INSIGHTS
Our research suggests investors and their financial advisors should look beyond the static
rules of the past when seeking to achieve stronger results from their retirement income
withdrawal strategies. A portfolio-based solution using a more robust withdrawal rate
framework may help investors better address their retirement funding needs by embedding
market risk, longevity risk and evolving personal circumstances in a way that a cash-flow-
based approach simply cannot.
As we have evaluated various withdrawal strategies and have taken into account new criteria,
we have found that:
• Maximizing expected lifetime utility (i.e., potential derived satisfaction) serves as a more
effective benchmark of retirement withdrawal success than typical measures, such as
probability of failure. Focusing on utility offers a way to quantify how much satisfaction
retirees receive from their portfolio withdrawals. This can help potentially increase
investors’ level of income when they are most apt to enjoy their retirement dollars, while
still avoiding the risk of premature portfolio depletion.
• Age, lifetime income and wealth all provide key insights into how to adjust investors’
withdrawal strategies throughout retirement. Holding all other factors constant, higher
initial wealth levels suggest individuals lower their withdrawal rates, while also increasing
their fixed income allocations. Greater lifetime income, through Social Security, pensions
and/or lifetime annuities, allows individuals to increase both their withdrawal rates and
equity allocations. Increasing age allows individuals to increase their withdrawal rates,
while also decreasing their equity exposure.
Sincerely,
2 B R EA K IN G T H E 4% RUL E
TABLE OF CONTENTS
5
Overview
7
Comparing different retirement income withdrawal strategies
9
Developing a dynamic decumulation model
14
Dynamic retirement income withdrawal applications
25
Conclusion
26
Appendix
In an ideal world, one could simply match all future expenses in retirement with the
proceeds from a portfolio of assets derived from pre-retirement savings, thereby
safeguarding adequate income and removing the risk of funding shortfalls. This is
difficult to achieve in practice, however, for two main reasons:
The unpredictable nature of these two critical inputs highlights some of the
weaknesses in conventional approaches to retirement income planning. Indeed, there
is mounting evidence that the static withdrawal rules of thumb that may have worked
well enough in the past likely do not offer the most efficient usage of retirement
assets. The 4% rule in particular has faced increased scrutiny, prompted by the
current prolonged low interest rate environment and the negative impact fixed
withdrawals had on shrinking retirement account balances in the wake of the 2008
financial crisis.
1
Pew Research Data; December 2010.
2
The term lifetime income refers to any income that is “guaranteed” and will last for life, such as Social
Security, pensions and/or lifetime annuities.
6 B R E A K IN G T H E 4% RUL E
Comparing different retirement income
withdrawal strategies
Evaluating various retirement income withdrawal approaches starts with defining the objectives of a successful post-
retirement decumulation strategy. Most would agree that the primary focus of a prudent withdrawal approach is
to maintain a careful balance between managing lifestyle risk and longevity risk, two critical, if at times conflicting,
goals. The key is to generate and withdraw enough from retirement savings to finance expenses at a level that
maintains a sustainable post-retirement living standard, while avoiding the uncertainty of running out of money.
It is also important to remember, however, that there is an In addition, adequate decumulation sustainability requires
emotional value to retirement income, as well as a monetary one. accounting for a broad range of market scenarios and planning
As such, we recommend adding a third goal to this list: maximiz- for as many future (and historical) trajectories of the financial
ing how much utility value investors receive from their withdrawals. markets as possible, including severe downside scenarios such
This offers a more holistic perspective around the withdrawal as those experienced in the financial crises of 2008.
planning process to help capture the full potential of retirement
All of these considerations provide useful context to compare
assets. For example, the risk of running short of money is easy
different retirement income withdrawal strategies. Consider
to grasp, but pulling out too little is also problematic, in our
the two most common approaches:
opinion. Setting aside specific bequests and/or legacy aspirations,
an excess level of unused wealth at death may only represent • The “4% rule” dictates that individuals withdraw 4% of their
assets that could have been utilized to enhance the richness of initial portfolio value in the first year of retirement and
an individual’s retirement experience, perhaps significantly. annually increase that amount by the inflation rate of the
Hence, we believe the aim of a withdrawal strategy should be to preceding year to maintain purchasing power (alternatively,
exhaust retirement assets in the most efficient manner possible, inflation increases may be based on historical rates or long-
while mitigating the risks of premature portfolio depletion. term averages). This approach focuses on withdrawals only
In order to incorporate the concept of utility value into the and does not recommend a particular asset allocation.
withdrawal process, we focus on a metric known as expected Dollar amounts are determined strictly by portfolio value,
lifetime utility, which quantifies the collective perceived without any additional consideration to individual retiree
satisfaction of all withdrawals received in retirement. While characteristics around wealth, age or lifetime income.
this measure can arguably be somewhat subjective, it draws • The required minimum distribution (RMD) approach is
from well-established microeconomic principles that offer based on the amounts that the U.S. government requires
important insights into the emotional aspects of investing. retirees to withdraw from traditional Individual Retirement
A robust withdrawal framework also needs to take into account Accounts and employer-sponsored retirement plans
a wide variety of personalized factors that may influence the beginning at age 70½. Annual withdrawals are determined
optimal income strategy. Specific individual investor charac- using the following equation:
teristics, such as age, wealth level, level of lifetime income Withdrawal amount = Portfolio value / Remaining life expectancy
(e.g., Social Security, pensions or lifetime annuities), life
expectancy and risk preferences provide key inputs into The RMD approach also does not recommend a particular
determining an appropriate asset allocation strategy and the asset allocation, nor does it account for retiree wealth or
resulting withdrawal rate that can be realistically supported. lifetime income, though it does consider age.
