You Can’t Spend More Than 4% of Your Retirement Savings Without Going Broke

Yes you can!  Another easily disproved myth.

In their study “Why Annuities Work Like a License to Spend”  David Blanchett and Michael Finke* conclude:
. . .every $1 of assets converted to guaranteed income will result in twice the equivalent spending compared to money left invested in a portfolio. The size of the effect is large enough that the explanation is likely a combination of behavioral and rational factors. 

I find this to be true in the plans my clients & I develop together as well. 

Here is a good example.

Imagine you plan to retire 0-10 years from now and are entering another market similar to that shown in the chart below.  In fact, just change that 3rd digit in the years from 0 to 2 and from 1 to 2.  So the time range is 2020 to 2033.

What happens if you are retiring “now”, in 5 years or in 10 years?  

Retire Now.  Let’s say you’re starting with $500,000 and need $20,000/yr withdrawals in today’s dollars.  At average inflation for the period of 2.15%  by the 10th year you would need $24,740 in withdrawals.  And you would have already spent over $220,000 of your original $500k.  Your remaining $280k will last only 10 years (with no inflation but also no gains).

Retire in 5 years.  As you can see, in the 5th year your money has shrunk by 20%.  4% only yields $16,000/y, not enough to meet your budget.  So, withdrawing $22,244 (your 2020 budget gap inflated by 2.15%) you are out of money after 18 years.

Retire in 10 years.  By the 10th year you have just recovered from a second market “correction”.  The amount you need for your budget is now $24,740.  Just to make the math easy let’s assume no inflation and also no earnings on your conservatively invested retirement portfolio.  Your money will last 21 years at that withdrawal rate.

 Consider another scenario, the income annuity.  This illustrates the guaranteed lifetime payout for a 58 yr old with $500,000 in an average indexed annuity with an income rider.  If he begins income immediately, he is guaranteed $20,787/yr for life.  That is slightly better than the 4% rule on a market-based portfolio.  And it will last a lifetime.

How about in 5 years?  Without the annuity, at that point his account would be worth $400,000.  But with the annuity he is guaranteed $29,106/yr for life, an effective payout rate of 7.2%.  Unthinkable at the bottom of a market correction.

What does taking annuity income in the 10th year look like?  As you can see, it looks unbelievable.  Consider this:

  • Had he stayed in the market he would still just have his $500,000.
  • To keep up with inflation he would need $24,740 a 5% withdrawal rate which would last to his mortality.
  • But with the annuity he is guaranteed $47,457.yr. in the 10th year.  For life, an effective payout rate on his market-based money of almost 10%.

This illustrates the problem of sequence of returns risk and how income annuities protect you.  It also illustrates how correct the authors of this study are:  The annuity has doubled spending.  (Typically, unless the client has significant other assets we would ladder the annuities to kick in successively to handle inflation.)

Your Constructive Comments are Welcome! 

David Blanchett is managing director and head of retirement research at QMA, the quantitative equity and multi-asset solutions specialist of PGIM, the $1.5 trillion global investment management business of Prudential Financial.

Michael Finke, Ph.D., is a professor and Frank M. Engle Chair of Economic Security at the American College of Financial Services, where he leads the Wealth Management Certified Professional program.

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