← Ready For Retirement
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Retirement should not feel like an exercise of surviving on a fixed budget. You've worked too hard for too long and you've built your nest egg. Now it's supposed to fund the lifestyle you want to live. There's a massive disconnect happening right now. There's too many different retirement income strategies. Do you put your money into the guarantees of an annuity or do you invest it for growth to outpace inflation? So many different options that you have. The truth is too many people are using the wrong strategy because they're using 1990s math for a 2026 retirement. Today, we're going to put the four biggest retirement income strategies head to head. I'm going to use a $1 million hypothetical retirement portfolio to show you the impact each of these strategies would have. So by the end of today's video, you can confidently understand which will be right for you. Let's take a look at strategy number one. And let's first look at purchasing an annuity. Now, there are many different types of annuities that you could purchase. For the sake of this example, I'm going to use something called a single premium immediate annuity. So what that means is you have a lump sum of money, in this case a million dollars. You use that to purchase an annuity contract that immediately starts paying out payments that last for the rest of your life. So before exploring the pros and cons, let's actually look at what those numbers could look like. Now, I went to an online calculator and I plugged these numbers in. So this is in no way saying this is the premium or this is the amount that you would receive. This is simply me acting as if I was a 65 year old male living in California. What would my income amount be? Well, when I went through that calculation, and this was for Sing Life only, so I would get this money for the rest of my life. The amount was $6,455 per month. On an annual basis, that's about $77,500 per year. Well, the upside is I put that money in and I'm getting the equivalent of about 7.75% of what I put in in terms of income. The other upside is that money lasts for the rest of my life. I don't have to worry about what markets are doing. I don't have to worry about investing my money. I don't have to worry about any of that. All I have to do is know that on one day every month, I'm going to get $7,455 deposited into my bank account. It's guaranteed income for life. And it's a simple set it and forget it income strategy. So that's the upside. Now, what about the downside? Well, the first downside is inflation adjustments. If you're looking at that number, you're saying, wait, 7.7% per year, that seems like a really healthy amount that you're taking from your portfolio or that you're getting from from your portfolio via this income stream. It is, but that's because you're not getting an inflation adjustment. When you talk about other rules, like the 4% rule or other frameworks we'll talk about later in this video, you are assuming that you start with that amount, but then you're adjusting it for inflation over time. With this annuity, you're starting at a higher amount, but it's not adjusting for inflation over time. So at some point there's a crossover. Now, you could purchase annuities that have inflation adjustments built in, but you're going to be taking a bigger step back in some cases a very big step back in terms of the initial amount that you'll be receiving. But that's the first downside. In this specific example, there's no inflation adjustment. So that income amount that seems like a lot of money today starts feeling like less and less money every year into retirement. You fast forward 10 years, 20 years, 30 years down the road. That represents very little compared to what it could buy today after inflation. The second downside, that is not money that can pass along to heirs. Now, the calculation that I ran was a single life annuity. If I were to die and it was a single life annuity, my spouse would not get any of that. There's a simple fix for that. You could run a joint life annuity or purchase a joint life annuity. Now you're going to receive a bit of an income reduction. The amount of that reduction fully depends on the age of your spouse. The older she is, in my case, the less of a reduction I would receive. But if I'm 65 and she is 55, it's going to be more of a reduction because that income has to be guaranteed for both of our lives. Because she's younger, the annuity company is going to reduce that. But here's the thing. Once the both of us have passed, there's no residual value left over for heirs. That may or may not be a big deal for you. You might not even have children. If that's the case, it does not matter what Residual value there is. But if you compare that to a million dollars, let's say in an IRA or brokerage account, if you pass away three, four, five years into retirement, heck, 30 years in retirement, and there's still money left there that can all pass to your heirs. If you purchase an annuity today and you pass away tomorrow, that money's gone. That money goes to the insurance company, and that's part of what you are getting when you purchase the annuity. Lifetime income, whether the income's for 40 more years or only 40 months. Now, taking a quick step back, as I mentioned at the beginning, there's different types of annuities. In certain annuities, they have provisions that account for that. But any provision that accounts for that means you're accepting a lower income amount to start. So all that has to be taken into account. Now here's a final two cons. Number one is there's an opportunity cost. In the majority of market environments, you could have done better had you invested your money and let that money grow for you over time. So that is a downside. You are probably, and this is of course how the annuity company makes money. If they were guaranteeing better outcomes than the market would return, there's not any money left for them to make. So you're probably going to be outperformed if you simply use history as a guide of the market outperforming or whatever the annuity will guarantee to you. But another downside that too many people don't