Many of the agents that work with CG Financial Group are well aware of the “Four Percent Rule” and the history around it. You probably are as well. I also make sure that agents are very familiar with the 2.8 percent rule. Why do I think understanding these rules are important for folks that sell annuities? Because these “rules of thumb” were not created by annuity practitioners, yet they do a great job of selling annuities if they are used correctly. I do it all the time.
To review, in 1994 William Bengen created what turned out to be quite a profound retirement rule of thumb that many practitioners have followed over the decades. That rule is, whatever your retirement balance is, if you multiply that by four percent, that is the amount you should take no more out than in your first year of retirement. Then—in the following years—you can take the same amount adjusted for inflation. What that means is, somebody who has $1 million as a retirement balance should not take out any more than $40,000 in the first year of retirement. The inverse math is to say that whatever the client needs in annual retirement income, they can multiply that by 25 to arrive at the dollar amount required at retirement to support that level of withdrawals. Whether you multiply the annual need times 25, or multiply the retirement balance times four percent, that is the four percent rule.
To keep it simple for consumers what I say is, “Whatever you need in retirement income, multiply that times 25 and that is the retirement balance you should have, which is usually a lot of money.” But I also make sure to state this next part. That the four percent rule is outdated!
What is the new rule? The new rule is that if you have $1 million at retirement, you should multiply that by 2.8 percent! That’s right, Morningstar says that because interest rates are so low today that 2.8 percent is a more reasonable assumption. When you take that same inverse math, I tell consumers that today they need to multiply their annual retirement need by approximately 35! That means that our retiree that needs $40,000 per year in income should have a balance at retirement of approximately $1.4 million.
Again, these studies are not made-up studies by insurance agents just to sell more annuities, which is one of the reasons I like them. To the contrary, these studies are from credible sources like William Bengen, Morningstar, Wade Pfau, and a large list of others.
Now to the punchline: There is a part of the financial products world that allows you to purchase your retirement at a “discount.” What I am referring to is annuities. For instance, today it is not uncommon to have a payout factor on an indexed annuity with a GLWB rider to the tune of five percent for a 65-year-old. Payout factors vary by age which will make my math below change. What a payout factor of five percent means is, whatever the income amount is that somebody needs in retirement, multiply that by only 20 times—versus 25 or 35 times. That will be the required amount to have your X dollars in annual retirement income guaranteed. So, for our individual needing $40,000, he/she only needs $800,000, versus $1.4 million. That represents a 20 percent discount from the four percent rule ($1 million) and a 43 percent discount from the 2.8 percent rule ($1.4 million). Now that’s Champagne value on a Busch Light budget!
Disclaimer with the last paragraph: Technically those old rules of thumb include inflation adjustments where many GLWBs do not. I have previously written a response to that which you can request from me.
One last very cool point: once a retiree guarantees themselves that baseline income level they need in retirement with annuities, whatever they saved by putting less money into that annuity relative to the stock/bond portfolio using the 2.8 percent rule, they can now be more aggressive with. In the example above, that dollar amount was $600k that they “saved”. Hence, putting only $800K in an annuity is $600k less (and 43 percent less) than the $1.4 million used in our “2.8 percent rule”.
Using software that uses 5,000 different Monte Carlo data points in the market, I am then able to see what happens to a consumer’s portfolio if we did two things:
- Introduced annuities into the portfolio to support their desired $40k per year (in the previous example).
- Became a little more aggressive with the remainder that is outside the annuity value.
Once the annuity is introduced, the chances of “retirement success” rises—in some cases to almost 100 percent. But even more interesting is, for the remaining portfolio balance that is outside of the annuity, this software allows me to toggle over to a more aggressive portfolio than the baseline setup. This allows us to see how that $600k invested more aggressively impacts the projected portfolio value and the chance of success. Many times, the chance of success increases even further.
The last part is extremely interesting because it is a different way of thinking about a conservative client’s portfolio. This is the idea of being very conservative with a chunk of the client’s portfolio and aggressive with another chunk of their portfolio. This is in contrast to just being conservative with the entire portfolio.
Some might think it is dangerous to have a chunk of their portfolio that is more aggressive than what was originally intended. I would argue that if you have the client’s baseline income need that is guaranteed through the use of the annuity, then the more aggressive approach with the remainder of the money can bear fruit.
Of course, the proper licensure is required to give recommendations around the securities. However, even if you are not licensed to discuss the securities portfolio with your clients, you can discuss your philosophy above with “investment advisors” that you can network with as a referral source. I have seen many agents over the years that work in partnership with an investment advisor or two and they each have their own spoke in the wheel. The agent is the insurance expert, and the Investment Advisor is the securities expert. That is a quick “Networking Idea” for you.
