Retirement income strategies:
What have we learned?
John Ameriks
Principal
Vanguard
May 19, 2009
Agenda
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An old problem on a new scale
Products old and new
Consequences of volatility
Implications for planners
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The changing retirement landscape
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Key forces in the United States
The baby boomers are retiring
DC (or DB) lump sums are more prevalent
People are living longer
Health care burden is rising—even with Medicare
> Many retirees face an “asset/income” challenge.
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The changing consumer landscape
Growing consumer anxiety in the United States
Pre-retirees who are “very concerned” about:
70%
57%
60%
53%
50%
46%
44%
40%
49%
35%
53%
49%
44%
36%
28%
30%
20%
61%
60%
15%
10%
0%
Cuts in social
security
2004
Outliving savings
2006
Source: McKinsey & Company, 2006.
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Interest rate
changes
Health care
costs
Guaranteed
income
Market
fluctuations
Inflation, taxes
Spending is more complicated than saving
Accumulators:
How much
should I save?
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How should
I invest?
Spending is more complicated than saving
Retirees:
Can I
stomach
income
volatility?
How
can I
minimize
taxes?
How much can I spend to –
• Avoid running out of money?
• Avoid undue frugality?
• Leave something for heirs?
How much
will healthcare
cost?
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When
can I afford
to retire?
How do I
estimate
my income
needs?
How
should I
invest?
Retirement income planning
Trading off conflicting goals and risks
Income goals
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Risk mitigation
Constraints
• Regular income
• Investment risk
• Investment costs
• Flexible spending
• Inflation risk
• Guarantee costs
• Survivors/bequests
• Longevity risk
• Taxes
The “eternal triangle”
Cost
Risk
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Return
Competing priorities
Older Americans spending from long-term accounts
100%
96%
29%
95%
93%
92%
90%
85%
85%
23%
16%
33%
39%
82%
41%
30%
27%
59%
50%
67%
72%
60%
53%
41%
69%
49%
55%
39%
55%
18%
11%
0%
Keeping control
Very important
Source: Vanguard, 2008
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Ensuring my
money lasts
Protecting
assets
Keeping up w ith
inflation
Somewhat important
Unexpected
expenditures
Guaranteed
income
Basic living
expenditures
Regular monthly
income
Leaving
inheritance
Charitable giving
The income-solutions marketplace
Portfolio
(non-guaranteed) options
Guaranteed options
Income investing
First generation
Systematic withdrawal plan
(SWP)
Immediate income annuity
Second generation
Payout funds
“Living benefits” annuity*
Other retirement income solutions include:
“DB in DC” deferred annuities, longevity insurance, and reverse mortgages.
*Such as an annuity with a Guaranteed Minimum Withdrawal Benefit (GMWB) rider.
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Systematic withdrawals: the 4% rule
=
100K
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$100,000, annual income
shouldn’t exceed $4,000,
with CPI adjustments
in future years
Systematic withdrawals and longevity risk
Historic probability of going broke in 30 years
44%
29%
13%
0%
$4,000
$5,000
$6,000
Initial annual withdraw (plus inflation thereafter)
$7,000
Source: Vanguard Investment Strategy Group
IMPORTANT: The projections or other information generated by this analysis regarding the likelihood of various investment outcomes are hypothetical in nature, do not
reflect actual investment results, and are not guarantees of future results. Note: This analysis does not consider taxes. Annual returns and inflation for a given asset allocation
are based on historic data from 1926 through 2007. Past performance is not a guarantee or a prediction of future results. Stock market returns are for Standard & Poor’s 500 Index
from1926 to 1970, the Dow Jones Wilshire 5000 Index from 1971 through April 22, 2005, and the MSCI U.S. Broad Market Index thereafter; bond market returns are based on the
Standard & Poor’s High Grade Corporate Index from 1926 to 1968, the Citigroup High Grade Index from 1969 to 1972, the Lehman Long-Term AA Corporate Index from 1973 to
1975, and the Lehman Aggregate Bond Index thereafter. Results may vary with each use and over time.
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Payout funds: A new approach
to systematic withdrawals
The investor’s problem
• How much from my lump sum should I withdraw?
• How do I manage my portfolio in light of my spending?
• What are the mechanics of taking out money?
Payout funds: a “do it for me” income program
• “SWP in a box”– fund manager oversees payouts
• Embedded portfolio strategy – integrated with payout strategy
• Monthly distribution payments using distribution mechanics of mutual funds
Two types in United States marketplace
• Liquidating – goal is liquidation of account over fixed period (e.g.,10 years)
• Endowment – goal is perpetual stream of payments with residual balance
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At Vanguard: three funds, three objectives
Level
of initial
payment
Distribution Focus Fund
Growth and Distribution Fund
Growth Focus Fund
Level of expected growth in payment and capital*
*Growth payments and capital are not guaranteed.