think about is cash flow. It's really nice to have that consistent income. Retirement's not a consistent expense. You might need to purchase a vehicle in one year. You might have another year where you want to take a bigger trip. You might have some years where income needs are much lower with the annuity, you don't have the flexibility to increase and decrease the spending. Sure, if you get too much, you can turn around and save that, but you can never pull out more. You can never say, I'm getting this monthly amount. I need a one time distribution. The annuity is not going to provide that. So it's a poor fit if your spending is going to be more lumpy or uneven in your retirement years. So who is this the best fit for? Generally speaking, this type of an annuity is best for the person that craves certainty over flexibility and even the potential to perform better. So that's strategy number one. Strategy number two is living on dividends only. Let's take a look at that million dollar portfolio again. So assume you invest that million dollar portfolio in the S&P 500. Today, the dividend yield in the S&P 500 is in the low 1% range. Let's assume it's 2%. This rises and falls based upon the valuation of The S&P 500, based upon the dividends that the underlying companies are paying. But just to keep this illustration simple, let's assume you were to put your money into an S&P 500 fund or any diversified mix of stocks in your to receive a 2% dividend yield. What's the upside? Number one, the upside most people is it just, it feels safer. You're not having to sell investments to cover your income needs. You're getting paid a dividend. Now, there's a counterpoint to that that I'll mention in a second, but it feels better. There's a mental accounting piece here to you to see that cash flow show up on your statement. You don't have to go sell shares. The second benefit, dividends remain extremely resilient even when stock prices fall. Now, this is not a hard and fast guarantee, but you can look at many of the downturns the market has experienced. And the market goes like this. It's way up and way down. And that's just a normal of the market. It always will be dividends. They remain pretty resilient, meaning even in years where markets drop quite a bit, for the most part, this isn't a guarantee that they always do, nor that they will in the future. But for the most part, dividends remain pretty consistent. So if you're relying on a dividend strategy, even if the price of some of your shares is rising and falling, it's not kind of the same impact on the dividend that those shares are that those stocks are paying. So that creates more consistency even if your overall portfolio value is fluctuating wildly. Now, what's the downside? Well, for the downside, let's just do some math. You have a million dollar portfolio. It's generating a 2% dividend yield. You get $20,000 per year. Now, that $20,000 per year historically has risen and it's risen even faster than inflation. But let's just compare that to the income yield that the annuity generated, about $6,450. You can already see one is significantly greater than the other. So the downside of the dividend portfolio is if you have a well diversified portfolio, you're probably living on a much lower dividend amount, a much lower dollar amount each year. Now you can say, James, there's no big deal with that. You just shift to higher dividend paying stocks. You're exactly right. You could shift that yield to 3%, 4%, 5% or more. But every time you make that shift, keep this in mind, you are simultaneously taking this diversified portfolio and concentrating it more and more into in certain sectors and certain asset classes, which is then exposing you to greater sequence of return risk. If you look at the top 10 dividend paying stocks in the S&P 500 right now, all of them have underperformed the S&P 500 over the last 15 years. Mean the more concentrated you get in these types of stocks, sure the dividend yield is higher, but the actual long term performance, there's no guarantee that it's going to be much better. So you start to introduce more risk into your plan. So the upside, you get dividends, you get cash flow, you don't have to think about it. The downside is if you actually want a dividend yield in today's market that is more than 2 or 3%, you're going to have a hard time doing so without being overly concentrated in certain sectors or asset classes. So yes, dividends feel safe, but they are not a free lunch. So let's go to the third strategy. Now the third strategy is relying upon the conventional 4% rule. So bill Bangin, he wrote the white paper back in the 90s about the 4% rule. At the time there was not research that said how much can you you take out of your portfolio while minimizing the risk that you run out of money. So he was the first one to really pioneer this research in. His research showed assuming you have half your portfolio in U.S. stocks and the other half of your portfolio in U.S. bonds, you could take 4% out of your portfolio. And even if you retired into a horrible bear market, using history as his guide at the time, you would not have run out of money over a 30 year time period. So think of that 4% rule as 4% is the most you can take out to still be okay in the worst case scenario. So what does that look like? Well, using a million dollar portfolio, that means $40,000 is what you would take out and you would then adjust that $40,000 per year for inflation over a 30 year retirement. And I say 30 year retirement because that's the time frame that he used when he did this research. Quick side note, if you're retiring early, if you might have a 40 to 50 year retirement based upon a long life expectancy and an early retirement, 4% rule might not be the best rule to use. It was not based, it was not assuming you could spend 4% forever. Rather it was showing that you could spend that for a 30 year retirement. So what are the upsides of the 4% rule? Well, number one is a pretty simple framework. What's the value of your portfolio? Day one of retirement, take 4% of that, adjust it for inflation. Number two is widely understood. This became the foundation of a lot of retirement income strategies. People