Foolishness of the 4% rule

[Deleted User]

lisyloo said:

Deleted_User said:

Is it?...  .......out of interest, how much does one of those cost, today?

A 55 year old female in the US would get an 8.05% payout rate at 65 based on 2012 mortality data. A male would get a better payout rate. You would need to get a quote for something accurate. 

Don’t we have gender neutral Annuity rates in the uk? Which is a benefit for women?

Yes but it might be less of a benefit for women than a disadvantage for males.  Unlike pensions, annuities are voluntary and people self-selct.  This should translate into more women taking annuities than men and companies pricing them based on female life expectancy.  

[Deleted User]

When talking about essential spending it can't be reduced, because it is essential, and an increase beyond inflation is likely not essential.  So the only option that makes sense is for unwavering index-linked withdrawal. 

You are assuming that essential spending is going up with whichever “index” you prefer.  In practice its unlikely to be true.  A couple of holidays a year might me essential for a 65 year old but an 85 year old might not be interested at all. Rental pricing or petrol might not be relevant at all. 

As people get older, the “inflation” which impacts them the most is healthcare. There isn’t a real market for healthcare; most countries have the government as one and only or the dominant buyer (even in the US).  The government has strong incentive to not let inflation impact healthcare.  Even as population ages and demand soars, prices are actually going down. Market retaliates by creating a shortage of supply and we get implicit healthcare rationing and having an indexed pension won’t help here.  

Its complicated but as discussed above, the cost of  retirees basic needs tends to go down as they age. 

bostonerimus

lisyloo said:

Deleted_User said:

Is it?...  .......out of interest, how much does one of those cost, today?

A 55 year old female in the US would get an 8.05% payout rate at 65 based on 2012 mortality data. A male would get a better payout rate. You would need to get a quote for something accurate. 

Don’t we have gender neutral Annuity rates in the uk? Which is a benefit for women?

I was thinking that too...

Time4T_Accounts

MK62 said:

Deleted_User said:

DT2001 said:

MK62 said:

Deleted_User said:

The 100% stock retiree is in danger of running out of money before 2030, but he might manage. Touch and go.  Looked even worse at times.

For most UK retirees though, you need to factor in the state pension - the effect of doing that will depend on when the SP becomes payable and the size ratio between the SP and the 4% rule's withdrawal, assuming you reduce that withdrawal by the equivalent of the SP when it does become payable.

While strictly speaking, it would then not be the vanilla 4% rule, it's probably more representative for most UK retirees. Once you do that even a 100% equity portfolio becomes a lot less touch and go.....

But, presumably - and I say this as a 63 years old who retired at 60, and who is heavily into stocks (but with 3 years+ cash) - wouldn’t one’s investment/withdrawal ‘strategy’ mature as one matures oneself? So,100% equity might be as much anathema as 100% annuity might be, all depending on one’s stage in life?  I do like the idea of SP deferral, though, particularly as a defence to be employed in the event of a sustained fall in Stock Market returns...

DT2001

MK62 said:

DT2001 said:

We used an annuity for my mother when she was 70 following my father’s death for the exact reason that Mordko suggested - certainty of income - it was funded by about 20% of her available capital at that time. The rest of her capital was used to cover one offs until she downsized (not in my original plan but equity release was). It was a punt as she had indifferent health (still going 20 years later, just) but it served it’s purpose.

As Mordko says annuities CAN be part of your plan even in today’s scenario. Is your strategy to have enough income until you die or to maximise income with the inherent dangers that entails.

I would reiterate my believe that flexibility and diversity are key in income and expenditure. Having been self employed for 25+ years I think helps the mindset needed.

Fair enough, but what if that same payout had cost 40-50% of her available capital.......annuity rates were a lot higher 20 years ago than they are today.

Not arguing with the idea of an annuity, just the current cost.

Is your strategy to have enough income until you die or to maximise income with the inherent dangers that entails.

Like most people I suspect, it's a bit of both (plus other considerations like partner provision, legacy etc). The problem is that imho, currently, annuities fail to accomplish the former.  Just to replicate the state pension would cost around £460k.

I would reiterate my believe that flexibility and diversity are key in income and expenditure

Me too......but there's not really much flexibility with an annuity.

If the cost of the annuity had been 40-50% I think we’d still have suggested it was worthwhile as there was the option of equity withdrawal /downsizing and it achieved the goal of covering all bar one off expenses. As it happened her ‘normal’ expenditure dropped when she stopped driving and didn’t get another dog.

