Which School of Thought is Right for You?
Even though some financial planning strategies have changed over the years, there are still two ways to generate reliable retirement income. While one method might work well for some people, it may not be beneficial for others, and vice versa.
So, which retirement income school of thought is best for you?
The way to determine that is to first have a good understanding of how both of these methods work.
Probability versus Safety in Retirement Income Planning
For many years, financial advisors worked with clients on probability-based strategies for withdrawing assets from their portfolio to use as a source of retirement income, while at the same time keeping money in the account(s) to continue growing.
In the early 1990s, it was deemed that 7% was a “safe” withdrawal rate that could allow retirees to access 7% of their portfolio every year without ever having to dip into their principal. This theory, however, ignored the real-world volatility of the stock market, and it was soon discounted as a viable income generation technique.
After doing more research, it was determined that 4% was actually a more realistic rate to use in a safe withdrawal strategy. In this case, using a portfolio that contained 50% equities and 50% bonds, this withdrawal rate could be more sustainable. This strategy soon became known as the “4% Rule.”
Over time, though, given the increased volatility of the stock market, coupled with historically low interest rates, 4% as a safe rate of withdrawal soon gave way to projections that were closer to the 2% range.
But even at just 2%, there is still no guarantee that the portfolio will last for as long as it is needed by a retiree – especially given the increase in life expectancy over time. Enter the safety-first retirement income generation school of thought.
Advocates of this income method view the prioritization of retirement goals as an essential component of developing a good income strategy. In this case, the idea of “utility maximization” is highlighted – where spending that is required to satisfy basic needs provides much more value and satisfaction to someone than the additional spending on luxuries after basic needs have been met.
Therefore, building a retirement strategy requires starting at the bottom and working up in order to properly fund each goal before moving on to the next. In this case, there is no such thing as a “safe withdrawal rate” like with the 4% Rule.
The whole idea around this safety-first strategy is to create an income “floor” that can be relied upon – such as Social Security, a defined benefit pension, or an annuity – and only then build in more growth-oriented (but volatile) sources.
In doing so, a retiree will be able to count on having the funds that are needed for necessities, no matter what happens in the stock market – and if the market performs well, they can also spend on “extras” like travel, fine dining, and fun. But it will not be devastating to their required living expenses if spending for these add-ons is not available.
Still Not Sure Which Retirement Income Strategy is Right for You?
If you’re not sure which retirement income strategy is best for you, don’t worry – you’re not alone. There can actually be many “moving parts” in any type of financial planning. With that in mind, the best place to start getting answers is to discuss your objectives and your options with a retirement income specialist.
At Annuity Gator, we make understanding retirement income easier. Our annuity experts can walk you through a variety of different strategies – and can even provide you with a direct comparison of specific annuities so that you can more easily narrow down which, if any, will fit your needs.