understand it, people get it. Even if you've never read the white paper, you've probably heard of the 4% rule. Another benefit is you do maintain flexibility and liquidity. You still have the portfolio. So if you do need to pull more, you can, if you do need to take more out at certain time in the future, it's not all tied up. It's not like an annuity where you're just receiving that income amount and then can't make adjustments along the way. The downsides though are this. When I talked about what this 4% rule was designed to do, it was designed to be the maximum you could take in the worst case market environments. So if you're that unlucky investor that retires at the worst possible time, this might be a fine strategy. But here's the reality. Most of you are not going to retire right before the worst bear market of the last 50, 100 years kicks in. So what does that mean? What means most people, statistically, almost all people, are going to underspend what they actually could have during their retirement years because they needed to protect against worst case scenario. So if you're not taking that into account, you might be spending way less money than your portfolio could otherwise have supported, even if you just get average or even slightly below average numbers long term in the market. So you're probably leaving something on the table. And in fact, most people who follow this rule pass away with more money at the end of their retirement than they had going into their retirement years. So that's the biggest downside. While you could consider this safe, safe doesn't always mean optimal. So what we really want to do is understand how can we simultaneously protect ourselves from, but also have a framework that helps us understand when can we start spending more, when can we start taking more out of our portfolio if the market's doing well, or at a minimum, if the market's not absolutely tanking, like some of this research was based upon when defining what that initial withdrawal rate should be. So this now brings us to the fourth retirement income strategy, which is a guardrails based income strategy. What does that mean? Well, the 4% rule is very helpful theoretically, but it's also fairly rigid. You look at a 30 year retirement and it's assuming that you start spending one number and then just adjust that for inflation over time, disregarding what the market does, disregarding some other things, it's simply spending that number, which is very simple, but probably so simple that it's not the thing that's actually optimizing what your money could do for you. The guardrails based framework. So Jonathan Guyton and others did this research that showed that you could actually start spending a greater amount from your portfolio and have that portfolio still projected to last for up to 40 years. And their research. But here's the thing, you can't just blindly start spending it and then set it and forget it. There's a framework that you follow and that framework includes some of the following items. Number one, don't just invest in the S&P 500 in intermediate term government bonds. Now to his credit, when Bill Bangam was doing this original 4% rule white paper back in the 90s, you didn't have access to all the asset classes that you have today, at least on a super cost effective, efficient manner. That's changed. So what the guardrails framework did is it says, well, what if you diversify your money further than just those two asset classes? Then the next thing it looked at was, well, with all these new asset classes, instead of just proportionately pulling funds like you would say using the 4% rule research, what if we looked at which of these had performed best? What if we took more money from the highest performing asset class in the least amount of money from the lowest performing asset class. What you're doing is by default now. You're allowing more of your assets to be sold high as opposed to selling when things are low. Then what if we also add some rules into this? You know what happens if you're spending as a percentage crosses a certain threshold? Do we freeze your inflation adjustment for the following year? Do we make a temporary cut? Or what if the alternative happens? What if you're spending as a percentage goes down not because the dollar amount you're taking out goes out, but because the markets are rising, so your portfolio value as a whole is growing, which means withdrawal rate for those dollars you're taking actually goes down? Well, what point can you give yourself a cost of living adjustment upwards? So there's all these different frameworks and if you can start to implement these, you can have the same reasonable expectations long term that your portfolio will last as long as you need it to. But instead of only taking 4% out to start, you might be able to start somewhere in the 5.5% range. So that's a dramatically higher amount of money you can take from your portfolio if you, if you can follow some simple and very reasonable and frankly, logical steps along the way to make sure that you're making the adjustments in the necessary time, starting with that same million dollars, just to put numbers to it, that might mean somewhere closer to $55,000 withdrawal rate in increasing inflation over time, with the caveat that you will make the adjustments when needed to either freeze your spending, cut your spending, or increase your spending, depending on what the market is doing. So at the end of the day, no single strategy is best for everybody. For some, it might be an annuity. For some, it might be dividend investing. For others, it might be the 4% rule of the guardrails framework. Some people even combine everything. But the first step is understanding what do you need your portfolio to do for you in terms of the income you need to maintain your lifestyle? Then you can start to understand which of these strategies might be best to fulfill that. If we can help, reach out to us here at Root Financial. We've helped hundreds of people retire. And a big part of that strategy is tying their income strategy to their investment plan, to their retirement plan, to their tax plan, to make sure that everything is managed in a very cohesive way.