J.P. Morgan Dynamic Strives to maximize Age, wealth, lifetime Yes Yes Yes
Strategy expected lifetime utility income, risk profile
As shown in Exhibit 1, these common approaches have pros financial markets, including the risks of extreme events such
and cons. The 4% rule is simple to understand and easy to as the 2008 financial crisis.
apply, but it has come under fire in the past several years
given that it does not hold up particularly well against • The J.P. Morgan Dynamic Retirement Income Withdrawal
longevity risk in extremely volatile markets, especially when a Strategy offers withdrawal rate and asset allocation
portfolio loses significant value during the early years of suggestions, both of which are proactively tailored to retirees’
retirement. The RMD methodology is better at ensuring that evolving circumstances and portfolio experiences on an
retirees do not deplete assets early, since it incorporates life ongoing basis. For a given age, level of wealth and level of
expectancy into its basic formula. However, it can be unstable lifetime income, our framework dynamically determines an
in terms of minimizing lifestyle risk, since it directly translates appropriate asset allocation and corresponding withdrawal
portfolio volatility into income volatility. For example, a 15% amount for the upcoming year. The resulting detailed output
asset decline automatically translates into a 15% RMD is based on sophisticated portfolio modeling that has largely
spending cut, potentially difficult to manage on a fixed budget. been out of reach for most investors. (For a more detailed
description of this process, please refer to the Appendix.)
Given these shortcomings, J.P. Morgan began to explore how
investors might better satisfy their retirement income needs. This highly personalized approach is also unique in the sense
It seemed intuitive that a more dynamic approach to that it has been specifically built around the concept of
withdrawal rate and asset allocation modeling could provide maximizing expected lifetime utility. Incorporating individual
the flexibility and customization necessary to minimize both characteristics and preferences as key inputs offers a
lifestyle risk and longevity risk, while extracting more potential disciplined yet dynamic withdrawal approach to help retirees
from a portfolio through a wider range of market cycles. The extract greater financial and personal value from their
result of this detailed research is a withdrawal framework that portfolios. This process seeks to help compensate for the
is much more adaptive to the dynamic aspects of post- magnitude of income shortfalls and extra spending that may
retirement decision making and the uncertain nature of transpire throughout retirement, while reducing the risks of
both outliving assets and excess wealth accumulation. The
result is a retirement income planning approach designed to
help achieve broader investment success across the entire
PLACING UTILITY VALUE ON retirement horizon.
RETIREMENT ASSETS
The fields of microeconomics and behavioral finance offer
practical insights into how investors tend to view and respond to
decisions about money and investing. Applying these principles
to a withdrawal strategy may help investors enjoy richer and
more fulfilled retirements by acknowledging the emotional
elements behind the retirement income planning process.
8 B R EA K IN G T H E 4% RUL E
Developing a dynamic decumulation model
To develop a cohesive withdrawal framework, we identified five key factors to address in our decumulation model.
Each of these variables can have significant impact on optimizing a post-retirement withdrawal solution. Following are
brief descriptions of each factor with the rationale for its inclusion.
Factor 1: Individual preferences for magnitude preference for withdrawals made earlier in retirement. This
and timing of withdrawals is also consistent with human behavior, whereby income
In order to evaluate the satisfaction, or utility, a retiree receives received earlier (e.g., today) is more attractive than income
from a given withdrawal strategy, we rely on a utility-based received in the future (e.g., tomorrow). It is worth noting
methodology to help measure and evaluate the emotional value that this time preference for earlier income is strictly
of each dollar paid out. We apply a utility function that can emotional in nature and distinct from the time value of
model retiree preferences for both magnitude and timing of any money, which instead accounts for the monetary
income received to help quantify this core input. discounting of dollars (i.e., dollars received in the future
compared to their present purchasing power).
• Withdrawal magnitude: The utility function around
withdrawal amounts is concave (or “curving in,” as shown in
Factor 2: Levels of wealth and lifetime income
Exhibit 2) with respect to increases in retirement income. In
It seems logical that different levels of wealth and lifetime
other words, retirees get less satisfaction from each
income, such as Social Security, pensions and life annuities,
additional dollar of income withdrawn above a certain point.
should generate different suggested asset allocations and
This is consistent with human behavior, whereby the first
withdrawal rates in retirement. For example, retirees with higher
dollar of income received carries more marginal satisfaction
initial wealth levels have a greater ability to withstand negative
than each additional dollar.
shocks, such as unanticipated medical, living or travel expenses
• Withdrawal timing: The utility function around when a due to inflation or personal emergencies. Similarly, individuals
retiree receives money includes a discount factor that and couples with significant lifetime income have a lower risk of
applies to each future withdrawal. This discount factor poorer outcomes later in retirement than retirees with less
increases as withdrawals take place in the future, as lifetime income, since this secured income baseline ensures at
illustrated in Exhibit 3. As a result, there is a time
35
10
30
8
25
Present utility
Utility
20 6
15
4
10
5 2
0 0
$0 $10,000 $20,000 $30,000 $40,000 $50,000 65 70 75 80 85 90 95 100
Spending Age
Source: J.P. Morgan Asset Management and Essays in the Theory of Source: J.P. Morgan Asset Management. For illustrative purposes only.
Risk Bearing, Markham Publ. Co., Chicago, 1971.
60
that meets income goals across a wider range of possible
40 scenarios is more robust and preferable to one that meets
retirees’ needs in only a small, specific set of market conditions.
