People save for retirement all their lives. Do you know when you will have enough to retire? Do you know how much income your portfolio will generate?
People save with 401(k)s, IRAs, SEP, SIMPLE, pensions, annuities, real estate, and life insurance. But at retirement, it’s time to stop putting in and start taking out. The questions I want to ask are:
How much money can you safely withdraw from your savings each year?
How much income will your portfolio generate?
Will your saving last the rest of your life?
Is one savings vehicle any better than another for providing retirement income?
Living off the interest/dividends
The problem with living off the interest is that you will eventually die with your your principal intact. That is money that you could have used in retirement. Living off the interest results in less overall income than tapping into the principal a little bit each year. Your savings will last the rest of your life, but you may have been able to take more income.
Living off the interest also doesn’t account for inflation. If your principle never grows and the cost-of-living goes up each year, then each year you’re purchasing power is slowly eroded. If the inflation rate were 3% for example, prices of goods would double every roughly every 25 years. If your income had been such that you could live off of it at the time you retired, it may not provide enough when you reach age 90.
The 4% rule
Financial Advisors use The 4%-Rule to determine the safe withdrawal rate from savings. The idea is that if you withdraw 4% of your assets each year it will allow your savings to keep up with inflation and ride the ups and downs of the stock market – assuming some of your assets are still exposed to market risk when you retire.
Unlike living off the interest, The 4%-Rule taps into the principal when necessary. It also allows the principal to grow when portfolio growth exceeds 4%.
The problem with the 4% rule, of course, is that it’s only 4%. If you had managed to save $1 million, for example, that would mean only $40,000 of income per year. Its even worse when your money is in a Traditional IRA or 401(k). Remember those tax deductions you claimed when you put the money into the IRA? When you retire and start taking income from your IRA/401(k) the IRS will tax every dollar as if it is income. So your $40,000 of income may look more like about $27,000. It’s very distressing to think that every million dollars of savings will only mean $27,000 of after-tax income.
What’s the best solution?
Think outside the box. You should be aware that using a life insurance retirement plan (LIRP) will likely provide more income than traditional retirement savings approaches. Many people don’t think about life insurance when they are thinking about retirement. But they should be! Dollar for dollar, a LIRP should provide greater retirement income.
It’s important to realize that a LIRP is able to provide more income because you never take money out. Policy loans are used to generate tax-free income. This means that 100% of your savings (cash value) still continues to earn interest/dividends. The advantage of this approach is readily apparent when you compare projections. The Rule of Thumb for a LIRP is 8% instead of 4%. This means that only half as much savings is necessary to generate the same amount of income in traditional savings.
Choosing the best retirement planning vehicle is hugely important. While 401(k) plans and Traditional IRAs are an attractive because of the immediate tax deduction, you need to remember that every dollar of interest and growth is taxed when it is distributed. This means that the 4%-Rule may turn into a 3%-Rule for IRAs.
A LIRP has many advantages over the conventional methods of saving for retirement. It’s important to remember that both Life Insurance and Annuities are life insurance products.1 This means that your savings is not at the mercy of market volatility. Moreover, a LIRP should provide more income than more traditional methods of savings. An 8%-Rule means twice as much income as a 4%-Rule.
As you approach retirement age, your investment strategy should be geared towards investments that protect your principal. Just remember that anyone who retired with their money exposed to Wall Street in 2000 or 2007 may have lost 35-40% of their portfolio’s value when the markets crashed. Life Insurance products dramatically outperformed Wall Street during this decade.
- Learn more about The 8%-Rule by clicking here.