Ask any reputable financial planner and they will respond that it depends – on a client’s time horizon, spending habits, risk tolerance, retirement age and how much comes from other sources such as Social Security and even a defined benefit plan for retirees lucky enough to have one.
Most planners are familiar with the 4 percent withdrawal rate research laid down more than 20 years ago by now-retired advisor Bill Bengen.
The Bengen Rule, a rule of thumb to establish a retirement income floor, is based on a 30-year time horizon.
But what happens with a 40-year or even a 50-year time horizon as people live longer and look to stretch out retirement income? Does the 4 percent rule still hold?
An extended period of low interest rates has put pressure on the 4 percent rule as well, as retirement income portfolios find it difficult to eke out gains without taking on more risk. And more risk is something many retirees can’t afford to take.
“Generally speaking, yes, the new school of thought on initial withdrawals is 3 percent,” said advisor Randy Bruns in Downers Grove, Ill.
But for retirees with a higher percentage of income from guaranteed sources and a lower percentage of expenses tied to nondiscretionary spending, withdrawal rates can be much higher than 3 percent, he said.
Shorter time horizons – 20 years, for example – and retirees with flexibility to adjust in turbulent times or absorb a change in the sequence of returns, can withdraw as much as 5.5 percent or even 6 percent of their retirement portfolio, retirement researchers have found.
An Argument for Annuities?
Is the longevity risk – the risk of retirees outliving their income – an argument for annuities?
Some advisors gravitate toward annuities to provide income. Meanwhile, other advisors - who balk at annuity fees, rigid products structures, their lack of capital appreciation and low yields - prefer to structure bond ladders or hunt for better returns with market-based investments.
If longevity risk isn’t an automatic argument for annuities, it is a good argument for delaying Social Security, which also happens to be the largest annuity program in the country, said David E. Hultstrom, principal of Financial Architects in Woodstock, Ga.
The longer Social Security recipients delay taking Social Security, the higher the inflation-protected payments guaranteed by Uncle Sam.
Hultstrom isn’t a fan of most annuities. But, for advisors leaning toward annuities, the next best option to delaying Social Security is an investment in a qualified longevity annuity contract, or QLAC, followed by a single premium immediate annuity, or SPIA.
Required minimum distributions (RMDs) from individual retirement accounts, which are set by the IRS at 3.65 percent for people age 70, is a good rule of thumb, Hultstrom said.
IRS tables progressively increase the RMD percentage as retirees age. The RMD is set at 5.35 percent for 80 year olds, 8.77 percent for 90 year olds and 15.87 percent for centenarians.
Winning the Income Showdown
Many advisors favor annuitizing at least a portion of a retirement income portfolio to cover “grocery money,” essential or nondiscretionary expenses.
Some retirees will have sufficient income from Social Security and portfolio distributions to pay for groceries and keep the lights on, but other retirees may want a separate annuity for supplemental purposes that Social Security doesn’t provide.
“It’s clear from almost any study that it’s not whether you should annuitize a portion of your portfolio, but how much?” said Scot L. Stark, owner of Stark Strategic Capital Management in Freeland, Md.
Using income annuities delivers a more efficient approach to meeting retirement spending goals than commonly thought, according to retirement income planning expert Wade D. Pfau at The American College of Financial Services.
An investments-only strategy can support greater legacy amounts than partial annuitization in the event of early death. But those higher legacy amounts come at the cost of not having a contractual income guarantee and less liquidity, Pfau argues in a paper titled “Retirement Income Showdown: Risk Pooling vs. Risk Premium.”
“Those favoring spending and true liquidity will find that it is much more difficult than commonly assumed for an investments-only strategy to outperform a strategy with partial annuitization,” Pfau writes.