20
0
65 70 75 80 85 90 95 100 105
Age
3
For further details, please see http://www.ssa.gov/oact/STATS/table4c6.html.
Source: J.P. Morgan Asset Management and Social Security Administration. 4
To calculate the probability of at least one spouse surviving to a given age,
For illustrative purposes only. use the formula P(A or B) = P(A) + P(B) – P(A and B). For ease of computation,
we assume A and B are independent so that P(A and B) = P(A) x P(B).
5
Our model assumes a one-third reduction in lifetime income upon the death
of a spouse, an approximation based on the current Social Security formula
Our framework weighs the utility of withdrawals at a given age rules applied to a couple with one working spouse. The exact reduction in
Social Security benefits will likely vary depending on the unique
by the probability of survival to that age to arrive at a survival circumstances of the couple.
weighted utility of withdrawal. Thus, each period’s withdrawal 6
To maintain parity in utility functions, we ensure the utility of $0.66 (two-
thirds of $1) spent by the surviving spouse is equal to the utility of $1 spent
utility is discounted by the probability of being able to actually by a couple. For further details, please refer to the exact specification of the
obtain it. For example, a 65-year-old couple’s survival weighted utility function in the Appendix.
utility for $1 projected to be withdrawn at age 75 is higher than
10 B REA K IN G T H E 4% RUL E
To capture the future uncertainty associated with the financial one-standard-deviation events and better reflecting their
markets, our model applies a forward-looking simulation that observed frequency. This revised set of assumptions and
generates 10,000 random equity and bond returns.7 We use statistical techniques is designed to help gain a better picture
J.P. Morgan 2014 Long-Term Capital Market Assumptions for of downside risk and provide a more realistic framework for
the purposes of calibrating expected performance, as shown identifying and testing potential investment solutions.
in Exhibit 5. The firm offers market assumptions that cover a
wide array of asset classes. Any number could be included in Factor 5: Dynamic nature of the
the model output, but we focused on two asset classes with decision-making process
very different risk/reward profiles to help simplify our
Evolution of an individual’s wealth in retirement will depend
analysis, while still effectively illustrating how retirees might
on actual realized expenses and the performance of portfolio
adjust risk exposure.
assets. As discussed earlier, although retirement expenses and
portfolio performance can be estimated, they cannot be
E XH IB IT 5: J.P . MO R GAN 2 01 4 L ON G-T ERM C APIT AL M A R K E T forecasted with any amount of detailed precision.
A SSUMPT IO NS
=
• Define utility function parameter values Solve for optimal asset Customized asset
to describe retiree preferences allocations and withdrawal allocation and withdrawal
• Define life expectancy from 60 onwards rates at each age to maximize rate considerations based on
• Set levels of retirement wealth and expected lifetime utility age, wealth, lifetime income,
lifetime income gender, marital status and
• Generate 10,000 simulations accounting for risk profile
non-normal financial market returns
12 B REA K IN G T H E 4% RUL E
• Second, it does not adequately allow for the risk of excess
wealth accumulation or any degree of potential shortfall ACCOUNTING FOR BEQUESTS AND LEGACIES
in retirement. Probability of failure metrics only consider The J.P. Morgan Dynamic Strategy can be customized to
downside risks in a binary fashion, the consequence of accommodate retirees’ specific bequest and legacy aspirations.
Because this model strives to exhaust retirement assets in the
which may be advocating strategies that are overly
most efficient manner possible, retirees simply must segment
conservative, either with low withdrawal rates and/or fixed whatever dollar amount they hope to leave behind away from
income heavy portfolios. This may risk unnecessarily their withdrawal portfolios. This ensures an adequate amount
reducing retirees’ standard of living, as well as resulting in will be reserved to fulfill their wishes rather than hoping
a potential accumulation of assets later in retirement for enough assets are left in their estates to meet these needs.
which investors ultimately have little need or use.
THE IMPORTANCE OF PLANNING FOR
A utility-based metric eliminates these problems. To be fair,
EXTREME MARKET EVENTS
even this preferred approach has drawbacks. For example, the
choice of utility function is not easy or clear cut, and even The concept of investment fat-tail risk refers to the relatively
smaller probability of experiencing extreme performance
then there is debate around the proper choice of parameter outcomes that may occur less frequently but remain well within
values to be used in calibration. The concept of utility also the realm of possibility. The challenge is that these severe
cannot be measured directly but rather relies on drawing events are completely random and may happen far more often
inferences from human behavior. Accordingly, there is still than most people are willing to contemplate. Just ask retirees
unlucky enough to suffer recently through two devastating
considerable subjectivity in measuring and evaluating the
bear markets and a decade of flat equity returns.
utility of different withdrawal strategies. However, while this
measure is by no means perfect, we believe it incorporates
much more realistic assumptions about human preferences
and retirement dynamics than traditional metrics. These
insights provide significant advantages in developing a
withdrawal model better structured to meet the real-world
needs of retirees.
