Latest Research for Planners: New Names and New Subjects

Journal of Financial Planning: January 2016


Harold Evensky, CFP®, AIF®, is chairman of Evensky & Katz/Foldes Financial in Coral Gables, Florida, and Lubbock, Texas. He frequently speaks on investment and financial planning issues, and is author of Wealth Management and co-editor of The Investment Think Tank.

Welcome once again to what’s new in research of interest to practitioners. In this column, I will share some of my regular favorites as well as a few new names, sources, and subjects. I’ll start with what I believe is one of the most critical subjects facing practitioners—retirement income. Following that are a couple of interesting papers related to taxes, then a quick reference to a few more interesting papers, including thoughts on the perennial debate of active versus passive investing.

Retirement Income

“Distribution Methods for Assets in Individual Accounts for Retirees: Life Income Annuities and Withdrawal Rules,” by Mark J. Warshawsky (The Journal of Retirement, Fall 2015). I begin with Warshawsky’s paper for a number of reasons. The first is to reintroduce you to a publication that I believe, along with this Journal, should be on your regular reading list. Second, Warshawsky’s December 2001 Journal paper, “Making Retirement Income Last a Lifetime” with co-authors John Ameriks and Bob Veres, introduced the use of immediate annuities to the profession. It remains relevant and deserves reading today.

In his current contribution, Warshawsky examines the two primary solutions for retirement income—immediate annuities and fixed percentage withdrawals from a total return portfolio (for example, Bengen’s 4 percent rule). It is the results of this analysis that deserve serious practitioner consideration. Key elements of the study are:

  • The 4 percent rule tends to fail for extended periods (i.e., >30 years) whereas immediate annuities provide continual cash flow regardless of market and economic contingencies.
  • A 3.5 percent or less real withdrawal rate is more appropriate than the traditional 4 percent.
  • When incorporating an immediate annuity at age 70, the annual payout almost always exceeds the 4 percent rule by significant amounts and does not risk full income exhaustion.
  • In spite of these advantages, immediate annuities are not suitable for all investors (for example, impaired longevity, liquidity needs, and adequate pension income).

His conclusion that all practitioners need to seriously consider is: “ … in light of the results presented and given that a retirement plan’s or account’s main purpose is to produce lifetime income during retirement, it is hard to argue against a significant and widespread role for immediate life annuities in the production of retirement income.”

“Dynamic Choice and Optimal Annuitization,” by David Blanchett (The Journal of Retirement, Summer 2015). In this paper, Blanchett looks at four different withdrawal strategies both individually and in combination. Arguing that the majority of research on optimal retirement income assumes all decisions are made at the time of retirement, he considers the potential value added with more active management (an approach I believe most professionals currently employ).

  • Static model: the retiree makes decisions only at retirement regarding both the withdrawal rate and immediate annuity allocation.
  • Dynamic withdrawal: the annual withdrawal rate is modified based on changing mortality similar to the formula used to estimate required minimum distributions.
  • Dynamic annuitization: the ability to purchase an annuity throughout retirement is a “call option.” With dynamic annuitization, cash flow planning is reviewed regularly and an immediate annuity is only purchased when necessary.
  • Dynamic withdrawal combined with dynamic annuitization.

Blanchett’s research concludes that a dynamic withdrawal/dynamic immediate annuitization strategy is optimal, resulting in an annual increase in risk-adjusted return of 1.34 percent compared to the static model. A dynamic withdrawal with no annuities provides an increase of 1.12 percent, and a static withdrawal and immediate annuitization just under 1 percent.

“Optimizing Retirement Income by Combining Actuarial Science and Investments,” by Wade Pfau (whitepaper commissioned by OneAmerica, In this paper, Pfau addresses the same issue as Blanchett, framing the issue as the difference between advisers who prefer a total return risk/reward portfolio versus those who prefer the contractual guarantees of insurance products. His research addresses these differences by comparing three retirement plan scenarios: (1) investments and term life insurance; (2) investments, joint and 100 percent survivor annuity, and term insurance; and (3) investments, single life annuity, and whole life insurance.

Based on comparing these alternatives for 35-year old and 50-year old couples, scenario 1 uses term life insurance to cover the mortality risk prior to retirement and systematic withdrawals for retirement income. Scenario 2 adds partial annuitization for retirement income, and scenario 3 incorporates whole life insurance with a combination of systematic withdrawals and annuitization. His finds “substantive evidence that an integrated approach with investments, whole life insurance, and income annuities can provide more efficient retirement outcomes than relying on investments alone.”

“New Research: Reverse Mortgages, SPIAs, and Retirement Income,” by Joe Tomlinson (Advisor Perspectives, April 2015). Tomlinson’s contribution is a useful introduction to the alternatives of immediate annuities and reverse mortgages. The subject is covered in depth in the next paper.

