### Author Topic: Two Questions: 4% Rule and Annuities  (Read 8251 times)

#### Rollin

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##### Two Questions: 4% Rule and Annuities
« on: January 29, 2016, 08:51:29 AM »
Question 1 – 4% Rule Calculation (Inflation Adjusted)

I often see posts that say for \$100,000 one can expect an income of \$4,000/year (invested properly of course) – simple right?  Getting inside this a little more though for my spreadsheet I’d like to know how you actually run the calculations?  I see “inflation adjusted” a lot and not sure how that works. For example, I just read that “the 4% rule -- initially withdrawing 4% of retirement savings and then increasing that dollar amount annually by the inflation rate.”  So that means that I calculate \$4,000 for year one, and with a 3% level of inflation (as an example) year two would be \$4,000 + \$120, or \$4,120 in income and so on (year 3 \$4,000+\$120+\$124??).

I actually thought it worked differently and was only depending on 4% year over year, not adding the inflation factor.  This was because I thought that the investment yielded approximately 7% in the 4% rule calculations (i.e., 4% + 3% for inflation), so you couldn’t count on getting the full 7%, but count on 4%.

I’m confused and would like help.  I'm looking to see how to run the first part of the calculation, and that is expected return on my \$100,000, and the second part being how much I can expect for income from year to year.

Sorry about the 4% Rule question, but when I research using the search tool it crashes (also there has been so much discussion over the years that it would take weeks to find what I'm looking for).

Question 2 - Immediate Annuity

In addition to my other income sources I may want to have some guaranteed income to count on.  My tax advisor is also a financial advisor and he suggested that I put some of my cash (currently invested in Vanguard indexed funds and in my deferred comp.) into an annuity.

The problem is that he’ll want to handle that for me and the last time I worked through him I found some pretty hefty fees (therefore Vanguard!)!  So, do any of you know how I can get one of these at a low cost (edit - I just discovered that Vanguard does this so I am researching this right now)?  I would also entertain opinions on the use of these in the first place.  I was thinking about one that guarantees income for 10 years because I'll be getting a pretty good raise when SS kicks in at age 62 for me (8 years away).  Here is what I read:

"A 10 Year Period Certain annuity pays income for 10 years. It does not pay for your lifetime. If you die during the 10 year period, your beneficiaries receive this income for the remainder of the term. At the end of the 10 years, your original premium is not returned since it was paid out during the term."

Lastly, I might only put \$100,000 of my \$500,000 available into a "product" like this.

•   DW’s IRA (in a few years)
•   Invested deferred comp. (at the moment it is a deferred comp program, but I’ll convert that once I retire) in stocks/bonds
•   Rental income
•   Small insurance stipend
•   Life insurance annuity
•   Pension
•   DW’s income(s)
•   Side gig
•   SS in a few years (I am 54 and DW is 55)
« Last Edit: January 29, 2016, 09:19:14 AM by Rollin »

#### FIPurpose

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #1 on: January 29, 2016, 09:36:31 AM »
My experience in annuities is none so I can't answer your second question. Concerning the 4% rule: It is not based on the average return of 7% with a 3% inflation. I don't even remember the last time inflation was even 3%. (Alright had to look it up, 2011 there was 3% inflation, but I wouldn't say we've averaged 3% in a long time.)

No the four percent rule is more of a study on what is the maximum withdrawal each year and still survive at the end of a 30 year period. I think of it more as a study on 'sequence of returns' and average volatility. Because if the market tanks for the first ten years, but then goes full steam ahead the next ten, people accumulating will love it because the sequence in which they go their returns were optimal, but retirees who were withdrawing during that period have done far worse than a 7% average would lead you to believe.

#### Rollin

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #2 on: January 29, 2016, 05:59:01 PM »
Thanks FIPurpose you helped clear that up for me.  Now, does this look correct to you or others?

