Which would you say people fear more: dying or running out of money? Two-thirds of Americans say they’re more afraid of running out of money before they die than they are of death itself, according to the 2024 Annual Retirement Study from Allianz Life Insurance Company. Clearly, most Americans need a retirement income strategy to address this concern.
To reduce the chances of retirees outliving their savings, a financial advisor named William Bengen came up with a retirement income strategy that has become known as the “4% Rule.” According to this “rule,” retirees can withdraw up to 4% of their assets each year, adjusted for inflation, for 30 years and potentially not run out of money.
It’s a Different World
A lot has changed since Bengen came up with the 4% Rule in 1994. For starters, the average life expectancy has risen: According to the Centers for Disease Control, a 65-year-old man today can expect to live an additional 18 years (to age 83) while a 65-year-old woman today can expect to live an additional 21 years (to age 86).
When examining the 4% Rule, today’s retirees must consider the uncertain economic environment and high levels of market volatility , along with the impact of investment fees on retirement income. Also, individuals may be more active and have higher living expenses in retirement than they anticipated, including healthcare and long-term care expenses.
A recent article in The Wall Street Journal went so far as to proclaim that the 4% Rule could put retirees “at risk of financial ruin” and lead to “catastrophic outcomes” if markets behave differently than in the past. The article cited a recent study that lowered the suggested 4% annual withdrawal rate to just 2.26%.
The following hypothetical examples illustrate the potential problems with the 4% Rule and present a possible alternative solution.
How a 4% Withdrawal Rate Becomes 5.5%
Lisa is a 65-year-old woman with a retirement portfolio of $1 million who wants to be able to withdraw $40,000 per year in spending money and make her portfolio last for 35 years, or until age 100. However, after paying a 1% advisory fee and underlying investment fees of 0.50%, her $40,000 annual withdrawal declines to just $25,000. To receive $40,000 of spendable income, she would have to withdraw $55,000 annually from her portfolio, or 5.5% of the portfolio balance. In addition, simply increasing her withdrawal percentage decreases the likelihood that her portfolio will succeed over the course of the next 35 years.
One potential solution to this problem would be for Lisa to purchase a fixed index annuity (FIA). FIAs generate a guaranteed stream of income in retirement in the form of annuity payments, no matter how long policyholders live or what happens in the market. This would provide Lisa with the peace of mind of having consistent, timely income every year regardless of market volatility.
An FIA is one of the few financial products that can remove longevity risk from the equation for retirees. Some FIAs also provide a guaranteed lifetime income stream via a lifetime income rider built into the contract or purchased separately. This level of certainty could help Lisa improve her overall retirement income strategy by reducing the risk that she runs out of money before she dies.
Generating the Same Income with Half the Assets
Eric is 60 years old and would like to retire at age 65. After calculating his estimated expenses, Eric determines that he needs an additional $10,000 annually to live his desired retirement lifestyle. To generate this amount of income by withdrawing money using the 4% Rule, Eric would need retirement assets totaling $250,000 (250,000 x 4% = 10,000).
What if Eric could generate the same $10,000 per year from less than half this amount? This could be possible with a fixed index annuity. If he purchases an FIA now at age 60, his lifetime withdrawal percentage will increase every year between now and when he turns 65 and begins receiving income payments from the annuity. The higher the withdrawal percentage, the less money he needs to purchase the annuity.
Eric can choose one of two lifetime withdrawal options: level income or increasing income. If he chooses level income, his lifetime withdrawal percentage will be 9.35% at age 65. In this case, he would only need to use $106,952 of his assets to generate $10,000 in annual income when he turns 65 years old (106,952 x 9.35% = 10,000).
With the FIA, Eric can protect his assets from market losses and contractually guarantee himself the $10,000 in annual income for the rest of his life. That’s a win-win!
The Power of the Annual Reset
FIA policyholders also benefit from the power of the annual reset. The interest credited each contract year is locked in and becomes part of the principal, so this amount is fully protected from market loss. Annual reset is also beneficial during years when the market index is down or flat since it protects principal and previously credited interest.
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Disclosure: Hypothetical examples shown are for illustrative purposes only. Guarantees in annuity products are backed by the financial strength and claims-paying ability of the issuing insurance company.
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