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Hi all -

(Warning - long post)

My Dad is about to retire at the tender age of 70. He's been a civilian employee of the Navy for 45+ years, and they take good care of their retirees. Between his and Mom's pensions and Social Security, they'll have more income every year (inflation indexed!) than their Quicken model tells them they spend. All is well.

However, Dad also has a 401-K equivalent (they call it a "TSP") that's a big pot of money. He is planning to take all that money and buy an annuity that will pay him a fixed amount over the rest of his life. When he dies, the money is gone. However, the annuity is only 6.8% or thereabouts. This seems awfully un-Foolish to me. It's not that my siblings or I need the money, but I think he could get almost the same amount of money out each year, and yet actually *grow* his pot of money, using a fixed percentage withdrawal method - check out the Retirement articles that TMFPixy has done.

Here's my mini-analysis: without being too specific, Dad's TSP contains somewhere between $100K and $500K. Pretending for the moment that it's exactly $100K, he would get $6800 per year from this annuity. The amount would be indexed to inflation but *capped* at 3% per year growth. I wrote a program to compute the compounded growth of the Consumer Price Index (CPI) over 30-year periods (yes, Dad's planning to live to 100) starting with 1914. The CPI data, by the way, came from the Bureau of Labor Statistics -

www.bls.gov

Not surprisingly, the 3% cap on the growth of his annuity eats deeply into the buying power of his income. For 30-year periods beginning in 1950, the buying power of his annuity never ended up greater than 60% of the compounded inflation rate (i.e. his buying power dropped by 40%). I do not like the annuity at *all*, Sam I am.

One of TMFPixy's wonderful articles shows that for 30-year periods, if you invested your money in the Foolish Four, then you could withdraw 6% of the money each year (adjusted by inflation!) and still be able
to take out your payment in the 30th year. Furthermore, you were likely to end up with a humongous amount of money (Pixy kept talking about estate attorneys - I keep thinking about a child-care center with Dad's name on it).

Now, this means that in each year, Dad can only take 6%, rather than the 6.8% that the annuity would pay him. And he's got a non-zero probability of having to reduce that payment, rather than guaranteed sorta-inflation-indexed payment from the annuity.

But on the whole, this looks like a huge win. There's a huge chance that he'll end up taking out *more* money each year than his annuity would have paid. Am I missing something?

Thanks for reading this far. If you're still interested, please help me with the following questions:

1. TMFPixy, presumably, has data showing how much you get to withdraw from your theoretical $100K pot each year. But I can't find it anywhere. Did you publish those tables?

2. I'm still a little confused about what the "fixed percentage with inflation adjustment" means. If your portfolio goes down in a given year, do you adjust *last* year's payment by inflation and take that? You mentioned the difference between what the algorithm did and what would be prudent, which made sense, but I couldn't tell exactly what the algorithm did. *My* prudent approach would be withdraw the minimum of (a) your fixed percentage amount and (b) last year's payment, adjusted for inflation.

3. Ann Coleman has me sufficiently nervous about the Foolish Four that I'm hesitant to recommend it to Dad, and yet it's one of the few mechanical strategies for which we have semi-long-term data. I'm in the situation that I have a strategy that has numbers I can use to sell Dad on my plan, but I'm not at all sure it's the strategy that I think is best for him. Any suggestions? :-)

If you're still reading this far, I really appreciate it.

Regards, Lee
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If dad feels more comfortable with fixed income, he can probably do better with jumbo CDs and have the principle to pass to his heirs. If he ladders his CDs, he can change to another form of investment if he wants to change his strategy later.

http://www.fisn.com/rates.htm

http://www.money-rates.com/cdrates.htm

http://bankcd.com/list.html

http://bank.imoneynet.com/savings/

https://deposits.providian.com/

On the other hand, if your dad is anything like my dad, he's not realy interested in what you have to say!

Good luck.
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Purchase of an "immediate annuity certain" is all about trading return for certainty -or- if you like, trading return for volatility. If your father is already covered in the pension & social security department; he should theorectically be ambivalent or actually embrace asking for higher returns with related volatility. Said another way, if his basic "living needs" are all covered; he should switch from risk avoider to risk taker to achieve the higher returns & therefore shun the annuity in favor of investing directly in higher relative risk instruments. Make sense?

TheBadger
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Greetings, Lee, and welcome. You wrote:

<<1. TMFPixy, presumably, has data showing how much you get to withdraw from your theoretical $100K pot each year. But I can't find it anywhere. Did you publish those tables?>>

No, only the final results were published.

<<2. I'm still a little confused about what the "fixed percentage with inflation adjustment" means. If your portfolio goes down in a given year, do you adjust *last* year's payment by inflation and take that? You mentioned the difference between what the algorithm did and what would be prudent, which made sense, but I couldn't tell exactly what the algorithm did. *My* prudent approach would be withdraw the minimum of (a) your fixed percentage amount and (b) last year's payment, adjusted for inflation.>>

The income taken each year was based on the initial draw as increased by inflation or decreased by deflation for the prior year. If you have $100K and begin taking 5%, then in the first year you take $5K and leave $95K at investment. At the end of the year you note inflation for that year was 3%. Therefore, you compute the second year's income as $5,150, which is the product of 1.03 times $5K. At the end of year two you note inflation is again 3%, so the next year's draw becomes $5,305, which is the product of $5,150 times 1.03. If there was deflation (none occurred between 1961 and 1998), then the draw would be decreased. The study did not adjust for the remaining size of the portfolio, something that would happen in real life.

