Can You Plan Your Retirement in Life Stages?

On this episode of The Long View, Justin Fitzpatrick, co-founder and chief innovation officer at Income Lab, discusses his retirement planning software, withdrawal rates, and investing in retirement.

Here are a few excerpts from Fitzpatrick’s conversation with Morningstar’s Christine Benz and Jeff Ptak:

The Role of Life Staging

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 I guess 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: Yeah, 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 kind of 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 kind of intuitively attractive to people.

The other thing is, you could begin planning that way, assuming that you’ll slowdown in your spending, which will – 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 the 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.

The Guyton Klinger

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 lifecycle, 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: Sure. Yeah, so I really like, and we’ve benefited a lot from, really at this point, decades of research on dynamic withdrawals, dynamic retirement income. But one of the issues with kind of 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.

So, as I mentioned with kind of the pool analogy or what we’ve referred to as the hatchet – so, 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, kind of, 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. So, 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.

How to Approach Withdrawal Rates

Benz: So, if someone wants to approach withdrawal rates in a holistic way that incorporates some of these things that you’ve talked about, so 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: Yeah. 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 kind of taking an inventory of all of the things that are going to help fund your spending in retirement. Like I said, kind of, diversifying income sources can be a great thing for retirees. And then, I like to think of it as kind of doing AB 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.