Enforcing the Rule

Jiab Wasserman  |  April 7, 2020

THE MOST POPULAR retirement income strategy is built around the so-called 4% rule. Three-quarters of financial advisors say they use some variation on this approach. But is it safe?

The 4% rule specifies that you withdraw 4% of your nest egg’s value in the first year of retirement. Thereafter, you increase the dollar amount withdrawn each year at the inflation rate. Based on historical U.S. stock and bond returns, that strategy should carry you safely through a 30-year retirement.

But there’s concern the strategy won’t work in today’s world, especially with bond yields so low. A 2013 paper by Wade Pfau and two other researchers even suggested the strategy might suffer a 57% failure rate over a 30-year retirement. In other words, there’s a good chance that retirees will run out of money.

What to do? In another study, Pfau proposed a different way to think about retirement income. He looked at a hypothetical 65-year-old couple whose lifestyle required a 4% inflation-adjusted withdrawal rate. He plotted how 1,001 different product combinations might perform if the couple were trying to meet two objectives: generating spending money and preserving financial assets.

Pfau found that the best way to meet those two goals was with a mix of stocks and single premium immediate annuities, or SPIAs. SPIAs shouldn’t be confused with other types of annuity, like equity-indexed annuities and variable annuities, which are far more costly and typically a bad deal for investors.

Meanwhile, Pfau found that relying on a traditional portfolio of stocks and bonds produced some of the worst outcomes. For instance, at 50% stocks and 50% SPIA, there was a 94% chance to meet lifetime spending needs, while leaving the couple with about 60% of their assets at death. But with 50% stocks and 50% bonds, there was an 88% chance of meeting spending needs, but with only 38% of assets left upon death.

In other words, immediate annuities can help retirees meet their retirement spending goals, while still preserving more of their assets. Many retirees will find that latter notion counterintuitive, because buying an immediate fixed annuity means turning over a big chunk of their assets to an insurance company.

Why are immediate annuities so helpful to a retirement income strategy? Longevity risk—the risk of running out of money before you run out of time—is retirement’s greatest financial risk. If you live well into your 80s and beyond, there’s a grave danger you could suffer financially because of persistent inflation, a stretch of lousy investment returns or high health care expenses, including the cost of long-term care.

Immediate fixed annuities can help protect against these financial perils. Along with Social Security and any pension you’re entitled to, they ensure you’ll have monthly income, no matter how long you live.

Annuities also have the virtue of simplicity. That’s an important advantage. As retirees grow older, they often struggle to make good financial decisions. On top of that, income annuities and other predictable income streams can improve retiree happiness, and may even provide the incentive to keep going and live a longer life. As Jane Austen wrote in Sense and Sensibility two centuries ago, “If you observe, people always live forever when there is an annuity to be paid to them.”

Despite all these benefits, immediate fixed annuities remain one of the financial world’s least popular products. Even insurance agents don’t make much effort to sell them, because the commissions they earn on immediate fixed annuities are small. But if your goal is a more comfortable, less anxious retirement, you might want to ignore the naysayers—and stash a slice of your nest egg in immediate fixed annuities.

In 2017, Jiab Wasserman left her job as a financial analyst at a large bank and is now semi-retired. Her previous articles include When You’re No. 2, Grab the Wheel and In Withdrawal. Jiab and her husband Jim, who also writes for HumbleDollar, currently live in Granada, Spain. They blog about downshifting, personal finance and other aspects of retirement—as well as about their experience relocating to another country—at

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4 months ago

Two words: variable withdrawals.

Betsy Larey
Betsy Larey
1 year ago

I beg to differ. The problem with annuities is they are not indexed to inflation. $2000 a month today is worth a whole lot less in 10/15 years. Especially given the fact we’re printing money today like we are playing monopoly. I keep 3 years ( keep 5 if you’re really conservative ) of cash/short term bonds) Don’t forget, if you own solid blue chips you’ll be getting around 2-3% in dividends.
There’s a reason why insurance companies live in glass towers in downtown. Annuities are sold not bought. Before you hand over your hard earned dollars to that nice salesperson, think about that.

R Quinn
R Quinn
1 year ago

I agree 100% with the value of some annuity income, especially when there is no pension, but convincing people to turn over that cash is a hard sell, often impossible. When I was working I installed a cash balance pension plan. It was technically a DB plan intended to pay as an annuity, but every person who retired took the lump sum.

On the other hand, even an annuity, pension and SS provide little inflation protection unless you pay for inflation rider within the annuity. Rather than give me inflation protection my SS benefit keeps going down as the Part B premium increase exceeds the COLA increase.

Langston Holland
Langston Holland
1 year ago

This article and the link to the Pfau paper changed how I think about fixed annuities vs. bonds during retirement. As you know, when sourced from a reliable company, fixed annuities offer the unusual benefits of extremely low risk and constant lifetime payouts.

In reference to inflation adjustments for fixed annuities, I think some of you whippersnappers may be missing an important point. Inflation is included in the paper’s comparison of stock/bond* vs. stock/annuity allocations. It’s the performance of the whole portfolio that matters, not that each component include an inflation adjustment.** Also consider that if the bond market suffers and/or you live long enough, you could use up your bond holdings to the point where you have to rely on something else. That isn’t going to happen with a fixed annuity and therein lies its potential risk/return advantage.

The paper takes the novel approach (to me) of calculating efficient frontiers for bond vs. annuity allocations. That means risk adjusted returns are considered for this critical phase of life where shortfalls become a very big deal. Unless you have a good deal more money than needed during retirement, you should consider fixed annuities.

* It’s helpful that interest rates are about the same now as when the paper was written in Sept 2012.
** Inflation adjusted annuities and variable annuities were also considered in the paper, but plain ‘ole fixed annuities spanked both of them (likely due to sales fees).

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