“The Reverse Mortgage: A Strategic Lifetime Income Planning Resource,” by Tom Davison and Keith Turner (The Journal of Retirement, Fall 2015). These authors provide a very clear discussion of how a reverse mortgage works. They are not unaware of most practitioners’ objections to reverse mortgages and acknowledge that the “... lore is that they are expensive and may even be dangerous.” However, they explain that since 2008, the product and process has changed significantly for the better. Their point is that reverse mortgages are not inherently harmful or dangerous, but like traditional mortgages, they are financial tools. In investigating the potential use of a reverse mortgage for lifetime income, they consider six scenarios.

  • Borrow early and use the proceeds early
  • Borrow early but defer the use of proceeds until later
  • Borrow late, use late (the last resort)
  • Monthly payments (tenure)
  • Borrow after portfolio down years
  • Salter, Pfeiffer, and Evensky “Standby Reverse Mortgage” strategy (from the August 2012 Journal paper)

The paper concludes that all five strategies (not including the “last resort”) improve a portfolio’s sustainable spending rate. And, the standby reverse mortgage strategy “... may have the best combination of improved sustainable withdrawal and borrowing power, and therefore a smaller loan balance at the end.”

The takeaway from these papers? Seriously consider the possibility of incorporating immediate annuities and reverse mortgages in your planning toolkit.


“What Would Yale Do if It Were Taxable?” by Patrick Geddes, Lisa R. Goldberg, and Stephen W. Bianchi (Financial Analysts Journal, July/August 2015). This is a very clever tax-related paper. Noting that practitioners dealing with ultra high net worth clients are attracted to the best practices of institutional managers, unfortunately, they face the real world friction of investor taxes.

Prefacing their research with the caveat that the examples are designed to be illustrations—not actual solutions—and that “it is important to not let the perfect be the enemy of the good” (I’m going to remember that), they back into Yale’s expected returns by using what they refer to as “reverse optimization.” They then adjust the endowment pretax returns to reflect the tax friction faced by retail investors. To estimate the tax impact, they consider three different strategies of after-tax portfolio implementation.

  • After-tax active equity: traditional, nontax sensitive, active management
  • Indexed equity
  • After-tax tax-advantaged equity: a combination of index equity and active managers who aggressively harvest losses

Based on this analysis, the paper reaches a number of interesting conclusions regarding the changes necessary when translating an institutional, non-taxable portfolio to a taxable portfolio:

  • After-tax equity: active equity and hedge fund allocations are eliminated, municipal bonds become a significant allocation, and private equity remains significant reflecting its relative tax efficiency.
  • After-tax indexed equity: active equity and hedge fund allocations are again eliminated with a smaller allocation to private equity.
  • After-tax tax-advantaged equity: as the allocation strategy is limited by the capital gains generated by other asset classes, hedge funds may become more attractive as a result of the tax-advantage strategy offsetting hedge fund tax inefficiency.

The caveat to this conclusion is the importance of the correlations between equities and hedge funds, as different correlations can result in material changes in proposed allocations. For example, although hedge funds were eliminated for after-tax equity and indexed equity no matter the correlation, using the low correlation Credit Suisse AllHedge Index (0.14), resulted in its inclusion in the after-tax tax-advantaged allocation. However, the high-correlation HFRI Fund Weighted Composite Index (0.88) was eliminated from all strategies.

“Tax-Efficient Withdrawal Strategies,” by Kirsten Cool, William Meyer, and William Reichenstein (Financial Analysts Journal, March/April 2015). I’ll summarize some key points of this important paper in the hope of encouraging you to read it in full.

Although conventional wisdom suggests a withdrawal sequence of taxable accounts first, tax-deferred (for example, 401(k)s) next, and tax-exempt (for example, Roth) last; conventional wisdom is wrong. There are a number of more efficient strategies. For example, time withdrawals from tax-deferred accounts for years when those funds would be subject to low marginal rates. A second strategy is to convert funds from the tax-deferred account to a Roth IRA to fully use the 15 percent tax bracket, and finally to reserve funds in a tax-deferred account to accommodate the possibility of large tax-deductible expenses, such as medical costs which often occur later in life.

The takeaway of these tax papers? Taxes matter!

Here a few other papers you might find interesting.

“Covered Calls Uncovered,” by Roni Israelov, and Lars N. Nielsen (Financial Analysts Journal, November/December 2015). Quite technical but potentially valuable, particularly if you have clients with significant undiversified equity positions that they are unwilling to liquidate.

“Reexamining ‘To vs. Through’: What New Research Tells Us about an Old Debate,” by Matthew O’Hara and Ted Daverman (The Journal of Retirement, Spring 2015). A rather scathing but persuasive argument in favor of a “to” glide path. “It is hard to find a rationale for taking more risk on the retirement date and at a later date when account balances or likely to be smaller than the planning horizon is shorter. Similarly, it is difficult to understand on what basis a glide path should continue to reduce risk after human capital has been exhausted.”

“Viewpoint: In Defense of Active Investing,” by Charles Ellis (Financial Analysts Journal, July/August 2015). Musings of one of my all-time favorite investment gurus. Read it; I guarantee you’ll enjoy it.

And I hope you enjoyed—or at least found something useful—in my musings. As always, if you read something you think should be shared with others, please drop me a note.  Email HERE.

Retirement Savings and Income Planning
Tax Planning
Professional role
Tax Planner