What happens year to year with the \$100,000 principal?  Assuming a 5% return and 3% inflation:

4% w/d     4% w/d     year
principle   before       with 3%    end
inflation     inflation     result

\$100000   \$4000   \$4000   \$96000 x 1.05 =
\$100800   \$4032   \$4153   \$96647 x 1.05 =
\$101479   \$4059   \$4181   \$97298 x 1.05 =
\$102163   \$4087   \$4209   \$97954 x 1.05 =
\$102852   \$4114   \$4238   \$98614 x 1.05 =
\$103545   \$4142   \$4266   \$99279 x 1.05 =
\$104243

#### maizefolk

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #3 on: January 29, 2016, 10:30:07 PM »
Yeah 7% (well 6.86%) is the compound annual growth rate of the stock market AFTER factoring in inflation. If you don't consider inflation it's a bit over 9%. So like FIPurpose says, the reason for the 4% rule is to deal with sequence of returns risk.

Also the 4% rule is that you adjust for inflation but NOT for changes in the size of your portfolio after you start making withdrawals. So in your scenario in year one you'd take out \$4,000, in year 2 \$4000*1.03 = \$4120, in year 3 4000*1.03*1.03 = \$4243.60, in year 4 4000 * 1.03 *1.03 *1.03 = \$4370.91 and so on. And that's true whether you earn an investment return of +25% or -40% in a given year.

Especially in low interest rate environments like today I think annuities tend to be a bad deal although for some people the lost expected investment returns are going to be worth it if it helps you sleep at night.

#### Telecaster

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #4 on: January 30, 2016, 01:00:01 PM »
Immediate annuities are one of those products who benefit only people who 1) can't afford them, or 2) don't need them.

It will take a bit of figuring but you can figure out the value, called the  Money's Worth Ratio (MWR), of the annuity yourself.  And what you'll find is the amount the annuity pays you is quite a bit less than the cost.  That's as you'd expect.  The insurance company is taking the market risk, and you have to pay them for it.
They have rooms full of pH D actuaries who are betting they will safely make money (this is, you will lose money) on the transaction.

#### Rollin

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #5 on: January 30, 2016, 01:29:28 PM »
Yeah 7% (well 6.86%) is the compound annual growth rate of the stock market AFTER factoring in inflation. If you don't consider inflation it's a bit over 9%. So like FIPurpose says, the reason for the 4% rule is to deal with sequence of returns risk.

Also the 4% rule is that you adjust for inflation but NOT for changes in the size of your portfolio after you start making withdrawals. So in your scenario in year one you'd take out \$4,000, in year 2 \$4000*1.03 = \$4120, in year 3 4000*1.03*1.03 = \$4243.60, in year 4 4000 * 1.03 *1.03 *1.03 = \$4370.91 and so on. And that's true whether you earn an investment return of +25% or -40% in a given year.

Especially in low interest rate environments like today I think annuities tend to be a bad deal although for some people the lost expected investment returns are going to be worth it if it helps you sleep at night.

Understood now, thank you.  I thought I'd need to keep adjusting the principle amount, which I should probably do just to keep track, but still count on the 4% + inflation.

#### Rollin

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #6 on: January 30, 2016, 01:32:36 PM »
Immediate annuities are one of those products who benefit only people who 1) can't afford them, or 2) don't need them.

It will take a bit of figuring but you can figure out the value, called the  Money's Worth Ratio (MWR), of the annuity yourself.  And what you'll find is the amount the annuity pays you is quite a bit less than the cost.  That's as you'd expect.  The insurance company is taking the market risk, and you have to pay them for it.
They have rooms full of pH D actuaries who are betting they will safely make money (this is, you will lose money) on the transaction.

Telecaster - I compared the 4% Rule with the annuities and there in a slight monthly advantage, but that is for an annuity that takes all my principle.  Heck, I can do that on my own!  Also, as you said, the more people ands organizations involved the more what I call "friction" costs are involved.  Each one being from my pocket to theirs!  I think I'll manage the \$\$ myself...

Thank you.

#### Indexer

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #7 on: January 30, 2016, 02:10:03 PM »

My conclusion:  You need a new tax advisor. Someone who is both a tax advisor and a financial advisor probably isn't very good at either. Is he a CPA? If he wants to act as a financial advisor I have a second question. Does he have his CFP? Even CPAs and CFPs in high end wealth management firms will work together before trying to master both fields. It is just a lot of information to master and stay current on. The other question you should ask, if he is acting as your financial advisor will he act in a fiduciary capacity? If he says no, fire him, he is looking out for himself and not you. Warning... he is probably going to say no.

