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Courtesy of Wade Pfau
Economist Wade Pfau’s point of view on the financing of pensions, the subject of a recent Barrons article, elicited many comments from readers, including those who thought Pfau erred in not extolling the virtues of stocks or real estate investment trusts that have a history of paying high dividends.
Pfau is doubtful. Owning stocks that pay a high dividend doesn’t provide the same safe retirement income as owning safe bonds “because dividends can be reduced,” he says.
He adds that if retirees are willing to hold a broad stock index and live on dividends, that’s a “rather conservative” strategy. The problem is that the
S&P500
the stock index is currently only yielding around 1.4%, and retirees with a dividend income strategy generally gravitate towards stocks with higher payouts.
“As soon as you move away from a diversified market portfolio, you take on more risk,” says Pfau, professor of retirement income at the American College of Financial Services.
Pfau thinks seniors cannot rely on continued stock market gains to fund their retirement. He recommended that they consider products like variable annuities, whole life insurance and reverse mortgages that will hold their value even if stocks fall.
On postponing social security
Other readers took issue with Pfau’s assertion that retirees should consider shrinking their portfolios to delay Social Security and receive a higher benefit. One reader said he starts Social Security at age 62, so he won’t have to tap into his 401(k) and reap the benefits of stock market returns until his required minimum distributions begin at age 72.
Pfau says this approach ignores the fact that stock market returns are not guaranteed and that deferring Social Security offers a guaranteed increase in benefits.
Pfau agrees that retirees will come out ahead if they claim Social Security early, they invest the money, and the stock market goes up quickly. “Obviously if you get 10% returns [in the market], you better claim early,” he says. “It’s just, what’s the reality of what’s happening over an eight-year period?”
Other readers said they wanted to claim Social Security sooner because the federal pension is underfunded and benefit cuts are likely.
Pfau calculated that even if benefits are reduced by 21% the year you turn 70, you’re probably still better off delaying benefits. Such a reduction in benefits would delay the break-even age to 83 instead of 80 for someone who waits until age 70 to claim, he says.
On Roth IRA conversions
pfa said Barrons he recently built a model to determine when it’s best to convert money from tax-deferred accounts to tax-free Roth IRA accounts. This prompted a reader to ask: what did Pfau’s model find?
“There’s no one answer,” Pfau said in a follow-up interview. “It depends entirely on each personal situation. On the amount you have in your tax-deferred account. On how much you have in your Roth. What are your spending goals? When do you apply for social security? »
In a Roth conversion, investors pay taxes on money transferred from their tax-deferred account to their Roth account. Conversions generally make sense when their current tax bracket is lower than their future tax bracket.
The question readers should ask themselves, according to Pfau: “Is there a chance of paying some taxes up front and avoiding higher taxes later?”
On long-term care insurance
Pfau has expressed skepticism about traditional long-term care insurance in the Barrons Questions and answers. But he said new hybrid products that combined long-term care insurance with life insurance or an annuity had potential.
A reader wanted more explanation. Pfau did some math on long-term care insurance, and he says the traditional policy he reviewed barely pays off, even if you use it for maximum benefit. And if you don’t need long-term care, all the money you paid in premiums is gone.
By contrast, combining long-term care insurance with life insurance means no more use-it-or-lose-it, says Pfau. “Even if you don’t need long-term care insurance, you get the death benefit,” he says.
Pfau has consulted for insurers, and his work is sometimes cited by the industry. One reader complained that “talkative but pushy insurance salespeople” had used Pfau’s research in a sales pitch for annuities.
Pfau answers: “I would like people not to use my research in any way. I caution that I am talking about competitively priced annuities. And there are non-competitively priced annuities that pay higher commissions” to sellers.
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