Review of Safety-First Retirement Planning

Review of Safety-First Retirement Planning

Book Review: Safety-First Retirement Planning


Written by the famous retirement researcher Wade Pfau, Safety-First Retirement Planning: An Integrated Approach for a Worry-Free Retirement is mandatory reading if you are planning on retiring at some point. While Dr. Wade usually does a good job translating technical work into readable prose, this book is still pretty challenging. It is best for those who have not oversaved for retirement and are considering exchanging some bonds in their asset allocation for annuities. Yes, annuities. They can play a vital role in an individual’s retirement plan.

Let’s dig in and review Safety-First Retirement Planning.


What Is Safety-First?

Wade differentiates Safety-First with probability-based (or investing) models. Probability probably isn’t the ideal term, but apparently he got stuck with that phrase as a legacy of past writings. The real comparison is of the use of insurance products (and risk pooling) in your retirement plan vs the traditional stocks and bonds of investment advisors of yore.

And that is an interesting point. Those who sell insurance products tend toward safety-first thinking (right after thinking about commissions) while those who sell assets under management think about probability-based models (right after thinking about fees). Is the dichotomy merely what advisor-type you happen to have? Insurance vs AUM?

No. We all have products in our retirement. Think about social security. There is no better guaranteed inflation-adjusted annuity out there than social security. The real question is should you have MORE products in your retirement plan?

Should you risk pool or use investments? Let’s find out.

And by the way, Wade’s book on probability-based retirement is How Much Can I Spend in Retirement? A Guide to Investment-Based Retirement Income Strategies.


Safety-First, Risk Pooling and Mortality Credits

Risk pooling and mortality credits are vital to understand when you are considering a Safety-First retirement approach.

We all use risk pooling when buying home or car insurance. Chances are not all of our homes will burn down the same year, so the insurance company covers yearly losses for a small number of people.

Risk pooling from annuities come from the knowledge insurance companies have that some people will live longer than others. And conversely, some will die before others!

In an annuity risk pool, those who die early fund the retirements of those who live longer via mortality credits. That is, because of mortality credits you get more in your very first check from an annuity company because they know that some people will die every year, which leaves more on average for everyone overtime.

This is an important concept to understand as the criticism of annuities is often “well they just invest in bonds… just invest in bonds yourself and you will get the same return.”

No, you won’t, because with an annuity you also get mortality credits. If you live past life expectancy, you will get more from an annuity than you could if you mearely invested in bonds or CDs and consumed the investment and principal.

On the flip side, if you die early, you might still have some principal left to give away as a legacy to your heirs.

But regardless if you live long or die early, each one of your payments from the annuity is more than if you self-funded your retirement through fixed income alone.

Fundamentally, however, annuities are about cash flow and really a hedge against longevity, not a play to have more money in your death bed.


What Kind of Annuity?

There are many kinds of annuities and I have written about these before. See my bit on the good annuity, and another one on the good annuity in an IRA.

The obligatory disclaimer is that not all annuities have mortality credits, and many are chock full of fees and unnecessary riders.

You must understand the purpose of the money in an annuity! I venture to say 90% of people who are sold an annuity do not understand why they are putting money to work in the vehicle.

You want to buy an annuity, not be sold one. Dr. Wade’s book is a good first step in understanding why you would want to buy an annuity.


The Basics of Safety-First

Here are some of the basic ideas behind safety-first retirement planning. First: you should fund your known future expenses with at least some secure, stable income sources.

Not all expenses! But remember, floor expenses will continue for as long as you live. Why not use social security, pensions, and income annuities to fund those known and often predictable ongoing liabilities? You can match your assets via guaranteed income streams with those liabilities.

Wade suggests you floor your basic spending needs with guaranteed, secure, ongoing income sources.

Beyond that, with your discretionary desires and expenses, you can take more risk!

Thus, no matter what happens, you will always have your basic expenses met. This decreases the chance you will wind up eating cat food under the bridge in retirement, and actually protects against longevity.

And, believe it or not, if you substitute income annuities for bonds in your portfolio (that is, adjust your asset allocation to be more aggressive because of the annuity), you wind up with more assets at the end of your life. Most folks think that buying an annuity automatically means less inheritance. Not true!

Less liquidity, yes. But think about the real role liquidity plays in your portfolio. Do you need to access all of your money all of the time?


Protection Against Longevity, But Not Inflation

If you want to read something more dangerous, try this Tax-Free Income For Life book which uses inflation-adjusted annuities in your Roth IRA for both longevity and inflation protection. By the author of the Power of Zero, this is craziness to the next level. I haven’t seen the book yet, but I’m sure there will be many appropriate criticisms to follow. Maybe another blog…


Caveats of Safety-First Retirement Planning

While you don’t need most of your funds liquid, it is important to have some funds available for lumpy expenses in retirement.

Next, always remember that you must be able to delay social security before you consider any other safety-first retirement plan. If you cannot delay social security and take advantage of the massive advantages, there is no reason to dig into this book.

Another consideration, if you actually have a pension, you probably are fine just with the pension and social security. The idea is safety-FIRST, not safety-only.

Finally, consider that rental income is also inflation adjusted and on going. But certainly not guaranteed.

There are lots of sources of income that need to be considered in retirement planning. This is your product allocation, a concept that Dr. Wade also talks about in his book.


Who is a Good Candidate for Safety-First?

If you have a big chunk of bonds to protect you against market volatility, and these bonds let you sleep at night, consider carving off a chuck of these bonds and buying an income annuity. Likely this will improve the outcomes of your plan. Monty Carlo odds will be better, your withdrawal rate on your portfolio will be lower, and you are safer and more secure.

It is literally win-win-win. Win for you, win for everyone else in your risk pool, and win for your heirs. Most people can do with a little annuity in their life. But as always, remember you want to buy this annuity, not be sold one.

Wade’s book is pretty complex, but you need to understand the complexities in order to buy an annuity. Always understand the purpose: why do you need an annuity? Once you understand the purpose, know what product you want to buy and do not be sold something “better.” Better means more better for the insurance salesman, usually. Wade does a good job showing what is in it for the insurance company and what it in it for you, the purchaser of the annuity.

In criticism, Dr. Wade seemed more rushed and the paragraphs ran on, and ideas are frequently repeated. While this book isn’t as good as his others, it is still mandatory reading if your assets fall in the middle, between too much and too little. It often seems that the happiest retirees are those with a money tree. When the check arrives every month, month after month and without fail, what is not to like?


Summary—Safety-First Retirement Planning

If you haven’t oversaved for retirement and you are worried about longevity, or you are worried about market volatility, this book is a good primer on the role annuities can play in your retirement.

On the other hand, if you have undersaved (and you wouldn’t be reading this if you had!), the main focus is on delaying social security.

In the middle, if you have neither oversaved or undersaved for retirement, taking some of your bonds and getting an income annuity makes a whole lot of sense. You need to educate yourself first, however, and Safety-First Retirement Planning is required reading.


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