Depending on how much you have with Vanguard you could probably get a free financial plan done. I think you need 500k there to get it for free. They should be able to run projections to make sure you have enough to retire. If you do want a financial advisor they will do it at a fraction of the cost of an annuity.

The 4% rule is the result of a lot of studies looking at how much you could take from a portfolio while adding inflation and the portfolio still survive a long period, like 30 years. Normally a fairly standard portfolio (50/50 or 60/40) can handle a 4% withdrawal rate. Normally at 3% or less the portfolio grows much faster than you are taking money out, and normally at 5% or more the portfolio has a hard time lasting unless you have really good market returns. Older studies came to this conclusion, and a lot of monte carlo analysis done since then has come to the same conclusion.

#### Rollin

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #8 on: January 30, 2016, 02:32:34 PM »

My conclusion:  You need a new tax advisor. Someone who is both a tax advisor and a financial advisor probably isn't very good at either. Is he a CPA? If he wants to act as a financial advisor I have a second question. Does he have his CFP? Even CPAs and CFPs in high end wealth management firms will work together before trying to master both fields. It is just a lot of information to master and stay current on. The other question you should ask, if he is acting as your financial advisor will he act in a fiduciary capacity? If he says no, fire him, he is looking out for himself and not you. Warning... he is probably going to say no.

Depending on how much you have with Vanguard you could probably get a free financial plan done. I think you need 500k there to get it for free. They should be able to run projections to make sure you have enough to retire. If you do want a financial advisor they will do it at a fraction of the cost of an annuity.

The 4% rule is the result of a lot of studies looking at how much you could take from a portfolio while adding inflation and the portfolio still survive a long period, like 30 years. Normally a fairly standard portfolio (50/50 or 60/40) can handle a 4% withdrawal rate. Normally at 3% or less the portfolio grows much faster than you are taking money out, and normally at 5% or more the portfolio has a hard time lasting unless you have really good market returns. Older studies came to this conclusion, and a lot of monte carlo analysis done since then has come to the same conclusion.

Yes, as he manages a lot of \$\$ for others.  Not me anymore, as the fees were way too high.  I took it all and went to VG.  He didn't like that, but duh!

#### MDM

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #9 on: January 30, 2016, 07:12:41 PM »
I actually thought it worked differently and was only depending on 4% year over year, not adding the inflation factor.  This was because I thought that the investment yielded approximately 7% in the 4% rule calculations (i.e., 4% + 3% for inflation), so you couldn’t count on getting the full 7%, but count on 4%.

I’m confused and would like help.  I'm looking to see how to run the first part of the calculation, and that is expected return on my \$100,000, and the second part being how much I can expect for income from year to year.

Sorry about the 4% Rule question, but when I research using the search tool it crashes (also there has been so much discussion over the years that it would take weeks to find what I'm looking for).

See http://www.retailinvestor.org/pdf/Bengen1.pdf and http://www.aaii.com/journal/article/retirement-savings-choosing-a-withdrawal-rate-that-is-sustainable for the original works that describe the assumptions behind the results.

#### Rollin

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #10 on: January 30, 2016, 07:58:43 PM »
I actually thought it worked differently and was only depending on 4% year over year, not adding the inflation factor.  This was because I thought that the investment yielded approximately 7% in the 4% rule calculations (i.e., 4% + 3% for inflation), so you couldn’t count on getting the full 7%, but count on 4%.

I’m confused and would like help.  I'm looking to see how to run the first part of the calculation, and that is expected return on my \$100,000, and the second part being how much I can expect for income from year to year.

Sorry about the 4% Rule question, but when I research using the search tool it crashes (also there has been so much discussion over the years that it would take weeks to find what I'm looking for).

See http://www.retailinvestor.org/pdf/Bengen1.pdf and http://www.aaii.com/journal/article/retirement-savings-choosing-a-withdrawal-rate-that-is-sustainable for the original works that describe the assumptions behind the results.

Good information MDM, and even suggests higher SWRs than 4%.  Thank you.

#### Rollin

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #11 on: March 23, 2016, 02:36:17 PM »
Yeah 7% (well 6.86%) is the compound annual growth rate of the stock market AFTER factoring in inflation. If you don't consider inflation it's a bit over 9%. So like FIPurpose says, the reason for the 4% rule is to deal with sequence of returns risk.

