Last Updated Sep 30, 2011 6:40 PM EDT
Each of these methods has its pros and cons, and much has been written about their relative merits by passionate defenders of each method. One way to assess which method might be best for you is to estimate and compare the amounts of retirement income you can generate from your retirement savings. As an example to show you how to do this, I'll estimate the annual amounts of retirement income that retirees with $100,000 in retirement savings can generate in today's economic climate using each of these methods.
Before I show you the results of this comparison, I need to explain how I came up with my estimates.
With managed payouts, the four percent rule has long been advocated as a "safe" way to generate retirement income. Under the four percent rule, you invest in a portfolio balanced between stocks and bonds, withdraw four percent of your initial balance, and then give yourself raises for inflation each year thereafter. In theory, with this method, you have a very low chance of outliving your retirement savings for retirements that last 30 years.
Recently, however, some financial writers (including me) have questioned whether a four percent withdrawal rate is really safe in today's economic environment of low interest rates and below-average dividend yields on stocks, and given the level of investment expenses that are commonly assessed against invested assets. Initial withdrawal rates of two percent or three percent have been suggested as a safer withdrawal amount, reflecting these factors. For the purposes of this comparison, I'll show retirement incomes using initial withdrawal rates of two, three, and four percent.
To estimate the amount of retirement income from an immediate annuity, I'll use the information from Vanguard's Annuity Access service as of September 21, 2011, for a single man, a single woman, and a couple buying a 100 percent joint and survivor annuity (this annuity continues the income as long as at least one of the two is alive). I've assumed all of these people are age 65 when they retire. To make the comparison consistent with managed payouts, I'll use an inflation-adjusted annuity, which adjusts your income for inflation each year after retirement. I'll also show an annuity that increases at three percent per year -- these annuities are a slightly less expensive way to buy inflation protection compared to annuities that have unlimited inflation adjustments.
With these descriptions out of the way, let's take a look at the results of the retirement income showdown.
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