326: The New Math of Retirement Spending and Investing

Welcome to Money For the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today’s episode, 326. It’s titled, “The new math of retirement spending and investing.”

A new member of Money For the Rest of Us Plus recently posted on the forums about monthly income plans, managed payout funds, income replacement funds, target retirement funds vs. immediate annuities. She’s planning on retiring in two years; she’s a conservative investor, feels like she doesn’t have much of a cushion when it comes to her savings, and is looking at all of these options and isn’t quite sure which (if any) are appropriate for her investing.

What Has Changed In Retirement Investing

I’ll admit, I had to look up what a monthly income plan is, or a managed payout fund, an income replacement fund. They sound like marketing terms created by the investment advisory industry, and to some extent, they are. We’re going to look at the new math of retirement investing and spending in this episode. What’s new about it? Interest rates are very low, and that’s starting to have an impact.

A number of listeners participate in the U.S. federal government’s Thrift Savings Plan. One of the options in that plan is the G Fund. This is a fixed-income fund, but it’s unique in that its yield is based on the average interest rate on all the Treasury bonds outstanding with maturities of four years or more. That’s what investors in this fund get, and the share price of the fund doesn’t fluctuate as interest rates change. Now, they don’t get the capital appreciation when interest rates fall, but they also don’t lose money if interest rates rise.

But now, the yield on that fund is only 0.9%. That’s what the fund earned in 2020. It didn’t even beat inflation. That’s a very different environment. That’s just one fund.

Another thing we face with the new math of retirement investing and spending is stock market valuations are extremely high, and inflation is unknown, and there isn’t even agreement on whether we are experiencing deflation right now, or inflation, and if inflation numbers are wrong. In the meantime, the Federal Reserve (the U.S. central bank) has stated that they’re willing to allow inflation to exceed its 2% target for some period of time in order to catch up so that the average inflation rate is about 2%.

Immediate Annuities and Safety First Retirement 

We’re going to take a look at retirement spending and investing in this episode, and let’s start by looking at some of these vehicles that this new member mentioned. Back in episode 279, I shared how in 2008 during the Great Financial Crisis I flew out to Maryland and met with the clients, who were individual investors, retirees; these were the clients of a client of ours, a financial planning firm. And I saw the impact that a 50% decline was having on their psyche. I came away from that meeting realizing there needs to be a different option.

It was in those next few months that I learned about immediate annuities. I attended a conference in Chicago, I learned all about the different insurance products. I obviously didn’t sell insurance products; in that episode, 279, I went into depth on immediate annuities and a safety-first retirement approach that Wade Pfau outlined in his book by that same name. Pfau writes:

“Safety-first advocates support a more bifurcated approach to building retirement income plans that integrate investment with insurance, providing lifetime income.” An immediate annuity is an example of one of those insurance products. The annuitant pays a one-time premium and then receives a monthly check for the remainder of their life, and if they desire, the life of his/her spouse. Generally, they’re level payments, but they can be set up with a cost of living adjustment.

The benefit of immediate annuities is it eliminates longevity risk. You get the payment as long as you and your spouse are alive. It eliminates market risk. The insurance company is responsible for investing the premium, and delivering the monthly annuity payment, irrespective of how investment markets return; whether interest rates go up or fall, whether the stock market has terrible returns, they make a promise to meet that insurance contract, to make those payments.

An immediate annuity potentially could eliminate inflation risk if it’s indexed to inflation, but that inflation writer can be very expensive. There’s also an option to get back some or all of the principal payment if the annuitant dies in the first 5–10 years of the contract.

I learned about annuities in 2008–2009 and recommended that to this financial planner client. There was only one problem—they didn’t sell insurance products either. And if a client would buy an annuity, that client would go to an insurance company, and that money would flow out of the individual retirement account or taxable account that the advisor was overseeing. And the advisor was charging an asset management fee; they received a percentage of the assets under management. And if a retiree takes a couple hundred thousand dollars out of that account to buy an annuity, then the advisor would make less money.

In addition, the mutual fund companies that the advisor was investing in would make less money, because the money would flow out of those accounts also.

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