Earlier this week, I reviewed common financial rules of thumb and offered a quick evaluation of how each rule would likely perform if accepted by an individual as the final word. One of these was the rule that convinces retirees they will be financially secure if they withdraw 4% of their nest egg for income one year and continue withdrawing the same amount adjusted for inflation each year.
Walter Updegrave has a much more detailed strategy for retirees who would like to make their money last from age 65 to 95 and beyond. He offers three alternatives that one can follow depending on their assets and their needs in retirement.
Three strategies for retirees
The first strategy is for retirees who have enough income from Social Security and pensions to cover basic expenses and who are confident in their ability to manage their portfolio.
For those in this situation the 4% withdrawal rule has a chance of succeeding — having your money last 30 years — 77% of the time. If you need more income than 4% would provide, you’re risking not having enough to last that long. For example, someone retiring today with a $1 million nest egg could withdraw $40,000 that first year. But if you’re 33 years old like me, you better plan on having much more than $1 million when you retire; thanks to inflation, an income of $40,000 thirty years from now will probably not be sufficient.
In order to maintain a 4% withdrawal rate, according to the article, is to maintain a portfolio of 50% stocks and 50% bonds. And by the way, a bad year in the stock market could wipe you out.
The second strategy offered by Walter Updegrave is for retirees who need more income for basic expenses than is provided by Social Security and pensions or who do not want to subject their portfolio to as much risk as required in the first strategy.
Take part of your nest egg and purchase a lifetime immediate annuity. This will provide you with steady paychecks for the rest of your life. According to the article, recent annuities pay out 8%, so you would only need $500,000 to make that $40,000 income mentioned earlier. These are most beneficial for people who live longer because money is pooled with other investors. Those who die earlier help fund the incomes of those who survive in retirement longer. The problem with annuities is your money is often locked inside them, and you can’t get it if you need it without paying steep penalties.
Walter Updegrave also offers a third strategy for retirees who need more income than Social Security and pensions provide but want access to more of their money. In addition to a portfolio of stocks and bonds, and an immediate lifetime annuity, add a variable annuity with a guaranteed lifetime withdrawal benefit to the mix.
Variable annuities are flexible but they are also expensive. Rather than 8% like the lifetime immediate annuity above, a 65 year old is likely to receive a 5% return. It is not rare for these accounts to charge a fee of 3% of your account balance each year. The author suggests that the optimal mix between these products and investments would be 25% of your portfolio in variable annuities, 25% in immediate annuities, and the remaining 50% in the diversified portfolio of stocks and bonds.
The problem with annuities
The sale of annuities, particularly variables annuities, is riddled with problems. These are very popular products for salespeople because they make a lot of money for the companies that sell them. It’s not rare for salespeople to misrepresent the product. Often customers are not given the full information regarding withdrawal penalties.
Here’s an example of an 86-year-old man who was pressured into buying a product he did not understand and would never benefit from. Dateline investigated annuities salespeople and found more deception in the industry. Ben Stein, however, credits variable annuities for making his parents rich, though it might be important to note that a Ben Stein’s long-time working partner is Phil DeMuth, a registered investment adviser (salesperson) who benefits financially when more people are convinced that annuities are good products.
How to make your money last, Walter Updegrave, Money Magazine, September 23, 2009
Updated December 14, 2017 and originally published September 26, 2009.