It used to be simple to figure out how much money to withdraw from your retirement savings each year. With the so-called 4% rule, you could cash out that percentage each year, with a little extra for inflation, and be fairly confident your money would last about 30 years.
Unfortunately, the market crashes of the past decade have thrown that rule into serious doubt. As it turns out, the 4% rule does not work if the market has a bad slump in the first few years of your retirement. In other words, if the timing of your retirement turns out to be wrong, you may find yourself in danger of running out of money.
A calculation from T Rowe Price illustrates the problem. T Rowe’s example shows a hypothetical person who retired on the first day of 2000. The retiree had a portfolio of 55% stocks and 45% bonds. He started with a 4% withdrawal rate and increased that 3% a year for inflation. Thanks to the tech crash, that retiree’s savings would have fallen by one third through 2010, leaving him with just a 29% chance of making it through three decades.
This prompts a big question from those of us preparing to retire. How should we plan to draw from our savings? There are several alternatives to the 4% rule. One is to use what are known as single-premium annuities instead of bonds. SPIAs may generate income with less risk and more consistency than bonds, according to proponents of this approach. Immediate annuities have a big drawback, though: In exchange for the guaranteed payouts, buyers lose access to their money. It is not available for emergencies.
Another option is to determine your life expectancy, using the assumptions used by the IRS, and divide your nest egg balance, each year, by the number of years remaining in your life expectancy. If the markets are good to you and your balance increases in a particular year, you’ll be able to withdraw more the following year. Unfortunately, if your savings shrink, so must the amount of your annual withdrawal.
One option that is popular with our clients is investing a portion of their savings in permanent life insurance. Because of the guaranteed nature of these policies, they allow investors to prevent principal loss and sustain stable growth. Permanent life allows policyholders to accrue cash values at a rate of interest that is fixed and not subject to market dips or crashes.
Having part of your savings invested so that it produces a guaranteed stream of income can create valuable peace of mind at a time when retirement certainties have turned into uncertainties. Permanent life insurance has a number of other benefits in addition to its cash-value feature, its guaranteed interest, and of course its death benefit. Customized permanent-life policies can serve as the cornerstone of your financial independence, as I’ve explained in my book The Private Vault: A Guide to Building Tax-Free Income in the New Economy.
Please don’t hesitate to contact me if you’d like to discuss ways to ensure your retirement money lasts as long as you do.
