Maximizing an affluent household’s after-tax safe retirement income¹ or legacy ²

During working years, people are saving and growing their portfolio and they need help with determining an optimal savings rate and asset allocation to achieve their goals. During retirement, however, there are more decisions to make. These include Social Security claim strategy, pension payout options, purchasing insurance or annuity products, determining how much to allocate to annuities, which type to buy, and when to start annuitization or lifetime income withdrawals, tax-targeting of disbursals from qualified accounts including Roth conversions; and capital gains management of non-qualified (taxable) accounts.

Each decision individually has a significant impact on the income plan; collectively, with their synergistic interactions, the value created for a retiree can greatly improve their quality of life in retirement. 

The analysis in the following example household was done using the intelligence of AIDA, Income Discovery’s retirement income analytics engine. AIDA co-optimizes all of these decisions – we call them levers – so an advisor doesn’t have to manually sift through hundreds of strategies. In one click, AIDA optimizes across thousands of retirement income plans to find the best combination of levers for a household. The following demonstrates the power of AIDA.

Example household
Anne and Ben Jenkins (both age 62) are both planning to retire in 2022. They have accumulated $1.1M in assets, split between non-qualified (taxable) accounts, qualified (tax-deferred) and Roth retirement accounts. Ben also has a $600K pension which can be taken as a lump sum at Ben’s retirement or converted into $3K/month lifetime income.

The Jenkins family wants their base spending to be $95K/year (growing 1% slower than inflation) with each needing $5K/year in additional healthcare expenses (growing 2% faster than inflation). Following a typical strategy, as shown in Figure 1 below, Anne and Ben have two choices:

• Spend $105,000/year in total including healthcare expenses with 53% confidence, much lower than their comfort level, or
• Spend $97,100/year in total safely, 8% less than they want to spend. 

Safely means that the household has a 90% confidence (Probability of Success) of fully meeting the income requirement into their mid-90s. A typical strategy, followed by most Americans, will keep the investment allocation constant after retirement, claim Social Security upon retirement, not purchase lifetime income or annuities, and take the pension as a lump sum. 

Figure 1

Additionally, without professional help, Anne and Ben take sequential disbursals from their non-qualified accounts through their 60s while the qualified balances grow, resulting in large RMDs and increased taxes in their 70s and 80s. 

Since investors become increasingly loss averse as they enter retirement, Anne and Ben need a holistic retirement income plan that will build their guaranteed income base, reduce pressure on their volatile assets, and make withdrawals from their SWP in a tax-efficient manner.

Solution
A unified income strategy, combining powerful dynamic tax-efficient strategies with building the guaranteed income base, can help control the risks facing Anne and Ben as they enter retirement and can maximize their spending or legacy, whichever is their goal.

As shown in Figure 1 above, by following a typical strategy and without professional management and monitoring, Anne and Ben either face an uncomfortable risk of depleting their funds or need to spend less than desired. This is not a palatable choice but fortunately these are not the only options. 

Maximize Safe Spending
As shown in Figure 2 below, if the Jenkins want to maximize their spending, they can spend 30% more annually than following a typical strategy, while reducing their overall risk. This is achieved by deferring both members’ Social Security benefits until they are 69 years old, moving 40% of their assets into a fixed indexed annuity, allocating the rest of their investments in a moderate portfolio, settling the pension as monthly lifetime payments, using multiple capital gains management techniques and taking tax-targeted qualified disbursals at a 12% incremental effective tax rate.

Figure 2 

Lifestyle vs Legacy
If the Jenkins would rather meet their planned spending goal and maximize the legacy for their heirs, the optimal strategy is different. As shown in Figure 3 below, they can safely spend $105K/year while increasing their average after-tax legacy to nearly $1.2M in today’s purchasing power. This assumes an effective tax rate of 20% on qualified assets inherited by heirs. Compared to the average legacy of $21K for the typical strategy, the optimal strategy’s bequest is well over 5 times larger.

The recommended strategy for maximizing legacy differs from the maximize spending strategy on two fronts: deferring both members’ Social Security benefits until they are 70 years old (instead of 69) and settling their pension payout as a lump sum (instead of lifetime income). They will still purchase a fixed indexed annuity, invest their remaining SWP in a moderate portfolio, and still utilize the 12% targeted qualified disbursals and capital gains management strategies.

Figure 3

As demonstrated above, utilizing an advanced retirement income analytics engine can determine a personalized tax-optimal strategy for each household. This can increase a household’s safe spending by as much as 30% or after-tax legacy by as much as 5 times. 

For more details on the assumptions used in this example household, including details of asset allocations, return expectations and annuity payout rates, see the Appendix.

1 Safe retirement income is the amount of income that has a 90% probability of success of money lasting into a retiree’s 90th percentile lifespan. Safe retirement income consists of all sources of income (not just guaranteed sources): Social Security benefits, pension payments, lifetime income payments, withdrawals from investments and any other incoming cash flows, such as part-time work and rental income. Safe retirement income is increased by Social Security retirement benefit claim deferral, purchase of annuities, settling pension as lifetime income payments, changing investment portfolio asset allocation, tax-targeting discretionary disbursals from qualified accounts and multiple capital gain management strategies. The amount of increase and the optimal strategy varies depending on the individual circumstances, annuity payout rates and capital market return expectations. Projections have inherent risks and limitations.

2 If retirees are satisfied with their planned spending and do not want to increase it, they can instead focus on maximizing their legacy. The amount of increase in after-tax legacy varies depending on individual circumstances and capital market return expectations. After-tax legacy may be increased by certain levers such as Social Security retirement claim benefit deferral, settling pension as a lump sum rollover, changing investment portfolio asset allocation, tax-targeting discretionary disbursals from qualified accounts and multiple capital gain management strategies. Projections have inherent risks and limitations.

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