(MoneyWatch) Do you want to have significant influence over how much monthly retirement income you receive from your 401(k), IRA, and other savings after you retire? A new study by the Stanford Center on Longevity and the Society of Actuaries (authored by the writer of this post) found that can best be achieved by picking the right retirement income solution.
The report estimates the monthly incomes that a 65 year-old couple with $100,000 might receive using six different retirement income solutions. These solutions, or generators, were chosen because they have a reasonable chance of delivering retirement income for the rest of your life, are readily available in the retail marketplace, could be offered in a 401(k) plan, and could be implemented by a knowledgeable "do-it-yourselfer."
The report analyzed three versions of, a method in which a retiree invests their savings and then, after retirement, systematically withdraws a portion of their savings with the intent (but with no guarantee) of making that money last for life. Essentially they are giving themselves a monthly paycheck drawn from their own retirement savings. These are the three versions the report analyzed:
A strict application of the four percent rule, where a retiree's annual income is set at an amount equal to four percent of their assets at retirement. This amount is then adjusted each year to reflect increases in the Consumer Price Index (CPI), and the retiree continues to withdraw income until they die or their savings is exhausted, whichever comes first. This method is labeled in the graph below as a "constant inflation-adjusted amount" strategy.
A retiree's annual income equals four percent of their assets at the beginning of each year; subsequent amounts of retirement income are adjusted up or down depending on their investments' performance in previous years. This method is labeled in the graph below as a "constant percentage" strategy.
- The annual income a retiree receives is equal to the IRS required minimum distribution (RMD) that applies after age 70-1/2 to deductible IRA and 401(k) accounts; the annual amount of retirement income the retiree can withdraw also depends on their investments' performance in previous years. This method is labeled in the graph below as a "life-expectancy percentage" strategy. From age 65 to age 70-1/2, their annual income equals 3-1/2 percent of their assets at the beginning of each year.
The report also analyzedfor which an insurance company guarantees that your income will continue for the rest of your life, no matter how long you live:
A lifetime annuity that is fixed in dollar amount, which is also known as a "single premium fixed" annuity (SPIA).
A lifetime annuity in which the annual income is increased each year for the CPI.
- A (GMWB), which is a hybrid annuity that combines the features of annuities with the features of systematic withdrawals. This annuity is also known as a "guaranteed lifetime withdrawal benefit" (GLWB).
The figure below shows the estimates of the annual amounts of retirement income a 65 year-old couple with $100,000 in retirement savings could receive each year using the six methods described above. The amounts shown are real, meaning they're adjusted to reflect inflation; as such, a flat line shows that incomes keep pace with inflation, while a declining line means that incomes don't keep pace with inflation.
The report used Monte Carlo simulations to project retirement incomes under a number of different economic scenarios. The graph below shows projected incomes under an economic scenario expected under the assumptions used by the report, which reflect the current low interest environment.
As you can see, there's a significant variation in the amounts of retirement income you can generate using the various systems, both initially and throughout retirement.
Here's an analysis of the results:
- The immediate fixed income and GMWB annuities provide the highest amounts of initial retirement income, but the amount decreases over time due to the effects of inflation. Inflation-adjusted annuities and two of the three systematic withdrawal methods (the constant percentage and RMD methods) adjust incomes for inflation and eventually deliver the highest amounts of inflation-adjusted income, surpassing fixed and GMWB annuities after 15 to 20 years.
- Upon retirement, the annual amount of income ranges from $3,500, provided by systematic withdrawals-RMD, to $5,490, provided by an immediate fixed income annuity.
- After 15 years, the amount of income (expressed in today's dollars, adjusted for inflation since retirement) ranges from $2,918, provided by systematic withdrawals-constant percentage, to $4,158, provided by an immediate fixed income annuity.
- After 30 years, the amount of income (adjusted for inflation) ranges from $2,092, provided by systematic withdrawals-constant percentage, to $4,000, provided by systematic withdrawals-constant amount.
The amounts expected by the Monte Carlo analyses show just part of the story. Stay tuned for my next post, which examines how the various systems perform under unfavorable and favorable economic scenarios.