Income Backwardization

As I’ll often do, I recently carved out time to review the latest in retirement income planning research (Some people golf, others travel, this is what I do for fun!). In my quest, I stumbled upon a summary titled, ‘39 Modern Retirement Income Planning Techniques’ by Wade Pfau, Ph.D.. Since this is so fascinating to me, I thought I’d fully explain all 39 techniques with you here. You may want to grab a cup of coffee…I’ll wait…

Clearly you have other things to occupy your time, so I’ll spare you the minutiae. As is often the case, one big idea bubbled to the surface. The challenge almost every retiree is trying to overcome is that of receiving the right amount of income at precisely the right time. While this may seem odd or even obvious, there is a strange dynamic at play. Retirees are most active early in retirement, and tend to have the greatest need for income early in retirement, not later. However, time is the greatest leverage opportunity for growing more future income by way of gains and growth in the markets. So, while waiting for money to grow into more future money, the retiree is tempted to spend less at the very time when they’re most active. It’s backward! (Or backwardization, which is a term I invented.)

Said another way, if a retiree has a million dollars and knows they have only 2 years to live, do the math on how much can be spent each year. Conversely, that million dollars spread over 40 years of a retirement must be put to work very differently. So even though income payout rates can grow over time, as there are fewer years left to collect due to shortened life expectancy, the greatest likelihood of using the saved money is in the earliest years. The retiree may not live 40 years, but just two instead.

Among the 39 income planning strategies, many encourage a retiree to increase spending over their retirement, as market gains grow the portfolio, and as life expectancy shortens. That sounds great, except for the fact that very few retires I know wish to delay travel, golf, and other endeavors until late in their lives. How many 90 year-olds do you know who are still traveling regularly?

As a result, we must consider retirement income strategies that allow for a retiree to spend more money earlier in retirement than later, while simultaneously protecting them from depleting savings before death occurs. This is the crux of the matter.

Every article and study I read on the subject of retirement income planning strategies ends with a similar phrase: “It depends.” How you build your income depends on a number of factors that require careful consideration and communication with your advisors. It’s nice to have 39 techniques from which to choose, but you know that such vast choices means there cannot be just one right universal way to build a retirement plan. There can be a right way for you, just prepare for some thoughtful planning in order to find it.