January 3, 2021
People are living longer but they are not increasing the
accumulated wealth needed to support a longer life of
retirement. On the contrary, the swing from defined benefit
to defined contribution pension plans has increased the
population of those reaching retirement age without adequate
provision.
One result has been a growth in what can be called
“partial retirement,” which involves continued employment
past the usual retirement age but at a reduced scale at
reduced income. A retirement plan to accommodate them should
notch at the age when partial retirement becomes full
retirement, at which point retirement payments should jump
to a higher level.
The mechanics of such a plan depend on the finances of
the retiree. A large segment of them are homeowners with
minimal financial assets, and I will use this group as my
example. The hypothetical retiree is 62, has financial
assets of $150,000 and a debt-free house worth $500,000. His
plan is to work half time for 8-12 more years, then retire
full time. Hence, he needs a retirement payment for 8-12
years to offset his switch to half-time employment, and a
larger retirement payment thereafter to offset his switch to
full retirement.
This can be accomplished by artfully combining annuities
with a HECM reverse mortgage credit line. The procedure is
as follows:
- The retiree’s financial assets are used to purchase
a deferred annuity on which the payments don’t begin
until the end of the period of partial retirement, which
I will assume is 8 years.
- During the 8-year period, the retiree would draw
funds monthly against a HECM reverse mortgage credit
line.
- During that period, the unused part of the credit
line would grow at the HECM interest rate plus insurance
premium, currently about 3.4%, accruing a reserve.
- The reserve would be invested in a saving account or
a similar facility.
- At the end of the partial retirement date, the
accrued savings would be used to purchase an immediate
annuity beginning at the same time as the deferred
annuity. This results in a jump in spendable funds
starting at the beginning of year 9.
- If the HECM rate increases during the partial
retirement period, the accrued reserve, and the jump in
spendable funds, will be larger.
- All monthly spendable funds include a 2% per year
inflation premium.
- I call the retirement plan organized in this way the
“partial retirement plan (PRP)
Chart 1 maps the spendable funds available to the
retiree, with and without an increase in the HECM rate.
Consistent with the retiree’s plan to transition to full
retirement after 8 years, even without an increase in the
HECM rate, the payment that begins in year 9 is more than
twice as much as the final draw from the credit line.
If the partial retirement lasts 12 years instead of 8,
larger reserve accruals will generate a larger
immediate annuity, and higher spendable funds beginning in
the 13th year. This is illustrated in Chart 2
which uses a HECM credit line rate of 3.4% for both cases.
The closest available alternative to the PRP is the
so-called 4% rule for drawing on financial assets, which
calls for payments equal to 4% of financial assets. To
increase comparability with PRP, I add a HECM tenure payment
based on the retiree’s home value. The tenure payment
provides a fixed monthly stipend for as long as the retiree
resides in his house. In addition, I reset the withdrawal
rate from 4% to the rates of return used by both PRP and 4%
rule.
The two approaches are compared in Chart 3 using rates of
3.4% and 6%. (Note that under the 4% rule, these are
withdrawal rates as well as rates of return on assets). The
4% rule provides more spendable funds than PRP during the
period of partial retirement, but significantly less
thereafter. At a 6% rate on the 4% rule, financial assets
are depleted and payments thereafter consist of the tenure
payment.