Also the 4% rule is that you adjust for inflation but NOT for changes in the size of your portfolio after you start making withdrawals. So in your scenario in year one you'd take out \$4,000, in year 2 \$4000*1.03 = \$4120, in year 3 4000*1.03*1.03 = \$4243.60, in year 4 4000 * 1.03 *1.03 *1.03 = \$4370.91 and so on. And that's true whether you earn an investment return of +25% or -40% in a given year.

Especially in low interest rate environments like today I think annuities tend to be a bad deal although for some people the lost expected investment returns are going to be worth it if it helps you sleep at night.

maisman (and others)

This quote is a subtle difference, but significant in its affect. This is from one of Vanguard's managed funds (Managed Payout):

"Why set the target at 4%?
Research from Vanguard and other retirement income experts has found that, by limiting spending to 4% of a portfolio each year, retirees have a higher probability of maintaining a stable income stream—one that can be sustained over the typical retirement period of 20–30 years, even in a low-interest-rate environment."

The way they say it is MUCH more conservative than the way I've begun to understand what the 4% withdraw amount is. Anyone read this differently?

#### maizefolk

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #12 on: March 23, 2016, 03:06:18 PM »
Yes that is way more conservative and not the same way I've normally seen the 4% rule formulated.

If you only ever spend 4% of your (current year) portfolio balance you are guaranteed to never completely run out of money.* But your annual spending might have to drop by 50% or more in years like 2009.

For people who have a lot flexibility in spending from year to year, spending a fixed percentage of their portfolios each year can often support a much higher average annual spending rate than locking in an (inflation adjusting) 4% of their first year of FIRE portfolio. But it'd be a much bumpier ride.

*This is essentially a version of Zeno's dichotomy paradox. Every year you only spend a fraction of your portfolio so you'll never be able to reach exactly zero even if you spent 50% each year.

#### MDM

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #13 on: March 23, 2016, 03:39:10 PM »
Quote
Variable percentage withdrawal (VPW) is a withdrawal method that adapts to the retiree's retirement horizon, asset allocation, and portfolio returns during retirement. It combines the best ideas of the constant-dollar, constant-percentage, and 1/N withdrawal methods to allow the retiree to spend most of his portfolio using return-adjusted withdrawals.

Don't know that any equation can satisfy all possibilities, but the VPW method isn't bad.

#### opnfld

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #14 on: March 23, 2016, 03:51:45 PM »
...but when I research using the search tool it crashes (also there has been so much discussion over the years that it would take weeks to find what I'm looking for).
Searching via Google with specific search terms followed by "site:mrmoneymustache.com" should help overcome the limitations of the forum's integrated search and give you a smaller list of threads to cull through.

#### Rollin

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #15 on: March 24, 2016, 05:04:19 AM »
...but when I research using the search tool it crashes (also there has been so much discussion over the years that it would take weeks to find what I'm looking for).
Searching via Google with specific search terms followed by "site:mrmoneymustache.com" should help overcome the limitations of the forum's integrated search and give you a smaller list of threads to cull through.

Thanks opnfld. I tried that the other day after someone else referred to it an it worked very well.

#### Scandium

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #16 on: March 24, 2016, 07:18:08 AM »
If you only ever spend 4% of your (current year) portfolio balance you are guaranteed to never completely run out of money.* But your annual spending might have to drop by 50% or more in years like 2009.

I don't believe this is correct. The 4% withdrawal used in the studies is rigid. It's the highest WR you can use always, without change, and survive all/most historical market periods. Great depression etc. Of course there is no 30 year period starting in 2009 so we don't know if it would work for that yet.

I say most, because I've seen claims that 4% will be ok through all periods, but when I run CFireSim it always fails for a 1962 retirement. So there are a few percent change of failure, 1962 and 2009 may be among them.

#### Telecaster

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #17 on: March 24, 2016, 10:08:10 AM »
If you only ever spend 4% of your (current year) portfolio balance you are guaranteed to never completely run out of money.* But your annual spending might have to drop by 50% or more in years like 2009.

I don't believe this is correct. The 4% withdrawal used in the studies is rigid. It's the highest WR you can use always, without change, and survive all/most historical market periods. Great depression etc. Of course there is no 30 year period starting in 2009 so we don't know if it would work for that yet.

