Shifting from accumulation to the distribution phase in retirement poses various challenges for personal financial planners. Jamie Hopkins, JD, LLM, CFP, director of retirement research for Carson Wealth, discusses these challenges and the reasons to focus on safety in a decumulation portfolio. Hopkins spoke at greater length on this topic at PICPA’s 2019 Personal Financial Planning Conference on Nov. 7 at Penn State Great Valley.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor

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Podcast Transcript

Transitioning from the accumulation to distribution phase poses challenges for financial planners. Jamie Hopkins, JDLLM CFP, director of retirement research for Carson Wealth, will discuss this topic at greater length at PICPA's 2019 Personal Financial Planning Conference on Nov. 7 at Penn State Great Valley in Malvern. Jamie joins me on the phone today to provide a preview of his presentation.

Jamie, thanks for taking some time out of your schedule to talk to me today.

[Hopkins] Yeah, absolutely. I really appreciate you having me on.

Is the distribution phase in retirement planning often overlooked and if so why is that the case?

[Hopkins] Yeah, absolutely. The distribution phase of retirement planning has gotten a lot of attention over the last couple of years. However, I'd still say to some degree planning for that phase is still a little bit overlooked. The actual phase itself every company, everyone's running ads saying, "Hey, we specialize in retirement income planning." The reality is very few people do. When you look across the board: are they trained; do they have the right tools, products, strategies in place? And for the most part I don't think very many advisers and financial planners do. It's still a growing area. When I joined the American College about seven years ago, I joined there to help build out a retirement income education program which was really about the first of its kind which is pretty amazing if we're thinking just seven years ago advisers were just getting trained on this. I still think there's a lot of work to do there, a lot of education, a lot of training, a lot of research, honestly, still to do on best practices on the distribution phase.

What's one way a financial planner can manage retirement income investment risks?

[Hopkins] I usually describe retirement income planning as trying to hit a moving target in the wind. The target is really the client's goals and we have to address retirement income planning as goal-based planning because everyone's goals in retirement are different. It's actually a lot different than saving for retirement where, generally speaking, I know the day you started working and I know you're going to retire in some typical five-year time period, somewhere between maybe 62 to 67 and that's almost everyone in the U.S. I can pretty much guess that. But when I get to retirement, we're going to have maybe 10% of retirees pass away in the first eight years of retirement but we're also going to have 10% of retirees live to 95. The bell curve there is much, much broader.

The challenges on investment risks, on longevity, on healthcare, those are all the things that are moving that target. I don't know where the target's going to be. Is somebody going to spend one year or 30 years in retirement that moves the target? And the last one is that risk, that investment risk, that's going to be the wind that blows us off course. For a lot of people – investment risks – we have to be more conservative right as we near retirement. The first five years before and five years into retirement are probably the single most conservative years in our investment life. So making sure that we have some type of strategy whether it's asset allocation, whether it's safe assets like CDs, bonds, term annuities, providing income, during those first years when sequence of returns risk is really at its height.

I appreciate that explanation there, Jamie. And speaking of explanations, I wanted to see if you could focus briefly on why it's important to focus on safety in a decumulation portfolio. What do you mean by that?

[Hopkins] I go back to the risks there and part of it is we do have a lot of risks that we could run into in retirement that could throw our retirement plan off course. When you think about the risks that are unique or challenging to retirement one of them is inflation. While inflation is to some degree a natural part of life and we're dealing with it all the time until we get to retirement and we're living on more of a fixed income, a fixed source of assets that are generating our retirement needs, we don't worry about inflation too much. Why? Well, because what happens if there's a lot of inflation and I'm working? My income typically increases at my job. We generally get by in life without ever really planning on inflation but then all of a sudden we get to retirement and that changes.

The other one there, average returns, are thrown out the window and what we start caring about in retirement is the sequencing of those returns. And to some degree we actually have less control over that than perhaps we do average returns. We might have a better control over, “here is going to be our returns over a 30-year period versus here is going to be our returns for the next five years.” That's actually much more complicated to model and predict. There's a lot more uncertainty in short term return assumptions. And that's really where probably the most famous research has come out around retirement income planning which was Bill Bengen's 4% rule back in the 1990s which said, "What can you safely withdraw from a portfolio of 50% large cap equities, 50% US bonds, and make it for 30 years?" And it's right around 4% and that's what's become known as the 4% rule.

