- Be stable or to fluctuate?
- Never go down or is it okay if it can go up and down?
- Last as long as you live or is it okay if there’s a chance it will end before you do?
Wall Street financial writers try to frame retirement planning as creating a large enough pile of investments to last through retirement. This approach has merit if the retirement goal is to leave money to your heirs, but the typical main goal in retirement planning is to have enough income. Since Wall Street manufactures investments, their go-to solution to generating retirement income is to withdraw a percentage of your investments and hope it lasts.
The problem is there are no guarantees with this withdrawal approach, so the suggested withdrawal percentage keeps getting lower. For years, the suggested “safe” withdrawal rate was 5%. This was generally reduced to 4% about two decades ago, but even at 4% the risk of running out of money early is as high as 32%*, so several advisors suggest that taking out 3% might be a better idea – or even limiting withdrawals to 2% from your investments each year would be prudent. The problem is most people saved for retirement with the expectation that the $500,000 they managed to put away would get them $25,000 a year and now they’re being told they should tighten their belt and settle for $10,000 in retirement income, to lessen the chance it becomes $0 down the road.
The odds that you won’t run out of money – even when taking out 4% a year – are still on your side. Based on the computer simulations that Wall Streeters like to run, in most scenarios not only does your income not go down but it increases. However, the question that remains is how big of a gambler are you?
The insurance world approaches retirement in a different way. Wall Street is all about managing the amount of risk the retiree retains; insurance companies transfer away the risk of income loss from the retiree to the insurer. They do this through an annuity in many different ways. Income choices from an annuity produce stable income that does not go down – even if the stock market or interest rates do – or can even automatically increase the income each year during retirement. The retiree can choose annuities where they have access to the cash value of the account and at least ensure that they (and any heirs) will get back all of what they put in. And these income choices guarantee that the income will last as long as the retiree does. These are the reasons that millions of retirees own annuities.
This is not saying that a retiree should place all of their money in annuities, but it does mean one should look at their personal situation and determine how much stable income they desire and whether an annuity income choice might be prudent.
* Finke, M. Pfau, W, & Blanchett, D. 2013, “The 4 Percent Rule Is Not Safe in a Low-Yield World,” Journal of Financial Planning, 26, 6: 46–55.