For years, the so-called 4 percent rule provided the baseline from which advisors launched strategies for retirement account withdrawals. The rule is simple, well-trusted, and relatively unlikely to fail — or at least it used to be. In today’s low-interest rate environment, the strategies that worked for the past 20 years are simply not cutting it, meaning that advisors and clients must readjust their expectations to uncover alternative solutions for providing sustainable retirement income.
While the word “annuity” may be a dirty one for clients who have traditionally sought aggressive investment returns (or worried about their high costs), the evidence cannot be ignored: new studies suggest that annuities are a competitive alternative to the newly old-fashioned 4 percent rule. For those clients unwilling to modify their retirement income planning strategy so dramatically, many advisors have discovered a new method for determining retirement withdrawal rates, inspired by the system used by the IRS itself.
The problem with 4 percent
As the name suggests, the 4 percent rule suggests that if your client withdraws 4 percent of the balance from a retirement account each year, he will be able to create a sustainable retirement income stream with virtually no risk of exhausting the account assets. This strategy has worked for years, more or less, but there have always been problems, such as the failure to account for actual investment performance in any given year. It has generally been a safe bet, however, that the client will not run out of money, which is the greatest fear for many retirees.
Today’s low interest rate environment has, unfortunately, eliminated the primary benefit of the 4 percent strategy — namely, the 4 percent rule is no longer a safe bet. A new study (by Texas Tech professor and Research magazine contributor Michael Finke) has produced evidence that, because interest rates are about 4 percent lower than their historical average, the anticipated failure rate for the 4 percent rule has jumped from 6 percent to a whopping 57 percent.
These numbers cannot be ignored. The study found that the failure rate would remain at 18 percent even if interest rates increase in five years’ time, though there is no evidence to suggest that we will return to 20th century interest rates anytime soon, if ever. The bottom line: it is time for clients to oust the 4 percent withdrawal strategy.
The annuity solution
Even if your clients are tired of hearing about the benefits of annuitizing their assets, it is becoming a simple fact that retirement accounts are not yielding the returns that they have in the past, and the potential of a 57 percent failure rate by following the 4 percent rule should get clients’ attention. When the 4 percent rule’s failure rate was a modest 6%, there may have been reason for clients to reject annuity products as noncompetitive, but today’s reality has changed the picture. Annuities should be seen as more attractive than ever.