Home / Blog / Immediate Annuities Vs. 4% Drawdown Method

Immediate Annuities Vs. 4% Drawdown Method

We spend most of our working lives trying to save for our retirement.  Unfortunately, there is much less focus on how to create an income stream out of that money when we actually get to retire.  The two main options we have for taking our money out of our retirement savings are purchasing an annuity or using the drawdown method.  In the Investor’s Business Daily article, “Cashing In Your Retirement Plan,” Donald Jay Korn compares the two options.  The traditional financial rule for drawing down your money has been a 4% withdrawal method.  Supposedly, your money should last throughout your retirement if you withdraw 4% per year, adjusted with inflation increases.  This 4% rule has been challenged lately because people are living longer and markets are more tumultuous, but we’ll still use that for the sake of comparison.

Mr. Korn uses an example of two different people who are retiring at the age of 65 with $1.5 million in retirement savings.  The first person plans to apply the 4% withdrawal rule, so he will receive $60,000 in his first year.  He will increase his withdrawals yearly to account for the rate of inflation.  In this example, the retiree should be able to live comfortably for 30 years without running out of money.  “Should” is the key word there though.  He does not have a guarantee.  The second person uses an immediate annuity instead.  An average immediate annuity payout for this person would be $9,000 per month, so he would receive $108,000 per year.  This equates to a 7% payout from his $1.5 million for as long as he lives.  When you just look at the payouts, $108,000 is certainly a better option than $60,000.  The man with the immediate annuity is also guaranteed not to run out of money, so he has no worry about longevity risk.  Another benefit to the higher initial payout is that you can delay social security until age 70 so that you receive the full benefit.

There are other considerations though between the two options.  In order to get the guarantees that come with an immediate annuity, you give up control of your money.  The man withdrawing 4% yearly has the option to take less or more money out if his needs change.  And although he receives much less in the first year of retirement, he will pass the $108,000 yearly mark at age 85.  This control is valuable to some retirees, which is why you have to weigh your own personal needs before making any concrete retirement product decisions.  It’s also a good reason to spread your money out over multiple sources rather than putting it all in one place.  If you spend less, you might have money leftover for your heirs.  An immediate annuity will not pass on any death benefits.  But the 4% method does come with the risk that if you live long or overspend, you will run out of money while you are still living.

Immediate annuities do offer flexibility.  If you want, you can add on death benefits, get access to your capital or have the potential for income growth.  Some annuities increase with the inflation rate as well.  Keep in mind that everything you add on to an immediate annuity will reduce the amount of your $108,000 payout.  With the 4% withdrawal method, you have no guarantees.  The peace of mind that comes with annuity guarantees is worth a lot.  Some experts recommend a combination approach with annuities and drawdown of the rest of your retirement savings.  Your annuity guarantees that you will not outlive your income stream.  Using the drawdown method for the rest of your money allows you more control and the ability to leave a legacy if markets do well.  A combination approach to retirement planning allows you to take advantage of the benefits of multiple retirement income options.

Written by

Follow Rachel, aka Finance Mama, on Twitter and Google+

Share Button
Comments are closed.

 

Copyright © 2018 AFYI Holdings Group, LLC. All Rights Reserved. No part of this article may be reproduced without the express written consent of AFYI Holdings Group, LLC.

Annuityfyi.com - Prefooter

× Popup Banner

FIA GUIDE

5 keys to making the right decision

Not Today
× Popup Banner

Discover How to Control Your Financial Future

FREE Download and Newsletter

FIA Guide: 5 Keys to Making the Right Decision

Not Today
× Popup Banner

Avoid Costly Mistakes When Picking Your Annuity

FREE Download and Newsletter

FIA Guide: 5 Keys to Making the Right Decision

Not Today
Share On Facebook
Share On Twitter
Share On Google Plus
Share On Linkedin
Share On Pinterest