Skip to main content
No. of Recommendations: 20
[This analysis is prompted by a question that was posed on another board. The subject is off-topic for that board, as it was really a retirement income question. So I moved it here. It was an interesting exercise to work up.]


Scenario:
By active investing, client has built up a $2M investment portfolio. He is now 65 years old and wants to retire with a steady income from the portfolio. Has "won the game" and now wants to have a no-drama, no-excitement portfolio. Does not want to have any more stock volatility, does not want to have to face 20% or 50% drops in year-to-year value anymore.
Any significant stock allocation is not acceptable. Wants to have a near zero chance of running out of money.

The task is: How to invest that $2M. For simplicity, ignore inflation -- even though inflation will certainly be a concern over a period of 35 years remaining lifetime.

============
One possibility:
Put the entire $2M into Tax-Exempt high-quality municipal bonds (such as VWIUX).
This pays approx $68,000 annually. (The equivalent taxable income would be about $80,000.) The principal balance would swing up and down as interest rates changed, but the dollar amount of the dividends would be fairly stable. The principal balance would certainly not swing as wildly as stocks would.

If $68,000 income is enough, that's it.

If the need is more than $68,000, then he will have to dip into principal. Eventually the account will be depleted and run out of money. So if he does this then he needs to make sure that the money will not run out in his lifetime.

The SSA mortality table says that he has essentially zero probability of living past 100, so it seems that he'd be safe in figuring that the portfolio must last for 35 years -- age 65 to age 100.

He could take $80,000/yr and the age 100 balance would be $1M
$90,000/yr and the balance would be $400,000
$95,000/yr and the balance would be $50,000

So the portfolio would sustain $90,000/yr and still last beyond age 100.

============
An alternate possibility:
Put 90% ($1.8M) of the $2M into municipal bonds as above.
Put 10% ($200,000) into a long-term stock market investment that would be ignored and untouched for 25 years.

The first 25 years of retirement, to age 90, he would take income from the municpial bonds, including tapping principal. At age 90, if he is still alive, sell the stocks and put that money into municipal bonds as above.

Looking at the different components, first the $1.8M of bonds.
He could take $80,000/yr and the age 100 balance would be $421,000. He would never need the money that was in stocks.
or

He could take $80,000/yr and the age 90 balance would be $990,000.
$90,000/yr and the balance would be $590,000
$95,000/yr and the balance would be $390,000

At $95,000/yr the account runs out of money in 29 years or age 94.

Second, Looking at the $200,000 invested in stocks, ignored and untouched for 25 years.
Using the historical S&P500 data, including reinvested dividends, on average the stock account would be $2.5M.
The historical worst case 25 year period the stock account would be $1.2M.
Capital gains tax would reduce this amount by 15%.

But the worst case in the past isn't necessarily the worst that can every happen. Let's work with a value that is one-half of the historical worst case -- $600,000.

Now at year 25, age 90, we sell the stocks and put that money into municipal bonds. The total amount in bonds will be:
$1.6M if he was taking $80,000/yr or
$1.2M if he was taking $90,000/yr or
$1M if he was taking $95,000/yr

If he was taking the recommended maximum of $90,000/yr, in this half-cut worst case, the money would last another 18 years, to age 108.

In the historical actual worst case, the $1.2M in stocks would be added to the $590,000 in remaining bonds for a total of $1.8M. Which is coincidently the same as we started out with. This would last for 32 years, to age 122.


============
Another alternate possibility:
Put the entire $2M into an Indexed universal life (IUL) policy. We'll ignore the logistical problems of putting $2M all at once into an IUL -- which are not inconsiderable, since the IRS has rules in place that are designed to prevent exactly that.

If we ignore the price of the life insurance that is an integral component of an IUL, at a withdrawal of $68,000/yr the IUL runs out of money in 27 years - age 92.
At $90,000/yr, the IUL runs out of money in 19 years - age 84.

But we cannot ignore the price of the life insurance. Life insurance at age 65 is very expensive. Easily $20,000 to $50,000 a year -- depending on how the IUL is structured. Even at $20,000/yr he would have to effectively withdraw $88,000 to get $68,000 of income.
And the IUL would run out of money in 19 years - age 84.

This alternative fails - it does not last 35 years.

============
Another alternate possibility:
Use the entire $2M to buy a Single Premium Immediate Annuity (SPIA).
Currently this would buy an lifetime income of $132,000 per year for the rest of his life. But that's it. There is no residual value, either before or after death. Once the $2M goes into the SPIA it is gone. All there is is the $132,000/yr income.
Print the post  

Announcements

The Retirement Investing Board
This is the board for all discussions related to Investing for and during retirement. To keep the board relevant and Foolish to everyone, please avoid making any posts pertaining to political partisanship. Fool on and Retire on!
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.