Is A Lifetime Annuity Better Than The 4% Withdrawal Method?

There is an ongoing argument in the financial world about which is better: an annuity that guarantees a lifetime payout* or a 4% withdrawal scheduled from your retirement savings or investments. George Mason University’s Mark Warshawsky (1) performed a detailed study recently to see which strategy was better. In Plan Sponsor’s article, “Comparing Lifetime Annuities and Structured Withdrawals,” John Manganaro (2) summarized the detailed academic analysis.

More U.S. workers than ever before are relying on defined contribution plans like 401(k)s to save for retirement. As fewer companies offer pensions, this trend will continue into the future. That leaves those workers to determine how they will take money out of their defined contribution plans and create income during retirement. Two of the most common choices are buying an immediate lifetime* income annuity with a portion of your retirement assets and following the 4% withdrawal rule. This rule has been around for a long time and assumes that your money will probably last for as long as you live if you withdraw no more than 4% each year. 401(k)s have been around long enough that we know how they work and the saving is seamless. But we’re coming to a time when more people than ever will have to create income from these assets and we don’t know the best way(s) to do that yet.

Despite the previous popularity of the 4% rule, it isn’t recommended much anymore. This rule recommends that you withdraw 4% of your retirement assets each year and to adjust that percentage occasionally for inflation. Keeping control over your money is the main benefit of using this approach. But there is no guarantee that you won’t run short of money at some point during your lifetime, especially if you live a long life.

Warshawsky’s study found that purchasing a lifetime annuity may be a better option for many retirees than using systematic withdrawals because you live with less risk and your income payments are typically higher. He says that immediate income annuities are still a better option even if you don’t annuitize your entire defined contribution plan savings.(1) There are still many benefits to annuitizing a portion of your retirement assets. The main benefit is that you don’t have the risk of running out of money during retirement when you purchase a lifetime annuity. Many people underestimate their lifespan, so they are at a risk of depleting their assets too fast. This happens even more so when you have control over all of your money. There is a risk that you will die before receiving all of your annuity premium back in income payments, but most annuities have a death benefit or offer one for purchase in a rider.

Both annuities and structured withdrawals are subject to inflation risk, so you have to put aside more money to make sure that you can account for future inflation. Annuities, however, do not subject you to market risk like structured withdrawals do. That is another reason that the article favored annuities for creating income from defined contribution plans. Warshawsky doesn’t think that annuities should be mandated by the government, though, because every family and individual have different needs and goals in retirement. It’s wise to speak with an insurance or financial professional with expertise in annuities about whether an immediate lifetime income annuity, a deferred annuity, or structured withdrawals fits with the best strategies for you, but this study author believes that annuities are a better choice.

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*Guarantees of annuities rely on the financial strength and claims-paying ability of the insurance company that issues them. Lifetime payouts may be a benefit of the base annuity contract, or may be offered through the additional purchase of a lifetime benefit rider.

1 Warshawsky, Mark. “Government Policy on Distribution Methods for Assets in Individual Accounts for Retirees.” MERCATUS WORKING PAPER, June 2015.

2 Manganaro, John. “Comparing Lifetime Annuities and Structured Withdrawals.” Plan Sponsor, June 9, 2015.

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