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Study Notes Challenges to Following the “Four Percent Rule”

WASHINGTON, D.C. – A recent study questions a decades-old rule of thumb for safely withdrawing funds from retirement accounts at a rate that can support a 30-year retirement. The research also found that including protected income offered by annuities can help ensure retirees meet their income needs. The study was published by Morningstar, Inc., a leading provider of independent investment research.

“Outliving retirement savings is a major concern for America’s workers and retirees,” said Frank O’Connor, Vice President, Research and Outreach for the Insured Retirement Institute (IRI). “This latest study by Morningstar summarizes several key points and concerns about current market conditions that may affect how long retirees can generate sufficient income to last throughout retirement.”

The “4% rule” was proposed by William Bengen in a 1994 paper, “Determining Withdrawal Rates Using Historical Data.” It is a guideline to determine a withdrawal rate that would theoretically provide sustainable income without depleting assets entirely over a 30-year retirement.

The rule is based on the notion that retirement assets are allocated to risk assets. Generally, an allocation of 50 percent in stocks and 50 percent in bonds would generate returns over time that support a sustainable four percent initial withdrawal rate that increases over time to keep pace with inflation.

The Morningstar paper notes that with interest rates at historic lows and equity markets at near historic highs, expected returns are likely to be lower in the future. This will require strategies that can mitigate the impact of market downturns on portfolios, and by extension, on future retirement income.

The paper also noted that one goal should be “to increase income from nonportfolio sources so as to reduce cash flow demands on the portfolio.” Morningstar suggests that one way to accomplish this is through annuities.

“Generating sufficient income from a retirement portfolio for what may be a 20- or 30-year retirement generally requires investment in risk assets like stocks, which are subject to volatility,” O’Connor said. “The catch is, while the market has been on a winning streak lately, it will inevitably suffer downturns which could seriously affect a retirement portfolio. Avoiding stocks entirely is not the answer, as most retirees have not saved enough to generate sustainable, lifelong income that will keep pace with inflation without some return on their investments.”

O’Connor noted that annuities can play a critical role in helping individuals meet their retirement goals.

“This is where annuities add tremendous value,” O’Connor said. “By providing protected lifetime income which, along with Social Security, covers basic expenses, retirees can feel more secure investing the rest of their portfolios in risk assets and ride out the ups and downs to achieve greater wealth over time,” O’Connor said.

“This strategy also creates opportunities for retirees to use their increased wealth to purchase additional annuities in later years, effectively giving themselves a raise at an older age, when an annuity will produce even more income per dollar invested,” he added.

O’Connor cited an example of this strategy where $100,000 invested in an immediate annuity at age 65 produces about $500 a month in income. At age 75, that rises to $700, or 40 percent more income for the same investment.

“Financial professionals can help workers and retirees use protected lifetime income products as part of their overall retirement strategy,” he noted.

Incorporating annuity products into retirement planning is an approach that consumers should embrace. IRI’s Retirement Readiness Among Older Workers report found that almost nine-in-10 workers want their sources of supplemental retirement income (i.e., sources other than Social Security) to last for their lifetimes.

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Contact: Dan Zielinski

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