14 B REA K IN G T H E 4% RUL E
2. Impact of lifetime income E X HI BI T 8 : U TI L I TY - BA S E D W I THD R A W A L R A TE S A N D
A L L O CA TI O NS A CR O S S L I F E TI M E I NCO M E L E V E L S (H OLDI N G
As discussed earlier, retirees with little or no lifetime income A G E A T 65 A ND W E A L TH A T $1 M I L L I O N CO NS TA N T )
have a greater risk of poorer outcomes later in retirement than 6.5 Withdrawal rate (LHS) Bond allocation (RHS) 60
retirees with higher levels of lifetime income. This suggests that
the effects of increasing lifetime income levels with regards to 6.0
50
Exhibit 8 shows how our dynamic framework quantifies the $20,000 5.5% 38%
precise relationship between lifetime income levels, withdrawal $30,000 5.7% 30%
rates and asset allocations. In this example, the suggested first $40,000 5.8% 24%
year withdrawal rate for a 65-year-old couple with $1 million in $50,000 5.9% 17%
retirement savings and $20,000 in lifetime income is 5.5%, with $60,000 6.0% 12%
a suggested 38% total portfolio bond allocation. For a 65-year-
Source: J.P. Morgan Asset Management. For illustrative purposes only.
old couple with $1 million in retirement savings and $40,000 in
lifetime income, the suggested withdrawal rate jumps to 5.8%
per year, while the suggested bond allocation decreases to 24%.
percentage decline in wealth, due for example to poor equity
BOTTOM LINE: Greater lifetime income, from sources such as performance, leads to a larger dollar and utility reduction
Social Security, pensions or lifetime annuities, allows retirees compared to less wealthy retirees.
to increase both their withdrawal rates and equity allocations.
Keep in mind that this concept is distinct from wealthier retirees’
financial ability to weather volatility, at least in terms of securing
3. Impact of wealth minimum baseline levels of living essentials (e.g., market losses
There are two main drivers to consider in terms of the impact are unlikely to result in wealthier retirees going hungry, but it
different wealth levels may have on the retirement withdrawal may prompt more at-home dinners than eating out at fancier
planning process. First, higher retirement wealth levels restaurants). Instead, it focuses on the greater emotional distress
require a smaller proportion of withdrawals to be spent on of experiencing larger dollar losses. This suggests that the effects
basic necessities, such as food, shelter and health care, of increasing wealth levels with regards to withdrawal rates and
allowing potentially more to be spent on non-essentials, such asset allocations should be as follows:
as travel and entertainment. Second, utility theory suggests
• For a given age and level of lifetime income, withdrawal
asymmetric attitudes of individuals with regards to gains and
rates at higher wealth levels should be less than at lower
losses. In a retirement context, reducing withdrawals by a
wealth levels. This is because the actual dollar amount
certain dollar amount carries more emotional distress than
withdrawn is substantially higher and the satisfaction
the pleasure obtained from increases of a similar amount. This
derived from greater withdrawals does not increase
effect is more pronounced for wealthy retirees, as a specific
E XH IB IT 9 : UT IL IT Y -B AS ED W I T H DRAW AL RAT ES AN D E X HI BI T 1 0 : S U M M A R Y O F HO W I ND I V I D U A L F A CT OR S MA Y
A LLO CATIO NS ACRO S S W EAL T H L EVEL S ( H OL DI N G AG E A T 6 5 A F F E CT W I THD R A W A L S A ND A S S E T A L L O CA TI O NS
A ND L IFETIME INC O M E AT $ 5 0,000 C ON S T AN T )
6.5 Withdrawal rate (LHS) Bond allocation (RHS) 40 Factor Withdrawal rate Equity exposure
35 Increasing age
6.0
30 Higher lifetime income
Withdrawal rate (%)
25
5.5 Higher initial wealth level
20
5.0 15
10
4.5
5
16 B REA K IN G T H E 4% RUL E
Multidimensional aspects of a • Case study 1: 65-year-old couple with $1 million in
dynamic withdrawal strategy retirement savings and $50,000 in lifetime income.
Our suggested withdrawal rate is 5.9% for the next year,
Although an analysis of each of these individual factors with a suggested bond allocation of 17% and the
provides useful background, in practice age, wealth and remaining 83% invested in equities.
lifetime income are likely to evolve concurrently throughout
retirement. Hence, it is important to understand how our • Case study 2: 60-year-old couple with $2.5 million in
model adapts withdrawal rates and asset allocations when retirement savings and $20,000 in lifetime income.
more than one factor changes at the same time, since this is Our suggested withdrawal rate is 4.8% for the next year,
how individuals typically experience retirement. with a suggested bond allocation of 47% and the
remaining 53% invested in equities.
Exhibit 11 offers specific examples of the J.P. Morgan
Retirement Income Withdrawal Tables generated by our • Case study 3: 80-year-old single female with $500,000
dynamic framework. These provide actual suggested in retirement savings and $20,000 in lifetime income.
allocations and withdrawal rates for different combinations of Our suggested withdrawal rate is 9.1% for the next year,
age, wealth and lifetime income. To illustrate how these tables with a suggested bond allocation of 28% and the
function, consider three hypothetical situations and the remaining 72% invested in equities.
optimal withdrawal and asset allocation suggestions implied
by our framework for each:
18 B REA K IN G T H E 4% RUL E
Stronger projected withdrawal
TAX CONSIDERATIONS
outcomes
Our model is focused strictly on optimizing withdrawal rates
Next, we wanted to evaluate how our framework might stand and asset allocations in retirement. It does not take into
up to the rigors of real-world retirement funding. We com- account any applicable taxes, due to the highly variable nature
pared the customized considerations of the J.P. Morgan of different tax situations.
Dynamic Strategy to the static output of the 4% rule and RMD
model, assuming a fixed 60% equity/40% bond allocation ONGOING ANNUAL TABLE UPDATES
across retirement for the latter two approaches. These tables may change in any given year, as new research
around retirement income withdrawals emerges and J.P.
