Can Withdrawal Strategies Be Customized for Clients?

Robo advisors offer commoditized investment solutions for those in the accumulation phase. But planning a retiree’s withdrawal strategy is much more complex. I examine new research that offers a way to algorithmically determine how to draw down one’s savings.

Researchers have proposed a variety of ways for retirees to turn savings into income, including such methods as the 4% rule or relying on required minimum distributions (RMDs). Methods proposed have typically been generic and not customized for individual retirees. Researchers at CANNEX, a Canadian retirement-research firm, have proposed an approach where the pattern of withdrawals reflects individual client attitudes toward risk. I’ll describe their proposed approach, provide my assessment, and offer more general comments on withdrawal strategies.

With the shift to defined-contribution plans, the retirement template has evolved to accumulating savings during the working years and then placing the responsibility on individual retirees to determine how to spend their savings during retirement. Spending funds too quickly risks old-age poverty, and being too frugal risks missing out on opportunities for enjoyment.

Of course, retirees could just buy annuities (along with delaying Social Security) and not be concerned about outliving their savings. This strategy makes sense to cover essential expenses. But there’s still the issue of timing discretionary spending, and there are retirees (or their advisors) who are not comfortable with annuities, and therefore face bigger challenges spending down savings.

Individual retirees will differ in how comfortable they are spending more early in retirement and risking coming up short in old age. That leads to the question of whether withdrawal strategies can be developed that adjust for such individual differences.

The CANNEX adaptive-withdrawal strategy

CANNEX recently published a white paper that proposed its adaptive-withdrawal strategy (AWS), which incorporates what it referred to as “longevity risk aversion.” Basically, those who are more concerned about outliving their assets should spend less in the early retirement years in order to hold onto more savings for later in life if needed. The specific method it proposed for coming up with spending recommendations involves economic utility analysis. The white paper doesn’t get into the utility function math, but the inspiration for this method goes back to research by Professors Huang and Milevsky at York University in Toronto, who published the 2011 paper, “Spending Retirement on Planet Vulcan.” This paper provided an in-depth description of the approach, including the utility math. It certainly will be worth reading the CANNEX white paper to gain a fuller understanding of what the CANNEX authors are proposing, and the “Planet Vulcan” paper for those who wish to delve into the supporting math.

A difficulty in customizing its approach for financial planning clients is that it requires specific numerical assumptions to do the utility math – a risk aversion coefficient and a personal discount rate. However, it is feasible to put in reasonable numbers for assumptions and propose general conclusions about retirement withdrawals, as the authors do in the white paper. This type of research can be useful.

The CANNEX authors make the argument that their approach to retirement planning produces higher withdrawals earlier in retirement, when retirees are able to get the most out of spending. Their approach incorporates variable longevity, so any utility from spending money later in retirement is discounted by an increasing probability of not living that long. They also confirm that higher levels of guaranteed lifetime income (Social Security, pensions or annuities) enable higher withdrawals early in retirement.