If you use an annuity to bolster DB and/or SP to a level that covers all/most of your basic level of retirement income the rest of your ‘pot’ can be invested aggressively. The success of this then allows either a good or luxury level of income. If you have two SP you’ll cover most people’s basics so shouldn’t need much of a top up. I’m not suggesting using all your funds for an annuity.

An annuity and SP are not flexible but have the potential to allow you to use your remaining funds more flexibly which hopefully achieves your overall goal (balancing a good retirement and leaving a legacy etc). By ensuring the minimum required is coming in you are protecting yourself against the failure of your SWR 🤣 

If you were offered double the current rates would you take it?

If yes, are you then protecting yourself against say a 50% drop in the markets?

[Deleted User]

but there's not really much flexibility with an annuity. 

Agree with DT that there could be much more flexibility for someone who has basic needs covered with annuity type income.

A proper withdrawal strategy which is 100% stocks and bonds means that your equity isn’t as liquid as it appears.  You shouldn’t be withdrawing more than the paltry 3.5% (or whatever it is) because those funds are spoken for.  They are your future 3.5% withdrawals. 

pensionpawn

MK62 said:

Deleted_User said:

DT2001 said:

MK62 said:

Deleted_User said:

The UK's Office of National Statistics disagrees......they say that the chances of a 65yo British male reaching 100 are 2.9%.   (that is, only 2.9% of 65yo British males alive today, will make it to 100)

Its completely irrelevant.  Sick 65 year olds have different life expectancies and annuity rates.  They wouldn’t even need a longivity insurance.  

 I provided expectancies for healthy Americans from actuaries, the stats that matter for annuities:  https://www.longevityillustrator.org/  Its a 10% chance of getting passed 98. Average life expectancy is 3 years longer for Brits, so will be higher percentage although I don’t have numbers for healthy Brits.  And ones chances could be even higher if he is well off and understands money, which a lot of people on this board do.  

Your chart gives no detail about the % of 65yo who are considered to be in excellent health......for all we know it could be 5% excellent, 90% average and 5% poor.........not really representative if it only applies to a small percentage of 65 year olds.......even if it's 33%/33%/33%, it'd still mean it only applied to one third of 65yo Americans.

Also, while 2 years may not make much difference at 55, at 98 it does.......in the UK, a 65yo female has a 10% chance of making 98yo......it's less than half that for 100yo.

That said, whether it's 5% or 10% is irrelevant really, as neither could be described as an excellent chance in my book.........if I told you a withdrawal plan had 10% chance of making it to 100, would you describe that as an excellent chance?

If you go to the link you get a personalised quote which is more relevant to your own planning. There is the caveat that the more factors that are pertinent to you the better the ‘forecast’ will be.
It is a step up from a generalised life expectancy table.

If you compile the factors that appear relevant to life expectancy (e.g. smoker, location, wealth, family history, current health etc etc) you can get a better estimate of your life expectancy which you then use to help formulate your retirement plan.
It maybe then that annuities are an important part of your plan or nigh on irrelevant. Whether the purchase is at retirement, 10 years after or if you survive to a certain point.

We used an annuity for my mother when she was 70 following my father’s death for the exact reason that Mordko suggested - certainty of income - it was funded by about 20% of her available capital at that time. The rest of her capital was used to cover one offs until she downsized (not in my original plan but equity release was). It was a punt as she had indifferent health (still going 20 years later, just) but it served it’s purpose.

As Mordko says annuities CAN be part of your plan even in today’s scenario. Is your strategy to have enough income until you die or to maximise income with the inherent dangers that entails.

I would reiterate my believe that flexibility and diversity are key in income and expenditure. Having been self employed for 25+ years I think helps the mindset needed.

In 2000 one financial advisor in Canada decided to track a year 2000 retiree’s fortunes using the 4% withdrawal rule and diversified investment vehicles available at the time. It is still being tracked.  The 100% stock option is doing the worst of all portfolio. 100% inflation linked bonds have done the best. Balanced portfolios are doing ok. 

The 100% stock retiree is in danger of running out of money before 2030, but he might manage. Touch and go.  Looked even worse at times.

For most UK retirees though, you need to factor in the state pension - the effect of doing that will depend on when the SP becomes payable and the size ratio between the SP and the 4% rule's withdrawal, assuming you reduce that withdrawal by the equivalent of the SP when it does become payable.

While strictly speaking, it would then not be the vanilla 4% rule, it's probably more representative for most UK retirees. Once you do that even a 100% equity portfolio becomes a lot less touch and go.....