We applied these three withdrawal strategies to the previous Morgan Long-Term Capital Market Assumptions and the U.S.
three case studies, running each hypothetical investor Social Security Administration’s Actuarial Life Tables evolve.
example through 250,000 simulations across the entire
retirement horizon until death. For each simulation, the ADAPTING TO SPECIFIC RISK PROFILES
market return each year drew from the 10,000 possible Our model output can also be adjusted to accommodate
equity, bond and inflation scenarios used in our optimization different risk profiles. Sample tables for investors comfor-
table with either greater or less market risk can be found
process, covering the gamut from strong rising periods to in the Appendix.
severe declines. Each withdrawal strategy was assessed in two
ways. First, we analyzed the distribution of portfolio values
over time to understand how successful the withdrawal
approach was in addressing key risks in retirement. Second,
we numerically evaluated how effective each strategy was at
maximizing retirement income for risk-averse investors.
95%
Real consumption stream ranges using the 4% rule ▲Steady income and
$240,000 consumption stream
▼Risk of excess wealth and
premature asset depletion
$190,000
Real consumption
$140,000
$90,000
$50,000
lifetime
income
$40,000
65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105
Age
$140,000
$90,000
$50,000
lifetime
income
$40,000
65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105
Age
Real consumption stream ranges using the J.P. Morgan Dynamic Strategy
▲Low risk of excess wealth accumulation
$240,000 and asset depletion
▲Variable consumption stream with higher
potential payouts earlier in retirement
$190,000
Real consumption
$140,000
$90,000
$50,000
lifetime
income
$40,000
65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105
Age
20 B R EA K IN G T H E 4% RUL E
E XHIBI T 13: PER CENT ILE OU T C OM E S FOR RE AL PORT F O L I O V A L U E O V ER T I M E
$1,200,000
$1,000,000
$800,000
$600,000
$400,000
$200,000
$0
65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105
Age
$1,200,000
$1,000,000
$800,000
$600,000
$400,000
$200,000
$0
65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105
Age
$1,200,000
$1,000,000
$800,000
$600,000
$400,000
$200,000
$0
65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105
Age
E XH IB IT 14 : KEY FIND I N GS
22 B R EA K IN G T H E 4% RUL E
Evaluating withdrawal strategies E X HI BI T 1 5 : A S S E S S M E NT O F CE R TA I NTY E Q U I V ALEN T S
U ND E R D I F F E R E NT W I THD R A W A L S TR A TE G I E S
for risk-averse investors
Case study 1: 65-year-old couple with $1 million in
The second part of our analysis evaluated how effective each retirement savings and $50,000 in lifetime income
withdrawal strategy was at maximizing retirement income for $110,000 $108,233
risk-averse investors. To quantify this, we applied the concept $105,930
of certainty equivalents. $105,000
Certainty equivalent
Certainty equivalents measure how much lifetime real income $100,000
individuals would accept in lieu of trading all of their
retirement assets and following a particular strategy, such as $95,000 $93,719
the 4% rule. The lower the amount, the less attractive the
$90,000
particular strategy is to the individual, because the person
would accept a smaller lifetime income stream instead of $85,000
following the strategy. In our analysis, certainty equivalent 4% rule RMD approach J.P. Morgan
Dynamic Strategy
accounts for the risk-averse nature of retirees through our
choice of utility function, as well as for the likelihood of
various financial market and life expectancy scenarios. This
helps us compare different withdrawal strategies using a Case study 2: 60-year-old couple with $2.5 million in
common risk metric. (Details of the mathematical calculation retirement savings and $20,000 in lifetime income
for these certainty equivalents can be found in the Appendix.) $160,000
$136,612
$140,000
Exhibit 15 presents our certainty equivalent findings for the three $122,409
$120,000
case studies. In these examples, a higher certainty equivalent
Certainty equivalent
$100,000
represents a more attractive withdrawal approach since the
$80,000 $72,557
retirees demand higher guarantees to forsake that strategy.
$60,000
$40,000
Our key findings are:
$20,000
• For case study 1 with the 65-year-old couple with $1 million 0
in retirement savings and $50,000 in lifetime income, the 4% rule RMD approach J.P. Morgan
Dynamic Strategy
certainty equivalent for the J.P. Morgan Dynamic Strategy is
15% higher than the 4% rule and 2% higher than the RMD
approach. In other words, this retired couple would require
approximately $14,514 and $2,303 in additional lifetime Case study 3: 80-year-old single female with $500,000 in
income each year for the duration of their life in lieu of retirement savings and $20,000 in lifetime income
$60,000
following the J.P. Morgan Dynamic Strategy, compared to the $54,032 $55,080
• For case study 2 with the 60-year-old couple with $2.5 $40,000
million in retirement savings and $20,000 in lifetime
$30,000
income, the certainty equivalent for the J.P. Morgan
Dynamic Strategy is 88% higher than the 4% rule and 12% $20,000
24 B R EA K IN G T H E 4% RUL E
CONCLUSION Based on our findings, a dynamic approach to setting withdrawal rates and asset allocations in
retirement appears preferable to the static, more simplistic methods typically used by investors.
The commonly applied 4% rule and RMD approach fail to address many of the highly personalized
aspects of retirement withdrawals. Both also came under considerable pressure throughout the
2008 financial crisis and subsequent extreme market volatility, in many cases risking early
portfolio depletion in addition to retirees’ ability to maintain their lifestyle standards. Accordingly,
many investors are reconsidering how to draw income from their retirement assets more
efficiently, while better acknowledging the realities of market uncertainty.
