We recently had David Lau from DPL Financial on the podcast, and he discussed an annuity that doubles its payout if the annuitant can't perform a certain number of activities of daily living. Does that concept appeal to you where it's not pure long-term-care insurance, but fulfills a similar function?
Fitzpatrick: I am not familiar with the specifics of that product, but in principle, sure. In fact, what I hear is that because the availability of long-term-care insurance has really decreased over the years, hybrid products tend to be the solutions that advisors are able to find to address that. And, in principle, again, it's this diversification. So, I just discussed pure self-funding, understanding basically how much less would I have to spend now in order to have some likelihood of having more assets if and when that need arises? It would be interesting to look at that compared with, for example, an annuity like the kind that you just mentioned.
Benz: Wanted to go back to taxes. You referenced earlier that retirees should be thoughtful, or their advisor should be thoughtful, about where they go for their cash flow needs on a year-to-year basis, which types of accounts they tap. Can you provide any sort of general framework that people should think about when they're thinking about their own retirement decumulation plan? You sometimes hear these rules of thumb that you should start with taxable, move on to traditional, leave your Roth till last. How should people think about that?
Fitzpatrick: I think this is another area where the specifics matter a lot. There's a lot of important things, including sensitivity of the family to taxes. For some people, it's a much bigger issue, either because they have higher income or just more attention paid to taxes. But I'd say, typically, what we see is that for those who have reasonably long longevity expectations, that's really important, because doing tax-aware or tax-smart planning and Roth conversions and so on can really front-load the taxes that someone might pay. So you need to have a long enough expectation of lifetime that you can recoup that initial outset. But that being said, we often see people, if they're in their late 50s, early 60s, mid-60s, there's a period when any delay in taking assets from tax-deferred accounts could hurt in the end. So, like you mentioned, there's a common rule of thumb of taking funds first from taxable accounts than tax-deferred accounts like IRAs and then Roth accounts. And I certainly understand where that comes from. But for many households, that's going to be doing yourself a disservice.
So, we help people understand what sort of tax brackets or Roth-conversion levels they might want to target and then see the effect of those over time. This is though also an area where future tax policy or even the future tax experience of a given household is another one of those known unknowns. So, we can certainly make assumptions and we have to about what tax policy will be in the future, but just a look at recent history shows that tax policy does change. There are also unknowns about many people who are married, filing jointly. At some point, if a spouse passes away, they may find themselves filing singly and now taxes have changed. So, there are a lot of unknowns there. An ongoing return to tax planning at least every year and making the best decisions you can at each point is really important, because things will change. In retrospect, you may wish you'd done something different, but we always have to do the best with what the information we have right now. What we can't do is set a plan in stone, never return to it, and just follow it no matter what.
Ptak: You've mentioned Income Lab's capabilities through the course of this conversation. We know that some of our listeners are individual investors who are managing their own plans. Can they access Income Lab's capabilities on their own? Or do they need to work with an advisor?
Fitzpatrick: We only license our software to financial advisors. But that being said, we work really hard on the research side of things, putting out papers, blog posts at varying levels of complexity. But I think that an interested individual investor could probably learn a lot about the concepts that we're implementing in our software either from our website, incomelaboratory.com, or follow us on LinkedIn where we're posting things there all the time. We're laser focused on retirement income and bridging the gap between the best in research—a lot of it done by practitioners and financial economists out there—and bridging that gap to actual retirees, mostly because by doing that we think people can live better lives, and it's people like my parents, it's family. I think one of our goals with our publications is to help everyone understand retirement, understand retirement risk, understand retirement decision-making in a way that can both improve their outcomes. We're definitely happy when people can afford a little better lifestyle and so on, but maybe just as importantly, affect their experience of retirement, that the amount of anxiety they might feel and so on. I think, hopefully, it's been clear in our conversation. We really think that retirees have a lot of power in that ability to adjust and in the nature of retirement, and I think that does a lot to help. And I think a lot of people need to hear that message because there is a lot of negativity and a lot of fear out there, and many retirees can actually breathe easier than they think.
Benz: Wanted to ask, Justin, you've been working in this area a long time. Are there any areas or is there one area that stands out to you as an underdiscussed area of further research, a space where you think this is a really important area that you perhaps would like to focus on in the future?
Fitzpatrick: Oh, so many. One issue with helping run a software company and doing research is that there's never enough time in the day. I imagine you feel the same. You and your team have put out a lot of great stuff. I think there's a few things that I think are really interesting to me that I'd like to look at, and there is a lot of research on some of this. One is portfolio construction over time and understanding how risk changes at different stages of retirement. So, we've observed that a lot of the work that people have done are on plans that are quite long. Often the standard is 30 years, which is reasonable. That takes somebody from their 60s to their 90s. I'm really interested in how plans might change when we're looking into people's 80s and 90s. What do shorter plans benefit most from? That's something I plan on looking at. Another is the planning we do—it all depends on assumptions, and capital market assumptions, inflation assumptions, and so on. I'm really interested in how to best produce those assumptions, what approaches would have done the best in the past. I think it's a meta question. It's like how good is your model of the world? I think we'll be putting out some research on that as well.
Benz: Well, Justin, this has been a very illuminating conversation. We really appreciate you taking time to be with us today.
Fitzpatrick: Well, thanks so much for having me. It's been great.
Ptak: Thanks again.
Benz: Thank you for joining us on The Long View. If you could, please take a moment to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.
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Ptak: And @Syouth1, which is, S-Y-O-U-T-H and the number 1.
Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.
Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.
(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis, or opinions, or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)