An Automated Solution For Generating Retirement Income

We’re often our own worst enemies when it comes to investing, which is why taking away the human element and automating decisions such as timing of purchases and regularly rebalancing will likely lead to better outcomes for investors. That makes the robo-advisor argument so compelling because it reduces the need for human intervention and sticks to your investment plan, no matter what the markets happen to be doing today.

But even if you’ve been convinced that a low-cost, broadly diversified set of index funds or ETFs is an ideal way to build an investment portfolio over the long term, questions abound when it comes time to turn your nest egg into a retirement income stream.

Investors at this stage become fixated on generating income through dividends and monthly income funds, unsure of the best way to create their desired annual income in retirement and scared of outliving their money.

An automated solution for retirement withdrawals?

Is there a way to automate the process? Last year Dan Bortolotti wrote a great piece in MoneySense about generating retirement income through a total return approach: keeping a portion of your portfolio in cash, fixed income, and equities and then creating a cycle of selling off ETFs to replace the fixed income each year.

Related: How (and when) to rebalance your portfolio

It’s one of the best examples I’ve seen on how to generate retirement income year-after-year, but I fear that in practice investors will be paralyzed by the process when it comes to their own portfolios.

Which got me thinking: can the robo-advisor industry respond to the needs of investors during their retirement withdrawal phase by automating a plan with a similar total-return approach? Perhaps they’re already doing this…?

ModernAdvisor founder and CEO Navid Boostani said an automated retirement withdrawal plan could be hard to grasp for most investors and the topic has come up several times with their clients.

“I think Dan’s right on the money with his idea of focusing on total returns as opposed to the income from the portfolio. But the implementation for most people gets tricky and cumbersome.”

He added that it could also get expensive if transactions costs are significant with respect to the size of their portfolio. His solution:

“Most robo-advisors (including us) elegantly solve this problem by automatically selling a portion of client’s holdings to raise enough cash to cover the outflows. This is done while still maintaining the client’s target asset allocation. Because transaction costs are included in our management fees, the additional trading activity doesn’t cost our clients anything.”

I’ve written before about how I’d like to see robo-advisors step in and offer an automated solution for RESPs – something along the lines of a target date fund that automatically rebalances and adjusts your portfolio allocation as your children get closer to college age.

Potential hurdles for robo-advisors to overcome

Could it be just as simple to set-up an automated solution for retirement withdrawals? Justin Bender, a portfolio manager at PWL Capital doesn’t think so. He finds it unlikely that robo-advisors will be able to effectively manage withdrawal portfolios “without being overwhelmed with additional administration and client correspondence.”

Bender says that potential issues may include:

1. RRIF minimum withdrawals – A financial planner would generally estimate how much tax will ultimately be owing, and withhold this amount as a percentage of the minimum. A robo-advisor will likely not do this, and then will be contacted by many of their RRIF holders in April of each year, when they require additional cash to pay their taxes.

If this continues, clients may have to contact the robo-advisor each quarter as their instalment payments become due (the robo-advisor may simply make a decision to withhold 30% from each payment, in order to minimize this potential issue).

2. Multiple account type holders – (i.e. personal taxable, RRIF, corporate taxable, TFSA). Robos may not be able to provide advice on which accounts to withdraw from in any given year (as most would have done zero retirement planning or projections.

3. Other account withdrawals – As RRIF minimums change each year, adjustments will have to be made to other account withdrawal amounts (i.e. if the RRIF minimum dollar amount drops due to poor investment returns, the client may need additional funds from their taxable account). This will require more client correspondence and more admin work to adjust the account withdrawal amounts each year.

4. Fixed income limitations – Robo-advisors do not typically use GICs, so Dan’s examples would not be possible – if they did start using GICs, this would add to the work they would need to do (i.e. it’s much easier to hold a short term bond ETF than to hold a ladder of 5 or more GICs that require manual ongoing attention).

5. Individual tax information – Robo-advisors do not have useful tax information about the client – this could be an issue for taxable investors, as the robo-advisor would be selling securities based on a set formula, possibly resulting in large taxable capital gains at inopportune times.

I have our clients sign a CRA T1013 form, which provides me with historical net capital gains, net capital losses carrying forward, past tax return information, RRSP/TFSA contribution room, etc.). I never rebalance a taxable portfolio without going through all of this information manually in order to make the most informed rebalancing decision (they would not have the time or data for this process). If a rebalancing decision is expected to realize a significant capital gain, we prefer to contact the client beforehand to discuss the proposed trades (even though we have trading discretion).

Final thoughts

Bender brings up some good points about an automated withdrawal plan for individual investors being more complicated and time-consuming than the robo-advisors are letting on. The robo-industry in Canada is small and the last thing it needs is to add a bunch of human employees to take care of individual retirement plans behind the scenes.

But I’m still convinced that the FinTech industry can find a way – that automating withdrawals through a total-return approach is going to lead to better outcomes for investors, including peace of mind knowing that an automated system is set up to ensure their portfolios last a lifetime.

