Which is better in retirement, $1,000,000 or $2,000,000?
Determining which is better for retirement, $1,000,000 or $2,000,000, demands a closer look at your personal retirement strategy. Consider the following scenarios for two couples of identical age, both with $1,000,000 in retirement savings. One couple manages to retire at 67 with an annual income of $80,000 from these retirement savings, while the other enjoys a lucrative $115,000 every year. What accounts for this striking difference, and why is the $115,000 guaranteed for life, and the $80,000 is not?
The tale of two couples
Meet two couples, both 60 years old, who planned to retire in seven years. Each took a very different approach to retirement planning. The first couple, let’s call them Chandler and Monica, worked hard to reach their $80,000-a-year retirement income and continue to work hard to maintain it. In contrast, the second couple, Ross and Rachel, took a more relaxed approach and are now enjoying their guaranteed $115,000 of retirement income every year. This is a hypothetical example for illustrative purposes only.
Chandler and Monica’s Plan
Chandler and Monica were both 60 and planned to retire at 67 after 7 years. They had saved $1,000,000 for retirement. They received advice, typical of many financial advisors, to adopt the 4% safe withdrawal rate. That meant if they still had $1,000,000 seven years later, they could withdraw $40,000 a year at retirement, and probably would not run out of money in their lifetime.
Unfortunately, $40,000 a year at retirement was insufficient for their retirement dreams. To achieve a more comfortable income, Chandler and Monica decided to pursue a riskier strategy to earn an actual rate of return of over 10.25% each year until they retired, in order to double their nest egg.
After seven long years of stress, worry, and sleepless nights, their efforts paid off. They managed to grow their $1,000,000 to $2,000,000. They knew that a 4% withdrawal from the $2,000,000 was $80,000, and they were happy with that. However, with their money still in on Wall Street, they knew they would face many more years of restless nights, and most likely some anxiety and tension. They feared that if their account ever fell to $0, they would no longer receive that $80,000-a-year income.
Understanding the Safe Income Withdrawal Rate
The concept of the safe income withdrawal rate is based on extensive research. Big research companies out there run mathematical calculations, often known as Monte Carlo simulations. For these simulations, they use numerous combinations of financial products, including stocks, bonds, cash, and commodities, stir them up with their algorithms, and analyze the data produced.
Their goal is to find the safe income withdrawal rate with a 90% to 95% chance that, regardless of your retirement savings mix of products, you will not run out of income during your lifetime (typically calculated over 30 years or using another success probability).
Origins of the 4% Rule
In October 1994, financial planner William Bengen published a paper, “Determining Withdrawal Rates Using Historical Data”, in the Journal of Financial Planning. This groundbreaking research used historical market data to test various withdrawal rates across all rolling 30-year periods since 1926. Bengen concluded that a retiree could withdraw 4% of their initial portfolio balance, adjusted annually for inflation, and reliably sustain income for at least 30 years, even through the worst market conditions.
Limitations of the 4% Rule
Bengen found that although the rule is fairly simple to apply, many failed to apply it appropriately. In the event of an era of prolonged low interest rates, combined with a 4% withdrawal rate, this combination could cause the underlying portfolio to drop to zero. Essentially, withdrawing $40,000 from a $1,000,000 nest egg could lead to financial insecurity.
While the 4% rule remains a useful benchmark, it should be treated as a flexible guideline rather than a definitive rule or guarantee.
Ross and Rachel’s Plan:
Ross and Rachel were also both age 60 and planned to retire at age 67 after seven years with their $1,000,000 savings. However, they recognized that the strategies they had been using to get to retirement were probably not the ones they would need to get them through retirement. They believed that the peace of mind that came with preserving their savings was more important than trying to grow them when nearing retirement.
So, Ross and Rachel sought out an independent financial professional who specializes in asset distribution rather than asset accumulation. They aimed for an additional $80,000 a year of retirement income, without exposing their savings to unnecessary risks. They wanted to be able to sleep at night without worrying about what’s happening on Wall Street.
Their distribution specialist leveraged advanced third-party software and years of experience to explore a wide range of annuities from top insurance companies. By shopping for Single Premium Immediate Annuities, Deferred Income Annuities, and both Fixed and Fixed Indexed Annuities, their financial professional was able to provide Ross and Rachel the ideal solution to meet their income needs.
Their Solution
Ross and Rachel entrusted their $1,000,000 to a big, strong, safe insurance company. The company was A-rated by A.M. Best, the world’s oldest insurance company rating agency. In exchange for their premium, they received a contract guaranteeing them $115,000 each year starting at age 67, backed by the full faith and credit of the insurance company, for as long as at least one of them remains living.
They chose a Fixed Index Annuity with a joint guaranteed lifetime income rider. This annuity allows them to benefit from the gains of a stock index but shields them from losses. The $115,000 per year is contractually guaranteed regardless of how much money is in the account. Even if the account balance somehow reaches zero, they are contractually guaranteed to receive the $115,000. And if they both died young, their heirs would receive any remaining value left in the annuity.
At this point in your life, would you prefer more of a sure thing or a maybe?
While a safe income withdrawal rate might be acceptable, a guaranteed lifetime income can be better. You might be one of many people nearing retirement who already have all the money they need to have a successful retirement. The only problem is that your money is not properly positioned in the correct financial instruments to maximize your protected income value.
The Optimal way to Retire
Success in retirement is not measured by how large your pile of cash is. It’s measured by how much income you have. If you ask 50 different advisors, you will get 50 different opinions on what the right way is to invest for retirement. The reality is that there’s only one optimal approach: by first securing a guaranteed lifetime income that you can’t outlive. This could come from Social Security, a pension, a private pension, an income annuity, or a fixed or fixed indexed annuity with a lifetime income rider.
In Conclusion
You need to understand what you are trying to accomplish. Focus on your outcome. You might be able to grow $1,000,000 into $2,000,000 and draw $80,000 a year from it. Alternatively, you could avoid the sleepless nights full of worry, tension, stress, and anxiety and find out if an annuity might make sense for at least a portion of your retirement plan.
A qualified financial professional can guide you to the right approach for your circumstances. You should feel confident about your financial future. When considering retirement, you want to find a financial professional who specializes in income distribution, who can help you make the right decision for your unique situation, even if it is not an annuity.
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About Author Steven Drahozal
Steven has been in the financial services profession since 1986. He is a small business owner of the Wealth & Income Management Group, LLC, and runs a life insurance agency. Steve has been a part of the Mature American Planning Company, a Michigan Corporation and insurance agency, since its founding in 1998. He can be reached at steven@retirewithwimg.com or (810) 626-5101.
Investment advisory services offered through Brookstone Capital Management, LLC (BCM), a registered investment advisor. BCM, the Wealth & Income Management Group, LLC, and the Mature American Planning Company are independent of each other. Insurance products and services are not offered through BCM but are offered and sold through individually licensed and appointed agents.
Any comments regarding safe income and secure products, and guaranteed income streams refer only to fixed insurance products. They do not refer, in any way, to securities or investment advisory products. Fixed insurance and annuity product guarantees are subject to the issuing company’s claims-paying ability and are not offered by Brookstone.
Index or fixed annuities are not designed for short-term investments and may be subject to caps, restrictions, fees, and surrender charges as described in the annuity contract. Guarantees are backed by the financial strength and claims-paying ability of the issuer. Please refer to the BCM firm brochure, the ADV 2A, Item 4, for additional information.