Now it's not so much as a rule as it was designed to show, “hey if you average 8% even for a 30-year timeframe you still can't withdrawal 8%.” You might only be able to withdraw four. And some of my colleagues, Wade Pfau being one of them, has shown that actually under today's market assumptions and interest rates which are at an all-time low again that could actually challenge the 4% and actually might be closer to three. And so, that's another risk we have to think about. And then I already mentioned longevity, we don't know how long we're going to live.

When you start looking at these risks that could throw us off track and off place in retirement the other thing is: can we get it wrong. Well, unfortunately we can't get retirement wrong in the sense that we run out of money because there's nothing else for us to do at 85. We're not going back to work at 85. That's it so we have to get this right. To some degree we have to just be more conservative than we would be in other time periods in our life. Safety matters, secure income sources matter, making sure we have enough income that can offset inflation, that we have income that lasts for a lifetime, and that we're not taking withdrawals that will deplete our portfolio too soon.

Can you briefly explain the three main philosophies of retirement income planning?

[Hopkins] One of the things that happens is we get to retirement. We talked about, "Hey, we need a plan. We need a plan." One of the big things we need to do is eventually decide what is our philosophy for generating retirement income. And what I mean by philosophy is there are really three main prevailing strategies out there that people will utilize, one of them being this systematic withdrawal approach. Again, that is an example of the 4% rule, that you take 4% of a portfolio each year adjust it for inflation. That's not the only type of systematic withdrawal approach possible. You could take 4% of the existing account balance. That's actually a very valuable strategy if we're willing to have variability, some fluctuation, or actual spending. That'll be a more successful systematic withdrawal approach. But again, it's essentially saying, "Do we have parameters around how we take distribution?"

Then the next one is really the flooring strategy also sometimes referred to as essential versus discretionary. And that's again goal-based planning, sitting down saying, "What are your needs in retirement? Which ones of these are essential that we cannot live without?" And then making sure we have enough secure income from Social Security, pension, CD, bond ladders, whatever secure income sources that we can get to meet those essential spending needs.

And then the third one is often what we call bucketing or time segmentation approach. And so, that is really setting aside money for different time periods in retirement. And so, to some degree what this bucketing is doing is approaching this as a risk mitigation measurement by attaching investments to time horizons. What we talked about before was equities or investments in the stock market, they're a little bit risky for a short period of time because there's a lot of volatility over one or two years. However, as time goes on the likelihood that we won't grow our wealth really decreases. After 10 years, 15 years, it's very unlikely that we won't see positive returns in an equity portfolio.

What bucketing says is, "Hey, we need that growth inside of our retirement income plan so let's set our equities out 10 years, out 15 years. Let's have a mixed bucket for the maybe years two to 10 or five to 10 and let's have all of our safe assets, our CD bonds term annuities in our front end. And what we're going to do is generate income from those and then our next portfolio we're going to allow our stocks and equities to grow. We're not going to deplete them." And what that hopefully does behaviorally is allows the client to stay invested in the market and not overreact during the first five, 10, 15 years of retirement when markets are fluctuating because the client knows that's not where you're going to generate their income from. I'd say those are the really the three main prevailing philosophies out there today on retirement income planning.

To follow up on that is there a more popular phase?

[Hopkins] Yeah, so when you look at the adviser world there's been some research done by FA Magazine and FPA on polling financial advisors to the most popular and most used approach. By far and away today from those research studies will show that financial advisors gravitate to the systematic withdrawal approach. So that's paying attention to 4%, taking systematic withdrawals. The other two approaches are used but again we're seeing a lot more people gravitate towards that systematic withdrawal approach.

Great. Well Jamie, thanks so much again for sharing this insight with our listeners. We're looking forward to hearing you at the conference in November.

[Hopkins] Absolutely. Looking forward to being at the conference in November and talking about the retirement income planning which is what I go to bed thinking about, wake up thinking about, it's what I love to do.

You live the life, right?

[Hopkins] Yeah, absolutely.