Payments may include return of capital and all the funds are subject to loss.
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Payout structure
Payment amount is based on rolling three-year average
net asset value—3%, 5% or 7%
Potential payment increase
Current year: Equal monthly payments
Next January
Endowment
Potential payment decline
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Income annuities
The traditional solution to longevity risk
$$$ 76
Investor A $
Investor B $
Annuity
pool
$$$$$$$$$$ 96
Investor C $
Pooling benefits
• Near-zero longevity risk
• Near-zero income risk
• Less required savings
…yet negligible adoption
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$$$$$$$ 86
The living benefit annuity
VA wrapper
• 5% for life
Age 65 investor $
Balanced
fund
• “Ratchets up”
in good markets;
no downside
• Liquidity at FMV
But
• Fees, surrender charges
• Insurer’s hedging skills
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Living benefit feature
$6,000
guaranteed for life
$5,500
$5,200
100K
$5,000
Portfolio value
This hypothetical illustration [or “example”] does not represent the return on any particular investment.
The final account balance does not reflect any taxes or penalties that may be due upon distribution.
Withdrawals from a deferred account before age 59 1/2 are subject to a 10% federal penalty tax unless
an exception applies.
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- 40%
Perhaps too good to be true?
• Hedging programs were apparently weaker than generally believed
• Providers on the retail side exiting this market
– Fidelity, Mass Mutual announcements
– Others financially stressed, prices rising
• How do you properly price this product?
– Long-term put options not widely available
– Dynamic hedges subject to dramatic price swings
– Behavioral elements highly uncertain
• Clients will need to be aware that the terms of the deal could change...
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Other income solutions
• Reverse mortgage market – continues at low level of usage
– Is it the right solution only for the house-rich and cash-rich?
• Longevity insurance – still novel product
– Will investors be this far-sighted?
• “DB in DC” – the return of the deferred annuity
– Should participants incur higher costs for a retirement income
“option” they typically don’t exercise?
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Vanguard’s perspective
• Despite all the product development –
– No “killer app”
– Hybrid solutions may flourish if hedging successful, costs fall
– Individual “income allocation” decisions, no universals or defaults
• The in-plan vs. beyond-the-plan dilemma –
– Fiduciary decisions
– Regulatory constraints
– Participant vulnerability
• Education and advice will be key
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Complexity – how many accounts do retirees own?
Including both transaction and long-term accounts
Percentage of retirees
15%
10%
5%
0%
1
2
Number of accounts
Median = 6.0
Mean = 6.7
Source: Vanguard, 2008
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3
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5
6
7
8
9
10
11
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15 or
more
The planner’s perspective
• Not a lack of strategies, but a lack of a framework for decision-making
– Need for methodology and process
– Need for client communication tools
• Having a robust retirement income plan – more than Social Security and a SWP
– Strategic use of annuities?
– Payout funds for discretionary income?
– New guaranteed options: what role will/should they play?
• The key questions:
– How will nonguaranteed investors react in times of volatility?
– Will the guarantors be successful with their hedging?
Bottom-line: Striking the right balance between risk, return and cost
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Disclaimers
For more information about Vanguard funds and variable annuity products, visit www.vanguard.com,
or call 800-523-1030, to obtain fund and variable annuity contract prospectuses. Investment objectives,
risks, charges, expenses, and other important information about the product are contained
in the prospectuses; read and consider them carefully before investing.
Annuity guarantees are based on the claims-paying ability of the underlying insurance companies
that issue the annuity.
The Managed Payout Funds are not guaranteed to achieve their investment objectives, are subject to loss,
and some of their distributions may be treated in part as a return of capital. The dollar amount of a fund’s monthly
cash distributions could go up or down substantially from one year to the next and over time. It is also possible
for a fund to suffer substantial investment losses and simultaneously experience additional asset reductions
as a result of its distributions to shareholders under its managed distribution policy.
An investment in a fund could lose money over short, intermediate, or even long periods of time because each
fund allocates its assets worldwide across different asset classes and investments with specific risk and return
characteristics. Diversification does not necessarily ensure a profit or protect against a loss in a declining market.
The funds are proportionately subject to the risks associated with their underlying funds, which may invest in stocks
(including stocks issued by REITs), bonds, cash, inflation-linked investments, commodity-linked investments,
long/short market neutral investments, and leveraged absolute return investments.
© 2009 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.
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