Have I not been pessimistic enough?
In a recent column, you’ll recall, I argued that retirees are caught on a treadmill fueled by low interest rates. On the one hand those low rates are crucial to keeping the stock market going, but on the opposite hand those rates mean that your portfolio dollars don’t go as far as they did previously. In short, retirees are having to run faster just to remain even.
Gloomy as this was, it had been nothing compared with the image painted by the favored Financial Samurai blog. As fellow columnist Shawn Langlois summarized, the author of this blog in effect argued that you simply would wish an $8 million portfolio so as to possess retirement income of $40,000 a year. Ouch.
Fortunately, things isn’t nearly as bleak as this.
One way to point out this is often to specialise in how an enormous your portfolio must be so as to get a guaranteed lifetime income in more than $40,000 annually. the solution , even with today’s low interest rates, is a smaller amount than $1 million. While that’s still an imposing amount of cash , it’s tons but $8 million.
Consider the accompanying chart, which reports the annuity payout you’ll purchase today with $1 million. the info are courtesy of a web comparison tool at ImmediateAnnuities.com. I assumed one male, either aged 65 purchasing an instantaneous annuity or aged 60 purchasing a deferred annuity to start payouts in five years’ time.
The chart reports the yearly payment level assuming either no inflation adjustment or what it might be within the first year if, in each subsequent year, it had been 3% higher. Notice that in no event is that the annuity’s annual payout but $40,000.
Why did the Financial Samurai conclude that you simply need such a lot money to retire on $40,000 a year? The author derived it from the annual income you’d earn if you took your entire retirement portfolio and purchased a 10-year Treasury. That admittedly may be a low number.
That is too pessimistic, however, for several reasons. First, in retirement you’re ready to draw down your portfolio’s principal additionally to living on its income. this is often why the tax code treats an enormous chunk of an annuity payment as tax-free, since it represents a return of principal. So take this under consideration when comparing annuities to other possible retirement finance options; on an after-tax basis, the annuity is probably going to seem even more favorable.
Another reason the Financial Samurai analysis is just too pessimistic: Annuity rates are more correlated with the company bond yield than the Treasury yield, as I showed within the chart that accompanied my recent column. Though the company bond yield has been coming down in recent years, it’s still larger than the Treasury yield.
Furthermore, most researchers have found, you presumably will have a better retirement standard of living if you are doing not annuitize with 100% of your retirement portfolio. Some financial planners recommend that you simply do so with perhaps one-third of it. The guaranteed lifetime income it might provide will enable you to require on more risk than otherwise with the balance of your portfolio, which should successively improve your retirement standard of living relative to what it might be if you annuitized your entire net worth.
So the analysis presented here is that the minimum. To the extent you’re ready to do better, of course, then you’d need but $1,000,000 to fund a retirement income of $40,000 annually.
None of this discussion suggests it’s easy to finance a cushty retirement. But, by an equivalent token, it’s important also to not exaggerate how hard it’ll be.
I also want to specialise in the impact of inflation on retirement income. Which does one think may be a better deal to get with $1 million? an instantaneous annuity that gives no cost-of-living adjustment (which within the accompanying chart translates into an annual payout of $59,124) or one whose payout grows 3% a year (which, per the chart, translates into an annual payout within the first year of $42,288)?
By way of a solution consider that, within the 13th year, the annuity with the three COLA can pay out $60,293, quite the $59,124 of the annuity with no annual increase. And, cumulatively over subsequent 23 years, the entire dollars paid out by the three COLA annuity will have exceeded the annuity with no adjustment.
So your choice between these two annuities will depend partially on your anticipation .