The 4% rule (or theory) says that at retirement, with a portfolio of 60% stocks and 40% bonds, one could withdraw 4% of the initial savings amount (and increase it by inflation every year). Then, the retiree would have a 90% chance of the growing income continuing for 30 years without the savings being completely depleted until the end of those 30 years. And a 10% chance the money will run out.
By the way, a 100% stock or a 100% bond portfolio has less than a 60% chance of lasting 30 years. A portfolio of 100% CDs doesn’t have a prayer. The research shows that under most long-term market scenarios (backcasting), a 60%/40% portfolio worked the best.
So, for example, someone with $500,000 at retirement could withdraw $20,000 in the first year. If inflation was 3% that year, the 2nd year, they could withdraw $20,600 ($20,000 +3%). That growing income could conceivably last for 30 years until the savings and income stream would be all gone.
Morningstar has recently upped its “safe” withdrawal rate from 3.3% starting in 2021 and 3.8% in 2022, back up to the historical 4% based on the higher yields in bonds today.
Does $20,000/year on $500,000 of savings sound impressive to you?
What if you/your spouse need income for more than 30 years? It does happen and will happen more often as larger numbers of boomers will reach age 100 and beyond. What if you retire early, like at age 55?
What if the “lost decade” of the 2000s happens again?
A Wall Street Journal article once stated: “If you had retired Jan. 1, 2000, with an initial 4% withdrawal rate and a portfolio of 55% stocks and 45% bonds rebalanced each month, with the first year’s withdrawal amount increased by 3% a year for inflation, your portfolio would have fallen by a third through 2010, according to investment firm T. Rowe Price Group. And you would be left with only a 29% chance of making it through three decades, the firm estimates.”
What might the same retiree do to improve their income without taking any stock market (or even bond risk as bonds went down by about 15% in 2022)… and, of course, sequence of returns risks?
Well, an annuity with a guaranteed lifetime income feature may be a solution worth considering.
With the same $500,000, a retiring 60-year-old couple could have a guaranteed JOINT lifetime income of $26,500 (a 5.3% initial payout factor). That’s about a third more starting income to enjoy than the 4% rule.
In fact, at a 3% inflation rate, it would take 10 years for the $20,000 “4% rule” figure to grow to $26,500. Ten years of lower income – and none of it guaranteed!
If that 60-year-old retiree were single, the initial payout and income would be higher (5.8%) and $29,000, respectively. That’s 45% more than the 4% rule – and fully guaranteed!
Let’s say the same couple bought the annuity at age 60 but waited until age 65 to retire. Furthermore, let’s say that the annuity never earned a dime over those five years, which has never happened.
Because they waited, their starting guaranteed joint lifetime income would be $35,500. If they delayed taking income until age 70, again with the annuity earning nothing during those ten years, the initial income would be guaranteed at $46,750. No ifs and no worry.
The older one is, the initial payout factors are higher. And the longer one waits to begin their lifetime income stream, the larger the initial check will be – even if the annuity earns nothing.
And those initial incomes will climb depending upon how well the indexes, like the S&P 500, earn over time. With the protection of no market losses, the increases in the annual income can regularly be 2-3 times the inflation rate used in the 4% rule.
By the way, my 40-year-old daughter is putting some retirement money into this annuity as a bond alternative. If she waits until age 62 to begin a joint lifetime income with her husband, her guaranteed initial payout rate will be 11.3% – nearly triple the 4% rule.
I’m certainly not suggesting that anyone put all of their savings into an annuity (I’m just using the $500,000 as an example). In fact, insurance companies won’t even let you do that.
Although I believe annuities are an excellent tool for pre-retirees and retirees, our firm manages some $8.5 BILLION at Schwab and Fidelity. I like asset class diversification, and in fact, I also add in the tax-free income benefits of life insurance when appropriate.
Yes, time and time again, academic research shows that adding guaranteed lifetime income from an annuity improves retirement outcomes. Let me know if you’d like to see some of those white papers.
Should you want to learn more about annuities, my I Didn’t Know Annuities Could Do That! book would be a great place to start. You can click on the title and be taken to Amazon to check it out.
Of course, we could always chat about this. Just reach out via phone or email.
