Because the primary objective for retirement is to build a safe and secure income floor for the entire retirement planning horizon, safety-first advocates recommend you consider pensions, bond ladders, and income annuities when meeting these requirements.
Once the foundation is laid for your basic income needs, you can then invest the rest of your money in more volatile assets (like stocks) that will fund your discretionary purchases.
For the sake of argument, let’s consider what would happen if you took your entire nest egg balance and purchased an annuity.
Using a simple generic online quote provider (note that this link is NOT an endorsement; it’s just for the sake of gathering numbers to illustrate my point), at the time of this publication, we find that a 45 year old couple could purchase a $1 million dollar immediate annuity from an A++ rated insurance company that would pay just over $40,000 per year.
That’s not too bad! Notice that we’re getting basically about the same 4% return on investment that we would have received with the 4 percent rule. Of course, the exception is that here the money is guaranteed for life. You will never stop receiving payments for as long as you’re alive (and the insurance company remains in business).
The bad news is that if you and your spouse get hit by a bus tomorrow, then the money is all gone.
(Note: You can buy annuities that leave behind some or all of your initial investment to heirs. However, the payout is considerably less.)
Recall that in the safety-first philosophy, legacy endowments like this are a secondary consideration. In this example, the primary goal of secure, guaranteed payments for life has been achieved.
How Does This Change Our Target Nest Egg Goal?
The reason I have included this chapter in our discussion is because, again, I think that it is absolutely vital to understand the meaning behind the numbers you plan to use for determining your nest egg goal. Whether those meanings have positive or negative connotations, it would be irresponsible not to consider the topic from all perspectives.
While I tend to lean more towards the probability-based school of thought, I don’t think you can (or should) dismiss what the safety-first approach is trying to accomplish: Confidence. Therefore, there is no reason you can’t combine elements of both strategies to come up with a winning, power-house combination!
Let’s say that you plan to retire by age 50 and would (again) like to shoot for a passive income goal of $50,000 per year. But this time you’d like at least half of our income ($25,000) to come from a guaranteed source. This way, applying an element of safety-first logic, you’d always know that your basic needs will be met.
Using the same online, generic quote tool as above, we find that we’ll need at least $550,000 to purchase an immediate annuity from a reputable source that will bring in this level of income.
To fund the remaining $25,000 of our desired income, we could then switch to a more probability-based approach. Using Kitces withdrawal rates as an example, we’d also need an additional:
- a) $555,556 assuming a safe withdrawal rate of 4.5%, or
- b) $454,545 assuming a safe withdrawal rate of 5.5%
This means that our total nest egg goal should be anywhere between $1,004,545 and $1,105,556 in order to execute this strategy.
(Note that these figures are not that far off from the goals we concluded we could use in the previous chapter.)
As I said, I included this chapter to give you broader perspective on retirement planning security in general.
Ultimately, the decision on how you’d like proceed is yours. Only you can define what “safe” really means to you.
If you are more comfortable with risk, then probability based methods may be more suited for you. But if having an absolute guarantee that you will always receive money every month no matter how the markets behave, then perhaps considering some or all parts of a safety-first philosophy may not be out of the question.