I looked to the U.S. for more examples and saw that Betterment, a robo-advisor founded in 2006 with over $4 billion in assets under management, had the most sophisticated automated retirement income solution. Here’s an example of Betterment’s dynamic approach to retirement income:

“Margaret is a 65-year-old college professor, and she is likely to live to 85 based on her family history and health. Using Betterment’s income service, her $500,000 Roth IRA is allocated for a 20-year time horizon at 56% stocks and her expected monthly withdrawal this year is $1,941—an annual rate of 4.65%. This is not her only income—she also has income from Social Security, a pension, and 401K.

If the markets go up: In the first year, her Betterment portfolio grows by 7% and her new balance is $510,000 even after a year of making withdrawals. She’s a year older, however, and now her new recommended allocation is slightly less risky. Margaret’s monthly withdrawal rate will now be about $2,062 (about 4.85% of the new portfolio balance, but about 4.95% of the original value).

If the markets go down: If instead the markets were down 7%, her new balance would be $443,338 after the withdrawals. The new withdrawal rate will be $1,791 per month, or $150 lower than the original starting withdrawal amount, and 4.30% of the original value.

Although the withdrawal amounts do change depending on Margaret’s portfolio performance, her average withdrawal over 20 years is expected to be around $2,503 assuming an average market return of 6%. It’s exactly this dynamic withdrawal strategy that virtually guarantees that her capital will last for the full 20 years. To be sure, every retiree can customize his or her time horizon.”

A question to our Boomer readers, those retired and soon-to-be: Would you sign-up for an automated retirement income solution that manages your portfolio withdrawals and asset allocation from year-to-year?

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  1. Des on June 6, 2016 at 6:11 am

    I’m *nowhere* near retirement, but I do have to say – I’m entirely with you on thinking that fintech will come up with a good solution!

    But maybe that’s just the tech-obsessed millennial in me speaking, haha.

  2. frost on June 6, 2016 at 6:38 am

    Put in simple term, no way! I have trouble enough trying to reach my own investor let alone trying to manage an automated system. I like a person to person management system. When I have a question or concern I expect it to be addressed quickly.

  3. Dot on June 6, 2016 at 7:58 am

    I’m semi-retired and yes.

  4. Marko Koskenoja on June 6, 2016 at 8:05 am

    Another thoughtful post and very relevant to me as I a semi-retired at close to 57 with investments split between a cash account, RRSP, LIRA and TFSA. I am using the method Dan described in his article. I put my money into Vanguard and BMO ETF’s as recommended by Dan, Justin and other writers at MoneySense magazine. I use TD DI but wouldn’t mind paying a fee (one-time) or small % for advice or a program which would allow the most tax advantaged way to drawn down my investments.

  5. Gary on June 6, 2016 at 10:43 am

    Not a chance! I’ve been retired 10 years and we have been making our own decisions on withdrawals. If there is a bad decision I know who’s responsible . The only persons that care about our investments is us! I see too many of our friends put blind trust in banks, insurance companies etc. and it scares the heck out of me.

    • Marko Koskenoja on June 7, 2016 at 7:45 am

      Good point Gary – thanks for the reminder. After years of paying high fees to bank mutual funds and “financial advisers” I too realized it was best to go tghe DIY route. I wonder if I am using the most tax efficient methods but the fees I would pay an adviser would likely eat-up any potential savings.

  6. Grant on June 6, 2016 at 1:52 pm

    Rob, I find it hard to see how the complexities of the withdrawal phase from multiple accounts etc. can be managed by a Roboadvisor alone. Perhaps a human financial planner giving instructions to the Robo advisor once a year as the variables change could work. Other complexities include when to withdraw early from an RRSP to reduce taxes later, and also to prevent/reduce amount of OAS clawbacks, come to mind, as well as when is the optimal time to start drawing CPP. Difficult to see a Roboadvisor alone doing these sort of things optimally.

  7. Deb on June 7, 2016 at 2:59 pm

    Yes it would be nice, but I’m kind of with Gary, Marko and Grant on this one. Would cost me money to find out if I should have anything in my situation.

  8. Mike Pennell on June 17, 2016 at 12:25 pm

    Retired at 53 with a defined pension and 300K in investments (RRSPs, TFSAs and High Interest accounts). I would move to a Robo advisor in a heartbeat the would take care of withdrawals from my investments as described above. I just want to enjoy sailing and my retirement! I have researched some of the Robo Advisors sites and have asked Modern Advisor if they have a “programme” for retirees, they said they did on their website but I could not find a strategy that suited me. I want a fire and forget method that will just give me money to support my retirement.

  9. Michael James on February 7, 2017 at 9:45 am

    Just withdrawing the right amount and shifting assets from stocks to bonds/GICs each year is the easy part. As Justin pointed out, minimizing taxes is the tricky bit. (Note that Betterment’s example uses a large Roth IRA to eliminate tricky tax decisions as a concern.) A robo-advisor is unlikely to have enough information about their clients to do it properly unless they collect a lot of extra information, including all forms of income clients have each year that are unrelated to their retirement accounts. Each year you have decisions to make about how much to take from RRSPs, TFSAs, and non-taxable accounts. Doing this well requires making guesses about future personal income and possible changes to tax rules. Doing this poorly leads to paying higher taxes.

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