Median withdrawal increasing when portfolio value is 0

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frp user
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Median withdrawal increasing when portfolio value is 0

Post by frp user »

Hi Jim,

I’ve been playing with various scenarios and…. I am wondering what it means that when median portfolio becomes 0 (around 2035), the median withdrawals actually start increasing (rather than becoming 0 as well)? (this is from the table in the Detailed view)

Peter

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Re: Median withdrawal increasing when portfolio value is 0

Post by admin »

Peter,

I believe you've found a bug, or at least a condition I didn't expect.

It appears that when the portfolio runs out of money, I incorrectly add income taxes to the withdrawal amount, artificially inflating the withdrawal amount in the case of an exhausted portfolio. This is only an issue in simulations where there is a high likelihood of running out of money (low prob. of success).

I think it will only take one line of code to fix the problem, but I'll need some time to test it out.

Congratulations. I've had almost 20k users since the beginning of the year and this is the first bona fide bug report in a long time. Thanks a bunch :)

Actually, it's a good catch and I appreciate you bringing it to my attention. I'll let you know when I post the fix.

Jim

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Re: Median withdrawal increasing when portfolio value is 0

Post by frp user »

Thanks…that’s great…I just want to also confirm that specified input desired ‘annual retirement spending’ is an after tax number (as per documentation)…

regards peter

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Re: Median withdrawal increasing when portfolio value is 0

Post by admin »

Peter,

Yes, the annual retirement spending is the amount you get to take home after taxes.

In the simulation, withdrawals from the taxable portfolio don't have tax implications since the simulation taxes portfolio gains when they happen (not entirely realistic, but workable). The implicit assumption is that your basis in your taxable portfolio is 100% of the balance and no tax deferral happens.

The simulation tries to make withdrawals from taxable first, once that's depleted, it moves on to tax free, then tax deferred funds. Amounts withdrawn from tax deferred accounts are increased by enough to pay the income taxes that are incurred as a result of the withdrawal. To be clear, if you need 50k, the simulation withdraws 50k plus the taxes due on that 50k, plus the taxes due on that extra withdrawal, and so on.

That's where the bug was. I increased the withdrawal amount by enough to cover the taxes on the withdrawals, even though no withdrawal could be made. The bug didn't change the probability of success, or the ending portfolio balance, but it did mess up the ending withdrawal amount in cases where the probability is less than 50%.

Anyhow, I posted a new version on the web site and if you close all browser windows and restart your browser before you go to the site, you'll pick up the new version. Also, if you click on the help button on the application, the version history should indicate that the last change was today.

Please let me know if this new version behaves as you expect.

Thanks,

Jim

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Re: Median withdrawal increasing when portfolio value is 0

Post by frp user »

Jim,

Thanks for the quick fix…very impressive!

I have a more subtle question (recall that I am doing some scenarios with annuities…specifically deferred annuities).

I want to simulate a no-COLA deferred annuity for an individual of Age=60 today(2007)…Specifically from a $1M portfolio, I take $50K at age 60 and buy a single payment non-inflation adjusted deferred annuity for which the insurance company promises to pay me $40k/year starting 25 years from now …I am using your ‘Additional Inputs’ tab…’Pensions(no cola)’ option….Start year=Age 85 (i.e. 25 years from now)…

So the question is, for this no-cola pension scenario, should the age=85 line in the ‘After Tax Income’ column under the ‘Detailed Output’ tab be adjusted for inflation over the 25 years of deferral, since all the other numbers in that output screen are “current(2007) dollars” not “2032 dollars”(i.e. the $40K pension becomes about 19.1K after 25 years of 3% inflation)? (It does get adjusted for inflation from the 25th year onward)

Thanks…

Peter
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Re: Median withdrawal increasing when portfolio value is 0

Post by admin »

Peter,

You sure are giving the planner a workout. I'm glad to see you using so many of the capabilities.

For a no-cola pension that starts in the future, you need to deflate $40,000 before you enter it. I suppose I could have done that myself, but I wasn't sure how people would want it to work, so I used the starting amount as entered and didn't start reducing it until the payments started.

For $40,000, I used =FV(-0.03,25,0,-40000) in excel to get $18,679 as the value to enter.

The more I think about it, I probably should do that myself in the planner. I'm not sure I can think of a case where the user would want to have the 40,000 payment NOT get reduced.

Jim

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Re: Median withdrawal increasing when portfolio value is 0

Post by admin »

I just pushed out a change on how the no-cola income is handled. Let me know if it behaves as you'd expect it to.

Thanks,

Jim

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Re: Median withdrawal increasing when portfolio value is 0

Post by frp user »

Jim,

That makes more sense to me as well…but I think, there still seems to be an issue with “Taxable Percent” related calculation when it is not zero(0)…e.g. I set it to 80(%) and the inflation adjustment doesn’t seem to come through.

Peter

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Re: Median withdrawal increasing when portfolio value is 0

Post by frp user »

Jim,

It works great now. Thanks.

You may want to update the FAQ section as well…thanks

Quote from Docs... "One case where amounts are not automatically adjusted for inflation is in the “no cola” income amounts that you can enter on the “Additional Inputs” tab. The no cola income types were specifically created so you can enter income that is not adjusted for inflation. In this case the income will lose purchasing power each year following the income stream’s start year."

Peter,

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Re: Median withdrawal increasing when portfolio value is 0

Post by admin »

Peter,

Thanks for the note. I posted an update to the FAQ to describe what the planner is doing w.r.t. no-cola payments. Please let me know if you think the explanation is understandable...

Thanks again for all the feedback,

Jim


Are the dollar amounts that I enter in the retirement planner adjusted for inflation automatically?

The short answer is yes. In general, all dollar values are shown in "today's value" dollars. For example, suppose you have estimated that annual retirement expenses will be $50,000 per year when you retire (in today's dollars). Even though you enter $50,000 into the planner for retirement expenses, the actual amount of expenses funded each year will likely be higher to keep up with inflation. Also, the ending portfolio balance is displayed in today's dollars rather than in inflated future dollars.

One case where amounts are not automatically adjusted for inflation is in the "no cola" income amounts that you can enter on the "Additional Inputs" tab. The no cola income types were specifically created so you can enter income that is not adjusted for inflation. In this case the income will lose purchasing power starting in the first year of your plan. For example, if you create an "Other Income (no cola)" entry of $50,000 starting in 10 years, the planner will start reducing the purchasing power of that payment at the start of your plan and by the time the payment begins in 10 years, its purchasing power may already be significantly reduced. Since all output amounts are shown in today's value dollars, this income will appear on the Detailed Output tab starting in 10 years as a payment of only $35,000 (the exact value is dependent on the inflation rate). That means that although the actual payments will be $50,000, they will only be able to buy what $35,000 can buy today. Further, in each year following the first payment, the output will show the payment's value (in today's value) slowly decreasing by the inflation rate.

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