The 4% Withdrawal Rule: How Fixed Index Annuities Can Help You Beat Retirement’s Oldest Rule of Thumb
For decades, the 4% Withdrawal Rule (also known as The 4% Rule) has been the cardinal law for retirees looking to manage their income in retirement. In short, the rule states that a person who withdrawals 4% of their retirement savings each year will have enough steady income to last the rest of their life. But with increased life expectancies and volatile modern markets, current financial advisors have begun casting doubt in the direction of this long-held assertion.
Fixed index annuities (FIAs) are one way to generate a guaranteed income stream, with payout rates that are even higher than 4%. To understand why, it is first important to understand the basis of the 4% Withdrawal Rule.
Origins of the 4% Withdrawal Rule
The 4% Rule was first popularized in 1994 by financial advisor William Bengen. In his research, Bengen discovered that there had never been a period of time in U.S. history, even during the most dismal markets, when withdrawing 4% has lasted a retiree less than 33 years. Thus, the 4% Withdrawal Rule was born.
In the intervening decades since Bengen conducted his research, American life expectancy has increased, meaning that “33 years” may no longer be synonymous with “the rest of a retiree’s life”. On top of that, the 4% Rule is based on financial accounts that are closely tied to the swings of the public market. Unpredictable markets have led some to question the efficacy of the 4% Rule—if erratic markets plummet right as a retiree begins withdrawing money from their account, their nest egg can lose value quickly. Overnight, that shrunken account can no longer sustain annual 4% withdrawals.
The 4% Rule was created when the stock market was on a strong sustained run, interest rates were markedly higher, and life expectancy was shorter. Now, 25 years later, the world is a very different place.
By all measures, the market is set for a major correction. Between 1997 and 1999, the 10-year treasury bill rate hovered around 6%—today it’s 1.55% and it looks like it will drop even further. And thanks to medical advancements, Americans are living close to five years longer than their ancestors were 25 years ago. The factors that made the 4% Rule pertinent no longer hold—and therefore nor does the promise of income for life from stocks and bonds.
Advantages of fixed index annuities
Market experts today are on high-alert for a market downturn that, in their opinion, is long overdue. Most bull markets last only five to six years, but our current upward trending market has lasted a full ten. In other words—now is the time to secure your finances.
With traditional investment vehicles, a market stumble might mean reducing spending for a year or two to protect your retirement account. For retirees, this could translate into putting off home renovations, forgoing a dream vacation, delaying medical care, or digging into other savings accounts—and even more, depending on the extent of the downturn.
Modern financial products, like fixed index annuities, offer greater financial security through guaranteed principal protection and robust lock-in rates . With this increased security, retirees can live at ease knowing that they will not suddenly find themselves in a difficult financial situation once they stop getting a paycheck.
With fixed index annuities, your principal is guaranteed—the money you invest upfront is secured to weather the storm of an unpredictable market. Not only that, but the interest earned through fixed index annuities is added back to your initial principal and is also protected. The longer you hold on to your fixed index annuity, the more your protected principal grows.
Can fixed index annuities help beat the 4% Rule?
The answer is: yes, FIAs can help beat the 4% Rule. The payout rate on fixed index annuities is typically 5% or higher, which already outshines other retirement income options. On top of that, fixed index annuities provide upside when markets are rising, and protection against a downturn. Even when there is a market correction, you have a safety net for your principal—the FIA payout remains constant. That’s not the case with the 4% Rule—when the market dives, the principal of the account shrinks. The 4% withdrawal rate now pulls from a smaller balance—so the amount withdrawn is smaller as well.
Moreover, FIAs can capitalize on gains once the markets rebound. If you are healthy and looking forward to a long life (and we hope you are!), consider FIAs—contracts that can help you beat the 4% Withdrawal Rule—as part of your diversified retirement portfolio.
To learn more, contact DeWitt & Dunn, specialists in fixed index annuities.