People often turn to general rules of thumb to help them simplify the complications of life and provide them with certainty in a world full of risk. Determining how much of your assets to draw down in retirement without running out of money is a complicated issue with many variables to consider.
One popular rule of thumb is called the 4% rule, which generally asserts that you should withdraw 4% of your portfolio balance the first year of retirement and then adjust that amount slightly each year for inflation. For example, the 4% rule would dictate that you withdraw $4,000 in year one for every $100,000 you have in retirement assets, and then increase that amount each year to adjust for inflation.
Assuming you have a retirement portfolio of stocks and bonds, you should be able to continue withdrawals for roughly 30 years. The 4% rule may be easy to understand and follow, if everything goes well.
But the simple rule might not work in a complicated world. As a research fellow for the Alliance for Lifetime Income and an economics and finance researcher at Johns Hopkins, I’ve studied the 4% rule. There are various risks to consider with retirement income, so it’s important to think beyond a simple rule and consider ways to mitigate these risks. One method is to purchase an annuity as part of a retirement plan. An annuity can provide retirement income that is protected from these potential pitfalls. Now, let’s discuss the risks:
Many retirees are living longer. According to the Social Security Administration1, one out of every four 65-year-olds today will live past the age of 90 and one in 10 will live past age 95. Hence, if you retire at 65, you may need to plan on your retirement portfolio to provide you with income well past 30 years of retirement. Annuities can be purchased with an option for providing income for as long as you live, which mitigates some longevity risk.
As we all saw during October, markets can be very volatile and can have significant up and down swings. Since the 2008-09 market crash, there have been eight market corrections2 when the S&P 500® dropped at least 9.8%. There’s no guarantee that the markets will continue to rise in retirement, increasing the risk that the 4% rule won’t be sufficient to guarantee necessary income in retirement. An annuity can be added to a retirement plan to provide a predictable income stream no matter how markets perform.