<<3. Ann Coleman has me sufficiently nervous about the Foolish Four that I'm hesitant to recommend it to Dad, and yet it's one of the few mechanical strategies for which we have semi-long-term data. I'm in the situation that I have a strategy that has numbers I can use to sell Dad on my plan, but I'm not at all sure it's the strategy that I think is best for him. >>

It's a very valid concern. Keep in mind this is a value strategy, and value strategy investing is very much out of favor right now, as is investing in old-line, stable industries in general. Also, the Dow now includes some non-dividend paying stocks, which throws in a factor previously not present in the FF selection methodology. Ask yourself how your parents would react to the significant short-term decline in the Dow over the last few weeks. If they're looking for "secure" income, then the market is the wrong place for that. They need to follow the course that makes them most comfortable. In the present marketplace, a FF strategy would probably make many retirees very edgy. There's more to life than having to worry about your stash, and if such a proposal would make your parents uncomfortable, it should not be followed under any circumstances.

I use the FF, and am very comfortable doing so; however, I am also quite used to seeing markets go down as well as up. That doesn't panic me, even with a retirement pot of money. Many, though, find a paper loss in the short-term too much to bear. Those folks then make the paper loss a real one by selling out because the pressure is too much to bear. What would your parents do? If they're satisfied with the lower (but "guaranteed") return and income of the annuity, then talking them into something else that might make them suffer huge pangs of anxiety could be the worst thing you could do.

Regards..Pixy
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(Another long post, please bear with me)

TMFPixy arranged the electrons thusly:

<<The income taken each year was based on the initial draw as increased by inflation or decreased by deflation for the prior year. If
you have $100K and begin taking 5%, then in the first year you take $5K and leave $95K at investment. At the end of the year
you note inflation for that year was 3%. Therefore, you compute the second year's income as $5,150, which is the product of 1.03
times $5K. At the end of year two you note inflation is again 3%, so the next year's draw becomes $5,305, which is the product of
$5,150 times 1.03. If there was deflation (none occurred between 1961 and 1998), then the draw would be decreased. The study
did not adjust for the remaining size of the portfolio, something that would happen in real life.>>

Thank you for the clarification - I hadn't realized that you just computed the 5% number once and then *only* adjusted for inflation. So now it's easy to see how, in a healthy bull market, your pot o' dough is likely to grow almost out of control.

Allow me to mention another strategy (which was alluded to in another one of Pixy's articles). You plan to live another 30 years, and decide that 5% is a safe withdrawal level. You start with your $100K and take out 5%, which is $5K. A year later, your $95K ($100K-$5K) has grown 20% (this is the Foolish Four after all) to $114K. You say, "I think I'll start a 29-year progam," and take out 5% of $114K, which is $5700. Your $108,300 ($114000-$5700) grows 10% the next year to $119,130. You say, "I think I'll start a 28-year withdrawal program," and take out 5% of $119,130 which is $5956.50. And so on.

So in this strategy, to the degree that your investments outperform inflation, you get to take more money each year. And you won't have *quite* the same runaway growth problem that a well-performing portfolio would give you if you only used the first year's number and then adjusted for inflation.

Will this work? Yes. Unlike the original strategy, which adjusts for inflation/deflation without watching your investment, by tying your withdrawal to the actual value of your pot of money, then you guarantee that you'll never overspend it. And, unless you change the strategy at some point, you'll leave your heirs with 95% of the balance at the beginning of the last year of your life.

The downside, of course, is that if your investments go *down* in a given year (which they are almost certain to do), then you have to take out less money the next year.

<<They need to follow the course that makes them most comfortable. In the present marketplace, a FF strategy would
probably make many retirees very edgy. There's more to life than having to worry about your stash, and if such a proposal would
make your parents uncomfortable, it should not be followed under any circumstances.>>

Piffle. I hate it when somebody points something out to me that I "know", but have been conveniently ignoring. A previous respondent had said something like "Your father should be more risk-tolerant since his basic needs are covered by pensions and Social Security." That phrase should have woken me up. Risk tolerance is as personal a feeling as whether you prefer a window or an aisle - even more so. If my Dad had $100 million in the bank, he'd worry about the fate of that $100K TSP; that's the cloth from which he's cut. As difficult as it is for me to accept, he might well be perfectly happy losing the spending power (due to inflation exceeding the cap on the growth in his annuity) in exchange for the certainty of always getting that fixed chunk of money.

And I am indebted to Pixy for reminding me of that.

Regards, Lee
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Very useful posts from a number of posters.

If you want to look at safe withdrawal rates, long-term survivability, and efficient frontier issues, you should check out The Retire Early board here on TMF (in Speakers' Corner) and 'intercst's' Retire Early Home Page at either


http://www.geocities.com/WallStreet/8257/reindex.html

or

http://www.retireearlyhomepage.com/

Although the discussion in those two places has a slightly different focus, I believe that there is some very useful information relevant to you father's situation, as explained by you, and assuming that he is willing to listen to you.

Hope this helps. REgards, JAFO
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