Maizeman's statement is correct, however that's not the 4% rule as commonly stated, as you point out.  The 4% rule as commonly stated is 4% of the initial balance, adjusted for inflation.

#### Scandium

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #18 on: March 24, 2016, 10:12:35 AM »
If you only ever spend 4% of your (current year) portfolio balance you are guaranteed to never completely run out of money.* But your annual spending might have to drop by 50% or more in years like 2009.

I don't believe this is correct. The 4% withdrawal used in the studies is rigid. It's the highest WR you can use always, without change, and survive all/most historical market periods. Great depression etc. Of course there is no 30 year period starting in 2009 so we don't know if it would work for that yet.

Maizeman's statement is correct, however that's not the 4% rule as commonly stated, as you point out.  The 4% rule as commonly stated is 4% of the initial balance, adjusted for inflation.
My bad. I missed be said 4% of current year portfolio. No that is not the traditional rule, and sounds rather inconvenient with huge swings in income. Of course you'd never run out..

#### maizefolk

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #19 on: March 24, 2016, 05:58:39 PM »
Yup. Just to be clear I'm not advocating that 4% of (current year) spending plan which is extremely different from the normal 4% rule spending plan. I was agreeing with Rollin that the quote from the Vanguard managed payout fund:

Quote
Research from Vanguard and other retirement income experts has found that, by limiting spending to 4% of a portfolio each year, retirees have a higher probability of maintaining a stable income stream—one that can be sustained over the typical retirement period of 20–30 years, even in a low-interest-rate environment."

Is different from and more conservative than what people normally mean when they say they talk about the 4% rule.

#### MustacheAndaHalf

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #20 on: March 24, 2016, 11:04:20 PM »
"... he’ll want to handle that for me and the last time I worked through him I found some pretty hefty fees ..."

That's a conflict of interest, isn't it?  He advises you what to do, then makes money if you follow his advice.  So if annuities aren't quite right for you, but you won't know the difference, he might choose his fees over your best interest.  I think you should at least try out a new tax advisor, to see if you like them better.  The fact he was not happy with you lowering your expenses at Vanguard is another clue where his motivations lie.  And if his fees for investing are higher than his fees for taxes, where will he put his effort?  Keeping up with his sideline business, knowing the tax code?  Or researching how he can increase his investment fees?

If you try someone else, you can at least compare.  Right now, it looks like you're letting the personal connection with this person get in the way of what's best for your retirement.  He will nag you to get your funds back - I'd say try someone new, who doesn't have an investment business on the side (or is that a tax business on the side?).

#### Mighty-Dollar

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #21 on: March 25, 2016, 02:02:47 AM »
My tax advisor is also a financial advisor and he suggested that I put some of my cash (currently invested in Vanguard indexed funds and in my deferred comp.) into an annuity.
NEVER mix insurance with investing! Your "financial adviser" is also a commission-hungry salesman. That's why he's recommending a product that will pay him about a 4% commissions if he can convince you to put money into it.

There are no "good deals" with annuities. Never have been and never will. Did your "adviser" talk to you about the nasty effects of inflation with that immediate annuity? If not then that's proof that he is recommending that annuity for his OWN best interests -- not yours.

Quote
The fact he was not happy with you lowering your expenses at Vanguard is another clue where his motivations lie.
Yes! He needs to RUN -- not walk -- out the door. Never work with this "adviser" again. Find a fee-only fiduciary or use Vanguard's "light advice" service.

« Last Edit: March 25, 2016, 02:05:36 AM by Mighty-Dollar »

#### Rollin

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##### Re: Two Questions: 4% Rule and Annuities
« Reply #22 on: March 25, 2016, 06:44:57 AM »
My tax advisor is also a financial advisor and he suggested that I put some of my cash (currently invested in Vanguard indexed funds and in my deferred comp.) into an annuity.
NEVER mix insurance with investing! Your "financial adviser" is also a commission-hungry salesman. That's why he's recommending a product that will pay him about a 4% commissions if he can convince you to put money into it.

There are no "good deals" with annuities. Never have been and never will. Did your "adviser" talk to you about the nasty effects of inflation with that immediate annuity? If not then that's proof that he is recommending that annuity for his OWN best interests -- not yours.