Guaranteed income is part of the balance sheet of retirees
3. This should affect the withdrawal rates from the portfolio.
Relatively speaking, the more a retiree’s wealth consists of guaranteed income, the greater the potential for withdrawal from the portfolio. Indeed, the potential impact of a “failure” is lower.
For example, a retiree who gets 90% of her income from guaranteed income may have a higher portfolio withdrawal rate than one who gets only 10% of guaranteed income, because the implications associated with portfolio deficits are very different.
Unfortunately, this is something that is generally not taken into account in financial planning tools that use measures like the likelihood of success to define an outcome.
A balance sheet can be extended to include other assets and liabilities as well. For example, a retiree might include other liabilities, such as the estimated total cost of retirement (ie retiree consumption).
It would also be possible to include the expected total value of human capital for those still working (as well as pre-retirement consumption). While there are a number of possible ways to do this, I am more interested in advisers who pass an estimated value of guaranteed income, which is why I am focusing only on that for this article.
Estimate of value
There are two possible approaches that can be used to estimate the value of a given stream of guaranteed income.
First, determine the value of a comparable private annuity. For example, according to immedieannuities.com, the payout rate of an immediate nominative lifetime annuity only for a 65-year-old man is around 6% as of May 24. This means that it would cost around $ 330,000 to replicate a face amount of $ 20,000. retirement benefit, without cost of living adjustment (COLA) for a 65 year old man.
Since there are no private annuities that offer benefits directly linked to inflation, the assumption of a fixed COLA of 2% (for example) would be one way to approximate the value of retirement benefits. social security.
Second, estimate its value using a present value calculation. To do this, estimate the term and a discount rate. The term can be the life expectancy of the individual (or couple) or the actual individual death weights by age (if you want to be fancy).
The discount rate should reflect the risk of the underlying payments. For example, social security benefits should probably be discounted using government bond yields or some other incredibly secure fixed income instrument.
I’ve put together an Excel file on my website that comes close to all of this, but it’s definitely not as complex as it could be.
It’s important to note that these estimates don’t have to be too precise (something is better than nothing), and approximations can work very well. For example, for an average 65-year-old, multiplying a Social Security retirement benefit by 20 is a decent estimate. Therefore, if the total benefits for a household are $ 50,000, the approximate value of those benefits is approximately $ 1 million.
Guaranteed income may not be what many advisors typically define as an asset; however, it clearly has economic value. Therefore, estimating the value of guaranteed income and sharing information with clients (especially retirees) can lead to better decisions and is something all advisors should do!
David Blanchett is Head of Retirement Research at Morningstar Investment Management LLC. The opinions expressed are its own and do not necessarily reflect the views of Morningstar Investment Management LLC. This blog is provided for informational purposes only and should not be construed by anyone as a solicitation to effect or attempt to transact in securities or to provide investment advice.