A dynamic approach helps to address these challenges, adeptly balancing the management of
longevity and lifestyle risk in a more prudent manner throughout a broader array of market
cycles. It also adds the holistic measure of maximizing retirees’ satisfaction with their
withdrawal dollars, strategically embedding the behavioral and emotional components involved
with retirement income into the withdrawal planning process.
While the calculations and portfolio modeling behind this methodology can be complex, the J.P.
Morgan Dynamic Strategy gives financial advisors general guidance to consider when planning
for their clients’ retirement funding needs. Our proprietary model helps investors and their
financial advisors adapt appropriate withdrawal rates and bond exposure on an annual basis,
tailored to the investor’s age, wealth, lifetime income and risk profile. Specific bequests can
also be accommodated. The projected output from this dynamic framework seems to deliver
stronger, steadier payouts throughout retirement, while reducing the risk of either exhausting
portfolio assets too soon or amassing a substantial surplus of money likely to go unused by the
investor. This offers a customized, more realistic withdrawal solution to help retirees
proactively prepare and respond to changes in the market environment, as well as their
individual retirement situations.
G
𝑅𝑅𝑡𝑡is=the𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝑛𝑛
guaranteed ⋅ 𝑋𝑋 income that the couple has each year
𝑡𝑡 real
C t
from sources such as Social is the individual’s
Security andwithdrawal
annuities from their portfolio at age t
Where
β is the individual’s subjective
G is the discount real
guaranteed factorincome that the individual has each year from sources such as social security
C is the individual’s withdrawal from their portfolio at age t
t
and annuities
mi is the probability that at least one member of the couple is
alive at age i given that
G is the guaranteed real bothincome
members are the
that at age t has each year from sources such as social security
aliveindividual
β is the individual’s subjective discount factor
γand annuities
is the risk aversion parameter of the individual
ψ
β isis the mi is the
individual’s
the individual’s probability
subjective
elasticity thatfactor
discount
of intertemporal the individual is still alive at age i given that the individual is alive at age t
substitution
W is the
m t is theindividual’s
γ is theportfolio
probability value
that aversion
risk the at age t is still alive at age i given that the individual is alive at age t
individual
parameter of the individual
i
X is the random variable representing the joint stock/bond
γ is the risk ψaversion
is the parameter of elasticity
individual’s the individual
of intertemporal substitution
real return distribution
ψ is the individual’s elasticity of intertemporal substitution
Wt is the individual’s portfolio value at age t
Wt is the individual’s portfolio value at age t
X is the random variable representing the joint stock bond real return distribution
X is the random variable representing the joint stock bond real return distribution
26 B R EA K IN G T H E 4% RUL E
We solve the problem for males UM and females UF via
backward induction Wefrom
solveage 120 to 60. The continuous
We solve the problem for the
malesproblem
UM andforfemales
males U
UM and females UF via backward
F via backward induction
induction
from age from
120 to 60. Theage 120 to 60. The
wealth
We to
solveguarantee
the ratio
problem space
for is
males discretized
and in uneven
females via backward induction from age 120
continuous wealth U
to guarantee
M ratio Uspace
F is discretized
continuous wealth to guarantee ratio space is discretized in uneven intervals with a higher in uneven intervals with atohigher
60. The
intervals with
continuous a higher
wealth concentration
to guarantee of points
ratio spacetoward
isThe the
discretized in The
uneven intervals with a mesh
higher
concentration ofconcentration
points towardofthe points
lowertoward
ratios.the lower
value ratios.
function is value function
interpolated is interpolated
between between mesh points
points
lower ratios. The value function is interpolated between mesh
concentration of points
using cubictoward
splines. the
Thelower ratios.
expectation The
over value function
stock-bond-inflation is interpolated
distributions
using cubic splines. The expectation over stock-bond-inflation distributions is done with 10,000 random between
is done mesh
with points
10,000 random
points using cubic splines. The expectation over stock-bond-
using
drawscubic our draws
from splines. from
The
assumed our assumed
expectation
distributions. distributions.
over stock-bond-inflation distributions is done with 10,000 random
inflation distributions is done with 10,000 random draws from
draws
our fromdistributions.
assumed our assumed distributions.
After we solve After
the we solve
problem for the problemwe
individuals forthen
individuals we couples.
solve it for then solve it for couples.
After
Afterwe
wesolve
solvethe problem
the forfor
problem individuals, we we
individuals thenthen
solvesolve
it it for couples.
for couples.
