Goodbye, 4% rule. Hello, 6% rule!

By Brett Arends

One of the cornerstones of retirement-planning advice has been the 4% rule. It might be time to reconsider.

For decades, one of the cornerstones of retirement planning advice has been the so-called 4% rule.

Financial advisers said that if you want to be sure of making your retirement savings last for the rest of your life, then in the first year of retirement you should withdraw no more than 4% of your portfolio's value. Then, in each subsequent year, you should raise the amount you withdraw by no more than the rate of inflation.

This was based on the assumption you had invested the portfolio in a conservative mixture of stocks, bonds and cash.

Good advice? Sure. Probably.

Once.

But not now.

If I were turning 65 and retiring tomorrow, I know for certain that I could beat that figure by around 50%. I could take out nearly 6% of my portfolio in the first year, not just 4%. And hike it each year, to help cover the costs of inflation. And do so without any serious risks or challenges. And I also know I would be guaranteed -- as close as anything in this business -- that my money would last until I died. Not just for 30 years, but even if I made it to 100 or 110.

How's that for a dramatic improvement in my material standard of living in my golden years?

The reason for this is simple.

The recent turmoil in the bond market has sent the payout rates skyrocketing on lifetime annuities, usually known as single premium lifetime annuities. These are regulated life insurance products that convert a sum of money into a lifetime income stream.

Annuity rates have risen so high that they are leaving traditional 4% withdrawal rates in the dust -- even on those annuities that also offer annual income rises to offset inflation.

Some simple illustrations.

A 65-year-old man buying a single-premium immediate annuity today can lock in a 7.7% annual payout rate, according to recent market data at the industry website immediateannuities.com.

That means someone with, say, $1 million could get a guaranteed income of $77,000 a year for as long as he lives, whether it be one year, 30, or even more.

A 65-year-old woman can lock in a payout rate of 7.3%. (The rate is lower, not because of sexism, but because women typically live longer, so they can expect more monthly checks.)

The same 65-year-old man could also buy an annuity that starts with a 5.9% initial payout rate, and then increases payouts by 3% every year. For someone with $1 million, that's $59,000 in the first year, just under $60,800 in the second, $62,600 in the third, and so on.

For a 65-year-old woman, the starting rate is 5.6%.

The payout rates are lower if you're younger when you buy the annuity, because you'll be getting those checks for longer. The payout rates are, by the same token, higher if you don't buy an annuity until you're 70 or even older.

There are some caveats and catches. (You knew nothing was free, right?)

The most obvious is that with most annuities there is nothing left once you die. The payout rates are so good partly because of the so-called mortality credits, which is a nice way of saying that the income for people who live to 100 is subsidized by the people who bought an annuity and then died young.

This only works if there is nothing left after you die. (Although you can cushion against the worst risks: Some annuities will pay out something to heirs if you die within, say, the first five or 10 years)

A second caveat is that when you buy an annuity, you give up liquidity. You lock up your capital. You get the monthly checks, but you can't get all your cash back in order to buy a home.

Everyone's situation is different. Many advisers recommend purchasing an annuity with at least part of your retirement savings. Right now, the rates are the best they've been in years.

The recent surge of annuity rates is catching the attention of the retirement experts at Morningstar, the financial analysis company. John Rekenthaler, a prominent Morningstar writer and vice president of research, tells me that they're starting to look at the products much more closely and plan to include a more detailed analysis in future research on retirement planning.

Of the latest annuity payout rates, especially those with annual income rises, he says: "That does sound like an attractive offer, subject of course to the usual caveats that lifetime annuities are best suited for those who expect to have above-average lifespans, and who don't wish to leave the assets that they spend on the annuity as a legacy."

In Morningstar's latest annual State of Retirement Income report, just published, they argue that an investor can safely withdraw 4% a year plus inflation, or better, using portfolios of stocks, bonds, cash and Treasury inflation-protected securities.

Single premium immediate annuities currently account for barely 3% of total U.S. sales of all "annuity" products. They were a paltry $9 billion last year. The other 97% largely consists of complex investment-plus-insurance products that have nothing in common with lifetime annuities and have a decidedly mixed reputation among analysts.

It's weird, because lifetime annuities are really nothing more than a do-it-yourself old-fashioned pension. Back in the day people didn't retire from a company with a sum of cash. They retired with the assurance of a monthly income for the rest of their life.

Meanwhile, the main criticisms of these annuities are far less than meets the eye.

For instance, sure, annuities lock up your capital. But so, really, does the standard 4% rule: You can't withdraw 4% a year, plus inflation, and make it last a lifetime if you also want to cash in your stocks and bonds to buy a house or a boat.

As for the issue of leaving an inheritance? The 4% rule was designed to minimize the risks you would run out of money before you died. But it offered no guarantee there would be much, or anything, left afterward.

Actually, the number crunchers on Wall Street admit that the 4% rule leaves a non-trivial risk that you could still outlive your money, especially if you live more than about 30 years.

In those circumstances, not only would your heirs not get an inheritance, but they'd end up paying your bills -- if you are lucky.

And while an annuity may leave them nothing after you're gone, it will also leave them nothing to fight over either. Let the lawyers weep.

Meanwhile, if an annuity boosts your annual income in retirement by 50%, you'll be a lot better able to make gifts to your heirs while you are still alive.

Food for thought.

-Brett Arends

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

11-17-23 1013ET

Copyright (c) 2023 Dow Jones & Company, Inc.