Precisely! Couples who have secured 2 x SP from 67, which at ~£18k7 index linked and tax free, are going to keep warm, fed and enjoy a few home comforts for the remainder of their days. For couples who also have upward of £0.25M each in their pension pots and equity in their home, they should be able to draw from their pots sufficient to top their pensions up to the PA and stay well under 4% SWR. That's ~£25k tax free pa, more via the UFPLS. For the worse case Armageddon scenarios that some wish to indulge in in this thread their equity of £0.25M will no doubt be growing each year too to provide a further safety net. I see no need to buy an additional annuity or delay drawing the SP. Horses for courses.... 

MK62

Deleted_User said:

but there's not really much flexibility with an annuity. 

A proper withdrawal strategy which is 100% stocks and bonds means that your equity isn’t as liquid as it appears.  You shouldn’t be withdrawing more than the paltry 3.5% (or whatever it is) because those funds are spoken for.  They are your future 3.5% withdrawals. 

Even after reading this several times, I still have no idea what it means....

[Deleted User]

Sorry, not sure how to make this point differently.  You could replace the word “liquid” with “flexible”. 

OldScientist

Terron said:

OldScientist said:

[snip]

So, for the current (US) retiree is the SWR 2.6%, 3.2%, 3.7% or 4.0% (subtract 0.5-0.7% for UK given our higher inflation during the worst case retirements)? For me, illustrates why an unwavering index-linked withdrawal for essential spending is unwise.

I think we are agreeing here!

When talking about essential spending it can't be reduced, because it is essential, and an increase beyond inflation is likely not essential.  So the only option that makes sense is for unwavering index-linked withdrawal. 

Ideally that would come from an index-linked DB pension, but we can't all work in jobs that give them, and the SP is not enough for the majority.
An index-linked annuity would be safe, but (currently at least) is more expensive (for most people) than using drawdown per the SWR for your country. So the 4% rule is wise for someone in the US who only just has enough to meet their essentials in retirement (~3.5% for the UK).

Of course it is wise to save more than the minimum, but knowing what the minimum is is useful.

BTW I believe the UK's SWR is lower because WW2 was even worse for the British economy than the 1970s, whereas the war was good for the US economy. The worst case for Britain is in the mid-30s not the late 60s as it is in the US.

Thanks for the info about the UK - there's a useful summary of Pfau's paper at https://www.advisorperspectives.com/articles/2014/03/04/does-international-diversification-improve-safe-withdrawal-rates for the UK with a 50/50 international stocks/bonds portfolio, the MSWR (SAFEMAX)~3.2%.

I think it depends on how you define 'essential' - there may be several layers

'basic essential' - keeping the lights and heating on, covering housing costs, and having enough to eat. According to https://www.retirementlivingstandards.org.uk the SP just about does this for a single person (~10.2k, excluding housing costs but inc a few extras) and easily does it for a couple (15.2k).

'lifestyle essential'  ('moderate') -  buying the things that people cannot envisage doing without (this is going to vary greatly from person to person), but that could actually be cut if necessary (i.e. not a threat to life). According to https://www.retirementlivingstandards.org.uk this is about 20.2k for singles and 29.1k for couples.

'lifestyle luxuries' ('comfortable')- anything else (33k for singles, 47.5k for couples)

If the portfolio was covering the basic essentials (although for a single person there is a shortfall in SP of only about £900 of meeting essential), the risk of total failure with the unwavering approach is what makes it extremely risky in the event of extreme longevity or a situation where economic conditions mean a new low in MSWR occurs.

For example, taking a single person with SP and 50k pension pot (close to the average of pension pots - of course, there are many people with no pension pots) - £900 is 1.8% of the portfolio, so could easily have been managed historically. A fixed inflation-linked 3.2% would give 1.6k per year with a zero historical probability of portfolio exhaustion later on in life. However, there is a strong possibility that there is more money in the portfolio at the end than at the beginning. In my view, someone on this tight a budget deserves the possibility of spending more than the bare minimum (and therefore one of the many dynamic withdrawal approaches), but this has to be a personal decision - there is no right answer.

With MSWR~3.2%, an annuity with RPI at 2.7% (at 65) isn't too bad (and RPI gives better increases than the CPI used in the SWR analyses) - however, wait until 70 and a rate of 3.6% looks quite attractive (provided your portfolio isn't too diminished in the years to age 70). For example, spending 25k of the remaining portfolio would provide the £900 per year indefinitely and, assuming the portfolio was above this (things would have had to have been pretty bad for a 50/50 portfolio to drop by half in five years, and still leave money invested for other spending.