1 1
⎧ ⎧ 1−1� 1−1�𝜓𝜓 1−1�𝜓𝜓 1−1�𝜓𝜓
𝛽𝛽𝑡𝑡 𝑚𝑚𝑡𝑡 𝑡𝑡
𝛽𝛽1− 𝑚𝑚
1�𝑡𝑡 ∑120 𝑖𝑖
𝑖𝑖=𝑡𝑡+1 𝛽𝛽1− 𝑚𝑚1𝑖𝑖� ∑120 𝛽𝛽𝑖𝑖 𝑚𝑚𝑖𝑖 1−𝛾𝛾𝜓𝜓
⎪�� 120 𝑖𝑖 � (⎪ + 𝐺𝐺) 𝑖𝑖 +��(𝐶𝐶𝑡𝑡 120
𝐶𝐶 �� 𝜓𝜓
+ 𝐺𝐺)𝑖𝑖
𝑖𝑖=𝑡𝑡+1
�𝜓𝜓 𝐸𝐸+𝑡𝑡 ��𝑈𝑈𝑡𝑡+1120�𝑊𝑊𝑡𝑡+1, 𝐺𝐺�� � �𝑊𝑊𝑡𝑡+1,𝑓𝑓𝑓𝑓𝑓𝑓
� 𝐸𝐸𝑡𝑡 �𝑈𝑈𝑡𝑡+1 𝐺𝐺��1𝑡𝑡 1−𝛾𝛾
< 120� 𝑓𝑓𝑓𝑓𝑓𝑓 𝑡𝑡 < 120
⎪ ∑𝑖𝑖=𝑡𝑡 𝛽𝛽 𝑚𝑚𝑖𝑖 ⎪𝑡𝑡 ∑120 𝛽𝛽 𝑚𝑚 ∑ 𝛽𝛽 𝑚𝑚 ∑ 𝛽𝛽𝑖𝑖
𝑚𝑚
⎧ 𝑡𝑡 𝑖𝑖=𝑡𝑡 𝑖𝑖 𝑖𝑖=𝑡𝑡 𝑖𝑖
∑𝑖𝑖=𝑡𝑡+1 𝛽𝛽 𝑚𝑚𝑖𝑖
120 𝑖𝑖 𝑖𝑖=𝑡𝑡 𝑖𝑖 1− �𝜓𝜓 1−1�𝜓𝜓
1
𝑈𝑈𝐶𝐶,𝑡𝑡 �𝑊𝑊𝛽𝛽𝑡𝑡, 𝐺𝐺�
𝑈𝑈𝐶𝐶,𝑡𝑡 �𝑊𝑊𝑡𝑡, 𝐺𝐺� = ⎪ 𝑚𝑚𝑡𝑡 = 1−1�𝜓𝜓
⎨⎪�� 120 𝑖𝑖 �⎨(𝐶𝐶𝑡𝑡 + 𝐺𝐺) + � 120 𝑖𝑖 � 𝐸𝐸𝑡𝑡 �𝑈𝑈𝑡𝑡+1 �𝑊𝑊𝑡𝑡+1, 𝐺𝐺�� 1−𝛾𝛾 � 𝑓𝑓𝑓𝑓𝑓𝑓 𝑡𝑡 < 120
∑𝑖𝑖=𝑡𝑡 𝛽𝛽 𝑚𝑚𝑖𝑖 ∑𝑖𝑖=𝑡𝑡 𝛽𝛽 𝑚𝑚𝑖𝑖
⎪ ⎪
𝑈𝑈𝐶𝐶,𝑡𝑡 �𝑊𝑊𝑡𝑡, 𝐺𝐺� =⎪ 𝑊𝑊𝑡𝑡 + 𝐺𝐺 ⎪ 𝑊𝑊𝑡𝑡 + 𝐺𝐺 𝑓𝑓𝑓𝑓𝑓𝑓 𝑡𝑡 = 120 𝑓𝑓𝑓𝑓𝑓𝑓 𝑡𝑡 = 120
⎩⎨ ⎩
⎪
𝑈𝑈𝑡𝑡+1 �𝑊𝑊𝑡𝑡+1, 𝐺𝐺� ⎪𝑈𝑈 𝑊𝑊𝑡𝑡�𝑊𝑊
+ 𝐺𝐺 𝐺𝐺 𝑓𝑓𝑓𝑓𝑓𝑓 𝑡𝑡 = 120
𝑡𝑡+1 𝑡𝑡+1, �
⎩ 𝑊𝑊 (1 − ℎ)𝐺𝐺 1−𝛾𝛾 1−𝛾𝛾 𝑊𝑊 (1 − ℎ)𝐺𝐺 1−𝛾𝛾 1−𝛾𝛾
𝑞𝑞𝑀𝑀,𝑡𝑡 𝑞𝑞𝐹𝐹,𝑡𝑡 𝑈𝑈 (𝑊𝑊𝑡𝑡+1 , 𝐺𝐺𝑞𝑞)1−𝛾𝛾 )𝑈𝑈+ 𝑞𝑞 �(1 −
𝑈𝑈 + 𝑞𝑞(𝑊𝑊(1 −, 𝐺𝐺𝑞𝑞)𝐹𝐹,𝑡𝑡1−𝛾𝛾
𝑡𝑡+1
𝑞𝑞𝐹𝐹,𝑡𝑡, )𝑈𝑈 �𝑊𝑊𝑡𝑡+1
+ (1(1−−𝑞𝑞 ℎ)𝐺𝐺 )𝑞𝑞 𝑈𝑈 + (1� − 𝑞𝑞𝑡𝑡+1 )𝑞𝑞, 𝑈𝑈 � 𝑊𝑊𝑡𝑡+1 (1 − ℎ)𝐺𝐺
𝐶𝐶,𝑡𝑡+1 𝑞𝑞𝑀𝑀,𝑡𝑡 𝐹𝐹,𝑡𝑡 𝐶𝐶,𝑡𝑡+1 𝑀𝑀,𝑡𝑡 𝑡𝑡+1 𝑀𝑀,𝑡𝑡 (1 − 𝑒𝑒)
𝑀𝑀,𝑡𝑡+1 − 𝑒𝑒)�(1 − 𝑒𝑒) , (1 −𝑀𝑀,𝑡𝑡𝑒𝑒) �𝐹𝐹,𝑡𝑡 𝐹𝐹,𝑡𝑡+1
(1𝑀𝑀,𝑡𝑡+1 (1 −𝑀𝑀,𝑡𝑡
𝑒𝑒) 𝐹𝐹,𝑡𝑡
(1 − 𝑒𝑒) �(1 − 𝑒𝑒) , (1 − 𝑒𝑒) �
𝑈𝑈=𝑡𝑡+1 �𝑊𝑊𝑡𝑡+1, 𝐺𝐺� =
𝐹𝐹,𝑡𝑡+1
𝑞𝑞 + 𝑞𝑞 − 𝑞𝑞 𝑞𝑞
𝑀𝑀,𝑡𝑡 𝐹𝐹,𝑡𝑡 𝑀𝑀,𝑡𝑡 𝑞𝑞
𝐹𝐹,𝑡𝑡 + 𝑞𝑞𝐹𝐹,𝑡𝑡 − 𝑞𝑞𝑀𝑀,𝑡𝑡 𝑞𝑞𝐹𝐹,𝑡𝑡
𝑀𝑀,𝑡𝑡
𝑊𝑊𝑡𝑡+1 (1 − ℎ)𝐺𝐺 1−𝛾𝛾 𝑊𝑊𝑡𝑡+1 (1 − ℎ)𝐺𝐺 1−𝛾𝛾
𝑞𝑞 𝑞𝑞 𝑈𝑈 ( 𝑊𝑊 𝑡𝑡+1 , 𝐺𝐺)1−𝛾𝛾
+ 𝑞𝑞 (1 − 𝑞𝑞 )𝑈𝑈 � , � + (1 − 𝑞𝑞 )𝑞𝑞 𝑈𝑈 � , �
𝑊𝑊𝑡𝑡+1 𝑀𝑀,𝑡𝑡= 𝐹𝐹,𝑡𝑡
(𝑊𝑊𝑡𝑡𝐶𝐶,𝑡𝑡+1
− 𝐶𝐶𝑊𝑊
𝑡𝑡 )𝑅𝑅𝑡𝑡 = (𝑊𝑊 − 𝐶𝐶 )𝑅𝑅 𝑀𝑀,𝑡𝑡 𝐹𝐹,𝑡𝑡 𝑀𝑀,𝑡𝑡+1 (1 − 𝑒𝑒) (1 − 𝑒𝑒) 𝑀𝑀,𝑡𝑡 𝐹𝐹,𝑡𝑡 𝐹𝐹,𝑡𝑡+1 (1 − 𝑒𝑒) (1 − 𝑒𝑒)
= 𝑡𝑡+1 𝑡𝑡 𝑡𝑡 𝑡𝑡
𝑞𝑞𝑀𝑀,𝑡𝑡 + 𝑞𝑞𝐹𝐹,𝑡𝑡 − 𝑞𝑞𝑀𝑀,𝑡𝑡 𝑞𝑞𝐹𝐹,𝑡𝑡
W𝑅𝑅t+1𝑡𝑡 = =𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝑛𝑛
(W t – C𝑅𝑅𝑡𝑡 t𝑡𝑡⋅)=𝑋𝑋R𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝑛𝑛
t 𝑡𝑡 ⋅ 𝑋𝑋
h is the percentage of guarantee lost when one member
of the couple dies
R𝑊𝑊Where
𝑡𝑡+1 = (𝑊𝑊𝑡𝑡 − 𝐶𝐶𝑡𝑡 )𝑅𝑅
t = Allocation t X
Where
• 𝑡𝑡 **
