Getting a handle on what retirement plan failure really means

Dirk Cotton, JDC Planning

I’ve certainly used the term “plan failure” more than a few times, which is why a recent blog post by retirement researcher Dirk Cotton caught my eye.

In Three Degrees of Bad, Cotton separates out what he calls “three progressive levels of failure.” Those are: (1) loss of “market-funded” standard of living; (2) loss of standard of living below the household’s “floor” income; and (3) bankruptcy. A fourth type of failure he describes is depletion of an investment portfolio, which is what many planners—and journalists—really refer to when they write about the risk of plan failure. Cotton, founder of JDC Planning, points out that portfolio failure can contribute to any of the other three types—or none of them, depending on how reliant your clients are on investments to support their standard of living.

“What most retirees want to achieve from a retirement plan is to maintain their standard of living through retirement no matter how long they live,” Cotton told me in an interview. “Leaving a legacy is probably the second most important goal for some, but not at all for others. So you can lose your standard of living due to various risks in retirement, but usually when you read about this topic it’s focused on sequence of return risk and probability of ruin, which refers only to the risk of depleting your investment portfolio before you die.”

The challenge for planners, Cotton thinks, is to sharpen communication with clients. “It’s important to communicate accurately about the problems and risks, and how we deal with them—because they are all separate risks.”

The most important retirement risks include longevity, inflation, health expense, long-term care and financial fraud. There certainly is market risk as well—stock market volatility, interest rate risk and sequence of return risk. But market risk might not impact your client’s standard of living, Cotton argues. Consider the example of an affluent retired couple with a $100,000 standard of living receiving $60,000 in Social Security benefits and $40,000 in fixed annuity income. “If that couple loses everything they have in the stock market, it wouldn’t have a huge impact on their standard of living, because [they] have secured that with financial products.”

I explored the concept of plan failure with Cotton this month in an interview for


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