Difference Between Investing & Income Planning
If you were given false information, when would you want to know about it? If the consequence was whether or not you would run out of money in retirement, it’s not even a question; you would want to know immediately.
If you have subscribed to the conventional knowledge that has long favored the “4% withdrawal rule” (which states with a withdrawal rate of 4%, of the value of your portfolio at retirement, adjusted for 3% inflation, your money should last for 30 years) then it’s time to know the facts.
How much money can I withdraw on an annual basis from my portfolio without running the risk of going broke? This is the kind of question that should keep you up at night.
Saving for retirement is now your responsibility. In today’s changing economic environment, it’s never been more important to know where you are on the path to financial security throughout retirement. It’s becoming more and more difficult to solve retirement the conventional way of just investing in a tax-qualified plan, buying a product or following the financial advice of the last 30 years. Hope and timing is not a strategy!
Volatility in the markets, historically low bond yields, and the fact that people are living longer has a lot of experts questioning the 4% safe money withdrawal rule. Morning Star recently concluded that a retiree who wants a 90% probability of achieving their income goal and having their assets last 30 years should only withdrawal 2.8% per year. To look at it in different light, if you retired today, at age 62, and had a portfolio of one million dollars, you could safely withdrawal $28,000 the first year, with 3% inflation the second year it jumps to $28,840 and so on. After that, pray you or your spouse don’t live past 92 years old. By the way, a married couple age 65 has a 40% chance that one of them will celebrate their 92nd birthday.
This is why income planning becomes crucial for people in or nearing retirement and you may want to work backwards to figure out your primary income need. When you add your Social Security payments, pension (if you are one of the lucky few) and investment income, there may be a gap in your primary income need. One solution that has been getting a lot of support lately is to use some of your assets to purchase an annuity with a lifetime income rider that will cover the gap and protect against longevity. The income stream may also be adjusted for inflation if desired.
By implementing a product allocation strategy combining annuities with a lifetime income rider and traditional portfolio strategies, you vastly increase the chances of having sustainable income in retirement no matter if live to be 85 or 105 years old.
Let’s look at the example above of a retired 62 year old with a million dollars. If you use the new proposed safe withdrawal rate of a 2.8% and increase that distribution by 3% every year for inflation, you could supplement your retirement as follows:
- Year 1 = $28,000
- Year 5 = $31,514
- Year 10 = $36,533
- Year 20 = $49,098
- Year 30 = $65,983
- Total withdrawals at age 92 equal $1,332,112
Now, let’s look at what we could achieve with an income planning strategy that includes an annuity with a guaranteed income for life rider and the conservative traditional retirement strategy. Let’s assume we put $500,000 in a fixed indexed annuity with a lifetime income rider and planned to turn on that rider at age 70 to start taking income. The other $500,000 we are going to place in a money market account with zero growth for this example. You could take $62,500 out of the money market for the first 8 years and spend down that account to zero and then, in the ninth year, you turn on the income rider from the annuity. From the annuity, you would be guaranteed an income stream of $61,884 for the rest of your life.
- Year 1 – 8 = $62,500
- Year 9 – ? = $61,884
- Total withdrawals at age 92 equal $1,861,448
Two more things you may want to ask yourself. First, who is taking on all the risk? Second, what will happen if you live past life expectancy? With the traditional asset allocation model, the investor has 100% of the risk. By diversifying a portion of your asset to the insurance company, you are transferring some of the risk and can sleep well at night knowing you have a sustainable income stream for life.