I would worry about the counter-party risk with annuities; if a single company goes out of business, you might be bust. Even if you distribute across many companies, I’d think it’s more likely that the whole sector goes bust than that your portfolio devalues to 0 in some other way.
For that reason I’d lean toward not putting too much of my assets in annuities—but maybe it works out so that the counter-party risk is smaller than the risk of running out of money otherwise.
The fear is not that the stock market goes to zero, just that it rises slowly enough that withdrawing 4% leads you to deplete your portfolio before you’re dead. Ending up in the horrible situation that you have no money and are still alive. Even proponents of the 4% rule will say the simulations only show that you don’t run out of money (say) 90% of the time. There’s a decent 10% chance that you will run out of money. The original 4% calculation was done during a great time in US market history, so I’m not sure how optimistic I am about that being the case in the future.
Anyway, that 10% risk has to be compared to the chance of the insurance company not paying out. You can of course spread out your annuity into 4 different insurance companies, say. But even if you don’t, just like your money in your bank account is safe (up to a certain amount) even if your bank goes out of business due to FDIC insurance, and your stocks/bonds are safe (up to some amount) even if your broker goes out of business due to SIPC insurance, there’s an equivalent for insurance companies. All states in the US have state guarantee associations that back at least $250K of present value of annuity benefits. See here for more: https://www.annuity.org/annuities/regulations/state-guaranty-associations/
I’m not saying annuities are a great idea for everyone. But they might be a good idea for those who are risk averse enough that they don’t trust the 4% rule and want guaranteed (up to some major system collapsing event that causes even the state guarantee associations to fail) income.
Learning about the existence of state guaranty associations has decreased my sense of how big I think the counter-party risk is; thanks for sharing this.
Re: running out of money, I’ve added a section on the risks of retiring too early to address this concern in more detail. I now agree that annuities might be a good idea to address this if you are old enough, and I was probably overly worried about counter-party risk.
Re: the 4% rule, it is indeed more of a guideline than a guarantee. More details are available here: https://thepoorswiss.com/updated-trinity-study/. The link shows a 100% stock allocation with a 3.5% withdrawal rate has a historical 98% success rate over 50 year periods starting from 1871 -- if you are never going to generate income again and are never going to increase real expenses, you may be able to buy quite a bit of safety by going to 30x instead of 25x and holding a 100% stock portfolio.
3.5% might be safer, although I should have emphasized that I’m skeptical because the link you gave assumes you’re invested in only US stocks. This is hindsight bias because it so happened that the US market beat the world market in the last 50+ years. A more unbiased calculation would use a world market index (something like VTWAX instead of VTSAX).
And also maybe one should do the analysis without assuming that your home currency is US dollars, to avoid the bias that the US has been very prosperous in the past century? Not so sure about this. Maybe everyone should redo the analysis using their own home currency (e.g., Canadian dollars, Euros, etc.) and then decide what X% they can safely withdraw in retirement.
Great point; I agree. Also a great example of missing an obvious risk; I hadn’t noticed that before linking.
The calculator here allows simulating withdrawal rates by asset allocation, although it only has data back to 1970 so is a bit limited. I get the same safe withdrawal rate (4.3%) for 30 year retirees using either 100% US or 50⁄50 US/ex-US over that time frame. 100% Japan had a 1.5% safe withdrawal rate.
I would worry about the counter-party risk with annuities; if a single company goes out of business, you might be bust. Even if you distribute across many companies, I’d think it’s more likely that the whole sector goes bust than that your portfolio devalues to 0 in some other way.
For that reason I’d lean toward not putting too much of my assets in annuities—but maybe it works out so that the counter-party risk is smaller than the risk of running out of money otherwise.
The fear is not that the stock market goes to zero, just that it rises slowly enough that withdrawing 4% leads you to deplete your portfolio before you’re dead. Ending up in the horrible situation that you have no money and are still alive. Even proponents of the 4% rule will say the simulations only show that you don’t run out of money (say) 90% of the time. There’s a decent 10% chance that you will run out of money. The original 4% calculation was done during a great time in US market history, so I’m not sure how optimistic I am about that being the case in the future.
Anyway, that 10% risk has to be compared to the chance of the insurance company not paying out. You can of course spread out your annuity into 4 different insurance companies, say. But even if you don’t, just like your money in your bank account is safe (up to a certain amount) even if your bank goes out of business due to FDIC insurance, and your stocks/bonds are safe (up to some amount) even if your broker goes out of business due to SIPC insurance, there’s an equivalent for insurance companies. All states in the US have state guarantee associations that back at least $250K of present value of annuity benefits. See here for more: https://www.annuity.org/annuities/regulations/state-guaranty-associations/
I’m not saying annuities are a great idea for everyone. But they might be a good idea for those who are risk averse enough that they don’t trust the 4% rule and want guaranteed (up to some major system collapsing event that causes even the state guarantee associations to fail) income.
Learning about the existence of state guaranty associations has decreased my sense of how big I think the counter-party risk is; thanks for sharing this.
Re: running out of money, I’ve added a section on the risks of retiring too early to address this concern in more detail. I now agree that annuities might be a good idea to address this if you are old enough, and I was probably overly worried about counter-party risk.
Re: the 4% rule, it is indeed more of a guideline than a guarantee. More details are available here: https://thepoorswiss.com/updated-trinity-study/. The link shows a 100% stock allocation with a 3.5% withdrawal rate has a historical 98% success rate over 50 year periods starting from 1871 -- if you are never going to generate income again and are never going to increase real expenses, you may be able to buy quite a bit of safety by going to 30x instead of 25x and holding a 100% stock portfolio.
3.5% might be safer, although I should have emphasized that I’m skeptical because the link you gave assumes you’re invested in only US stocks. This is hindsight bias because it so happened that the US market beat the world market in the last 50+ years. A more unbiased calculation would use a world market index (something like VTWAX instead of VTSAX).
And also maybe one should do the analysis without assuming that your home currency is US dollars, to avoid the bias that the US has been very prosperous in the past century? Not so sure about this. Maybe everyone should redo the analysis using their own home currency (e.g., Canadian dollars, Euros, etc.) and then decide what X% they can safely withdraw in retirement.
Great point; I agree. Also a great example of missing an obvious risk; I hadn’t noticed that before linking.
The calculator here allows simulating withdrawal rates by asset allocation, although it only has data back to 1970 so is a bit limited. I get the same safe withdrawal rate (4.3%) for 30 year retirees using either 100% US or 50⁄50 US/ex-US over that time frame. 100% Japan had a 1.5% safe withdrawal rate.
That’s quite interesting! What was the stock/bond allocation in your examples that gave you a SWR of 4.3%?
100% in US stocks gives a SWR of 4.3%;