Financial professionals occasionally lean on rules of thumb as general guidelines for retirement income planning. And just like any other shortcut, rules of thumb such as the commonly cited “four percent rule” have both advantages and shortcomings.
Among the rule’s advantages? For one thing, 4% is easy to remember, and it’s simple. In short, the rule recommends a 4% first-time annual retirement savings withdrawal. Every year thereafter, the investor would adjust for inflation over a 30-year retirement.
For many retirement savers and investors, a 4% annual withdrawal may provide a reasonable income, especially in combination with other income sources like Social Security benefits and pensions. But what about retirees without pensions, or whose Social Security retirement benefits aren’t so ample?
For numerous reasons we’ll review in this article, retirees who opt to follow the 4% rule could be at risk of running out — and outliving their retirement savings.
But financial professionals can offer clients advice and solutions that may help clients control the risks of retirement and achieve their retirement goals.
Acknowledge the 4% rule’s assumptions
The 4% withdrawal rule was intended to reflect a conservative approach overall, to help many retirees get a rough idea about how to budget their money to last — and maybe even leave a little something for their heirs, but it’s based on certain assumptions.
Consider this: the rule became popular in the 1990s. It reflects outcomes for an investor who’d stopped working in 1968, and who would live 30 years in retirement.1 So the rule assumes this imaginary investor’s gains and losses would reflect the markets and inflation rates of those years.
That’s not all. It also assumes a 50-50 stock-to-bond ratio.1 It doesn’t account for taxes, fees or other expenses that happen with each withdrawal, either. It’s also worth re-emphasizing: the 4% rule is based on historical market performance, and no one’s capable of predicting every future twist and turn of the markets.
One “rule,” many possible outcomes
Where might an investor run into trouble when following the rule? One major downfall of the 4% rule is that it doesn’t guarantee a lasting income. Any assumption not met has potential to change the outcome. Consider these factors that can each have its own impact on whether a retiree’s money will last their lifetime:
- Starting balances
- Market performance and sequence of returns
- Investment allocations due to risk tolerance
- Rates of inflation
- Age at retirement
- Required minimum distributions
- Life expectancy
- Unpredictable healthcare expenses
A retiree could experience a variation in any single factor, or their calculation could be hit by several factors together — so a 4% withdrawal rate has the potential to result in a lot of surplus at the end of life for some, and the far worse alternative, running out of a vital source of income, for others.
Help clients build a personalized withdrawal plan
Uncertainty will always be part of life, but you can help clients develop a more individualized rate of spending down their retirement savings. Start by asking the essential questions: how much they’re working with, the age at which they intend to retire and whether they have other income sources, including Social Security benefits and/or pensions.
Assess their risk tolerance, their need for access to liquidity and the level of confidence they want in the outcome. It’s also important to have conversations with clients about the adjustments they may need to make in the future, should conditions change significantly, to help shore up their savings to last over the long term.
The earlier clients start planning, the more choices they may have in terms of adjustments. A client may choose to save at a higher rate, invest more aggressively or work a few more years before retiring. But once retirement arrives, clients may have to choose between higher investment risk exposure and reductions in their withdrawals. For clients with modest nest eggs, this can be a really tough choice.
Look for solutions for today’s retirement realities
Let’s face it, even if a traditional, diversified retirement portfolio may perform well, it doesn't offer risk protection. But eliminating risk altogether also eliminates upside growth opportunities.
That’s where an annuity may provide the combination of growth potential and guaranteed income it takes to enable clients to participate in the market and maintain a reliable source of money in retirement. But not all annuities are alike; some wait to lock in the benefit base until income begins or reduce withdrawal rates down the line, so it’s important to understand all the details.
TruStage™ Zone Income Annuity, allows clients to choose a floor that reflects their risk tolerance along with a corresponding upside cap. And a guaranteed benefit base with an annual step up protects their guaranteed lifetime withdrawal benefit. A withdrawal rate of 6% at age 65 can be within reach with Zone Income Annuity. Clients can invest confidently knowing their income will never go down — for a reliable source of income to help them achieve their individual retirement goals. You can learn more about Zone Income Annuity by clicking the link below.