November 18, 2021 | Stephan Granitz, Chief Analytics Officer

Monitoring the Health of a Retirement Income Plan

The financial planning industry is lacking a reliable, consistent methodology for monitoring retirement income plans. Markets are volatile and loss averse retirees are susceptible to panic and may unnecessarily reduce spending if they see their account values dropping. Advisors need a way to quickly check on the status of their clients in retirement and whether any adjustments to the plans are needed. Retirees similarly need a way to be reassured that they are on track and can continue spending their planned budget. The existing methodologies for performing retirement income plan monitoring are inconsistent, time consuming, and overreact to market movements.

Figure 1: Monitoring a retirement income plan with SafePathSM

“Can a retiree continue to safely follow their income plan or do they need to make adjustments?” is a top of mind concern for decumulation-focused financial planners and their clients. The need for rules to adjust spending in the decumulation phase has been well covered by popular financial planning researchers such as Bill Bengen, Wade Pfau, Jonathan Guyton, Michael Kitces, and Stephen Huxley to leading financial research institutions such as Vanguard, J.P. Morgan, and the Center for Retirement Research at Boston College.

So far the research has been focused on a sustainable withdrawal rate with fixed inflation adjustments from a retiree’s investments based on historical market returns (see Bengen’s 4% rule) or following similar logic as required minimum distribution (RMD) tables. Advisors have often taken the approach of either extensive annual replanning of the retirement income plan or developing personal heuristics to determine if a plan is on track. The research generally ignores actual income needs and variation (see Figure 2), as well as timing of other sources of income such as Social Security, incoming cash flows, lifetime income sources, insurance, and pensions. The rules produced and current practices of advisors often result in annual income adjustments, which is too frequent for a reliable budget and not practical for retirees. Also, the rules are applied universally and not personalized per each retiree’s unique needs and circumstances. Most importantly, none answer the fundamental question “Am I safe?” throughout the income plan.

Figure 2: Withdrawal rate varies throughout the retirement income plan

Even the best retirement income plan can run the risk of coming up short in meeting a retiree’s income needs. There are many risks in retirement from unexpected expenses, rising prices, extended periods of market losses, outliving expectations, losing sources of income, and more. Rules for determining when to make spending adjustments must take into account all of these risks in the context of a retiree’s planned income needs, their risk tolerance for investments, and the timing and variation of other sources of retirement income.

As a solution to these issues, Income Discovery developed SafePathSM, a scalable, consistent process for monitoring retirement income plan health and recommending spending adjustments. SafePathSM has been tested on more than 100,000 retirement income plans. SafePathSM meets the needs of institutions, advisors, and retirees and was developed with the following principles in mind.

  1. Reductions in spending are painful

Retirees tend to be more loss averse than pre-retirees. Losses in both assets and spending are especially painful to this group. Retirees also tend to closely follow a spending budget as they are funding their spending from assets and not salary. Large or frequent adjustments make it very difficult to stick to a budget and live comfortably in retirement.

  1. Adjustments should be infrequent if planning to a high level of safety

Retirement income plans are generally made with long life expectancy (90th percentile) and high probability of success (90%) over a wide range of possible future market and inflation scenarios. Because the plans are determined at a high level of safety, frequent adjustments should be unnecessary as long as the plan is valid. Relatively small and infrequent adjustments can keep the plan on track.

  1. Annual replanning is time consuming and cannot scale

As more and more clients enter retirement daily, it will become an overwhelming task for advisors to fully replan each year for all retirees, a common method of checking plan health. Each advisor and their support staff has limited time available per client. That time should be spent building deeper, lasting relationships, not gathering paperwork and data and then rerunning thousands of plans.

  1. Annual replanning is overly reactive to market movements 

Not only is annual replanning time consuming and expensive, it is sensitive to timing and market volatility. Market movements near the time of replanning will have outsized effects on the measure of plan health and recommended income adjustment. Frequent unpredictable income adjustments makes budgeting impossible. This method also does not allow a retiree to check the plan status themselves.

  1. Plan monitoring and income adjustment recommendations must be systematized

Institutions and advisors need a methodical approach to monitoring retirement income plans which is consistent and scalable. The current approach of each advisor and client figuring it out on their own may be risky from a legal and compliance perspective and does not serve the client’s best interests. The systematic approach to determine plan safety should be thoroughly tested and reproducible.

SafePathSM takes into account all of these points and determines if a retiree can safely continue following their plan, giving them peace of mind in times of market volatility or after a significant unexpected medical expense. In case an adjustment is necessary, SafePathSM will minimize the frequency and amount of adjustments across the plan, generally avoiding making more than two adjustments per decade in the worst case. 

SafePathSM provides a standardized process at the institutional level for monitoring plan health of active clients in retirement income plans, reducing regulatory and compliance risk. It enables advisors to view the plan health across their book of business and frees them to focus on relationship building. Finally, SafePathSM empowers retirees to check on their plan, answering their key question “Am I safe?” and giving them confidence to spend as planned and enjoy retirement.

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