h is the percentage of guarantee lost when one member of the couple dies
28 B R EA K IN G T H E 4% RUL E
Results for varying risk aversion parameter values
The results in the body of the paper were completed with the following set of parameter values: γ=5, ψ=0.3, β=.98, h=1/3, e=1/3.
Here are similar results for more risk averse investors (the model run with the following parameter values: γ=7, ψ=0.2, β=.98, h=1/3, e=1/3)
E XH IB IT A4 : SUGGES T ED AL L OC AT I ON S AN D W I T H DR A W A L R A TE S F O R CO M BI NA TI O NS O F A G E , W E A L TH A ND G U A R A N T EED
INCOME FO R MAL ES
Males—$20,000 guaranteed income
Optimal withdrawal rate Optimal bond allocation
Age Portfolio Value % Age Portfolio Value %
$500,000 $1,000,000 $1,500,000 $2,000,000 $$2,500,000 $500,000 $1,000,000 $1,500,000 $2,000,000 $$2,500,000
60 5.3 4.8 4.6 4.5 4.4 60 37 50 54 57 58
65 5.8 5.3 5.1 5.0 4.9 65 39 51 55 57 59
70 6.5 5.9 5.7 5.5 5.4 70 41 52 56 58 59
75 7.4 6.7 6.4 6.3 6.2 75 43 53 56 58 60
80 8.7 7.8 7.5 7.3 7.2 80 45 54 57 59 60
85 10.3 9.3 8.9 8.7 8.5 85 47 55 58 59 60
90 12.5 11.3 10.8 10.5 10.3 90 48 56 58 60 61
95 15.2 13.7 13.1 12.7 12.5 95 50 57 59 60 61
30 B R EA K IN G T H E 4% RUL E
References
Bengen, William P. 1994. “Determining Withdrawal Rates Using
Historical Data.” Journal of Financial Planning 7, 4 (October):
171–180.
Epstein, Larry G. and Stanley E. Zin. 1989. “Substitution Risk
Aversion and the Temporal Behavior of Consumption and
Asset Returns: A Theoretical Framework.” Econometrica,
vol. 57, issue 4 (July): 937–969.
Sheikh, A., and H. Qiao. “Non-Normality of Market Returns:
A Framework for Asset Allocation Decision Making.” The Journal
of Alternative Investments, vol. 12, no. 3 (2010), pp. 8–35.
Grace Koo, Ph.D. Victor Li, Ph.D., CFA Jonathan Msika, CFA
Executive Director Vice President Associate
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