Morningstar’s latest report talks about a retirement income strategy with a 90% chance of success.
At the risk of stating the glaringly obvious, another way to describe this would be as a retirement income strategy with a 10% chance of failure.
In other words, according to this calculation, there is a 10% chance that you will run out of money after thirty years – around the time you are in your nineties, or perhaps just turning 100. A perfect time for a third career perhaps.
It sounds like a Dirty Harry parody. Do you feel happy?
Even these numbers are based on financial calculations known as Monte Carlo simulations, which assume that the future is a kind of random version of the past. Maybe that will be the case. But maybe not.
These exercises have been common since financial advisor Bill Bengen launched them in the 1990s. He was the man who came up with the 4% rule, referring to an initial withdrawal rate of 4%.
All of these calculations rely on several assumptions, from asset allocation to future returns, that could turn out to be wrong. They are always only indicative or indicative. The latest Morningstar analysis shows that the current outlook for those about to retire is not great.
These are valuable exercises, but a retirement plan with a 10% chance of failure looks a lot better in a spreadsheet than it sounds in practice. The problem is that when things go wrong, there is no – I repeat, no – way to undo the damage.
Like most people, I want a retirement income strategy with a 100% success rate. Every other priority—owning a vineyard in Napa, leaving a legacy, awarding a university chair in plant psychology—comes a very, very distant second.
An obvious way to achieve this goal would be to buy lifetime annuities: life insurance contracts that turn a pile of money into the equivalent of an old-fashioned pension.
Currently, by purchasing immediate annuities, a 65-year-old woman can achieve a 7.3% withdrawal rate and a 65-year-old man can achieve a 7.7% withdrawal rate. (Men get higher withdrawal rates because they don’t live as long on average.) These withdrawals are guaranteed until you die.
These are much higher than the 3.7% or 4.4% rates discussed in the latest Morningstar report.
Okay, this isn’t apples to apples. These annuities are delivered without inflation adjustment.
But if you add a 2% annual increase—which matches the Federal Reserve’s long-term inflation target—a woman could reach a starting rate of 5.9%, and a man a rate of 6.3%.
There are a number of disadvantages to annuities. One of them is that if you die young, you end up subsidizing the people who live long. In this way, the insurance sector can generate higher guaranteed lifetime incomes than an individual portfolio. Another is that when you die – whether after a few years or many decades – there is no more money.
But they let you get much more lifetime income from your portfolio without the risk of going bankrupt.
