This case study presents a very simplified example of a retirement income strategy. In reality, retirement planning involves multiple moving parts, including tax considerations, healthcare costs, market conditions, and evolving personal goals. Each retiree's situation is unique, requiring a tailored approach that balances income security, growth potential, and flexibility to adapt to life's uncertainties.  The information below is not comprehensive and should not be relied upon to make any decisions concerning your own situation.

Background

Joe (65) and Jane (63) Peoples are a married couple ready to transition into retirement. Like many retirees, they are faced with the challenge of ensuring their savings last while maintaining their desired lifestyle. Their retirement assets consist of $1,000,000 in Joe’s 401(k) with a 60/40 stock-bond allocation.

Retirement Income Needs

  • Target Monthly Income: $8,000 after tax ($96,000 annually) adjusted for inflation
  • Social Security Income:
    • Joe: $3,200 per month
    • Jane: $1,300 per month (Spousal Benefit)
    • Total Social Security Income: $54,000 per year
  • Income Shortfall: $42,000 per year

Joe and Jane need to generate an additional $42,000 per year from their investment portfolio to maintain their desired standard of living. Their question: How can we create a reliable and sustainable income stream that will last as long as we do?

The Traditional Approach: 4% Rule & Monte Carlo Analysis

4% Rule

If you've done any reading on retirement income planning, you've probably heard of the 4% Rule.  This is a rule of thumb stating that withdrawals from a 60% Equity/40% Bond portfolio should be limited to 4% of the portfolio initially, then adjusted for inflation going forward.  The target outcome of the 4% Rule is to prevent a portfolio from being depleted over a 30-year retirement but it is not guaranteed.

For Joe and Jane:

  • 4% of $1,000,000 = $40,000 per year
  • This is close to filling their $42,000 shortfall but may not be enough over time due to market fluctuations and inflation.

Monte Carlo Simulation

A Monte Carlo Simulation runs hundreds, thousands, or even tens of thousands of hypothetical outcomes based on the average past performance of specific classes of assets.  The goal of Monte Carlo analysis is to present a percent chance that the portfolio will last until a predefined life expectancy.  The Monte Carlo analysis projects Joe and Jane’s probability of success as a:

  • 77% success rate for their full $96,000 annual income goal
  • 95% success rate for an adjusted income of $89,546

While promising, a 77% probability still carries risk, particularly if there is a major stock market event that is not accounted for in the Monte Carlo analysis. If their portfolio were to decline significantly, they might need to cut expenses later in retirement.  If their investment portfolio is depleted entirely, they are left living off Social Security alone.

Other Impacts of Market Risk and Uncertainty

Many retirees face a deeper challenge beyond just the numbers—the fear of spending. The uncertainty of market-based returns often leads retirees to be overly cautious with withdrawals, sometimes sacrificing a more fulfilling lifestyle to avoid running out of money. Instead of enjoying their golden years to the fullest, they may hesitate to travel, make home improvements, or gift to family members due to financial anxiety. This fear-driven approach can limit the joy and purpose that a well-planned retirement should provide.

Exploring More Secure Income Solutions

Option 1: Adding a Single Premium Immediate Annuity (SPIA)

Joe and Jane could allocate $500,000 from their 401(k) to purchase a Single Premium Immediate Annuity (SPIA).  A SPIA is a contract with an insurance company where they guarantee a predefined income schedule over a certain timeframe.  In this case, the SPIA provides $33,550 per year of guaranteed lifetime income over the lives of both Joe and Jane.

With this approach:

  • SPIA Income: $33,550 per year
  • Remaining 401(k) Balance: $500,000, which continues to grow and can supply the additional $8,450 of needed income
  • Total Secure Income (Social Security + SPIA): $87,550 per year
  • Shortfall Covered: This meets their $96,000 income goal with much of it guaranteed for life

Benefits of a SPIA:

✔ Increases total income by 7.16% while improving income security
✔ Reduces reliance on market withdrawals—especially during a down market period
✔ Even if investments are depleted, Social Security & the SPIA ensure lifelong income

Option 2: Annuity with Guaranteed Income Rider

A more efficient option may be a deferred annuity with a guaranteed income rider. By placing that same $500,000 in an annuity from an A+ rated company, Joe and Jane could achieve:

  • Guaranteed After-Tax Income: Over $100,000 per year leaving $500,000 for purely discretionary spending
  • A 12.51% Increase in overall Retirement Income
  • Guaranteed Income for Life, regardless of market conditions 

Note that only placing $350,000 in the annuity with income rider is sufficient to achieve the desired income within the desired probability of success of 95%.  This also keeps an additional $150,000 in the investment portfolio to improve the ability to adapt to changing needs.

Benefits of Guaranteed Income Rider:

✔ Even higher guaranteed income compared to SPIA
✔ The flexibility to change the withdrawal schedule in the future (not available with the SPIA)
✔ No exposure to stock market volatility for desired income
✔ Allows remaining assets to grow while securing essential expenses

The Best Path for Joe & Jane

By integrating a guaranteed income solution, Joe and Jane could secure their entire retirement income goal with greater certainty and less market risk. Instead of relying on uncertain withdrawal strategies, they can enjoy retirement knowing that a significant portion of their income is protected for life.

Key Takeaways:
✔ The 4% rule and Monte Carlo analysis provide a useful guide but carry risk
✔ A SPIA or annuity with an income rider can guarantee income for life
✔ A 12.51% increase in income (via an income rider annuity) while offering greater financial security
✔ Even if market-based investments run out, Social Security & annuity income help ensure financial stability

Joe and Jane now have confidence in their retirement plan. They can travel, enjoy hobbies, and spend time with family without the constant fear of outliving their savings.
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