The Downside of Decumulation

The question isn’t at what age I want to retire, it’s at what income.

In this article, we will share an approach that will expose the weakest links to the most common choices when purchasing an annuity and provide you with the knowledge to increase your client income by as much as 20-40% using a new decumulation strategy. This approach will preserve and protect accumulated value and provide significant flexibility. Determining the best withdrawal rate for retirement can be a daunting process, especially when faced with uncertainties, such as:

  • Unknowable Future Returns
  • Unknowable Life Expectancy
  • Unknowable Future Expenses

A good question to ask yourself when planning is:
What assumptions must prove to be true, in order for my plan to work?

Over the last twenty years, the traditional options to increase or even maintain a nice retirement income has narrowed substantially.


Decumulation Risks

It is a well-known fact that the descent is the most dangerous part of mountain climbing. The same is true with retirement income. There are two phases to your investment life, accumulation, and decumulation. The accumulation phase is more forgiving because the longer time frame helps to absorb the market volatility and downturns and is the period where you are working and saving for the future. During the decumulation phase there is much impacting your account and several years of vicious volatility or low returns can negatively impact your lifestyle if you don’t have the right approach. This second phase receives little attention from the financial industry because most firms are focused on keeping you fully invested and increasing their Assets Under Management.

In an effort to keep you fully invested in the market, the most publicized strategies for decumulation have revolved around managing the risk of a volatile market by reducing the withdrawal amount.

Popular Income Options

In this section, we are going to help you better understand the mathematical principles of the various options. We are not covering the interest only option, such as bank CD’s, because, in today’s low-interest-rate environment, it’s not viable for most retirees.

1: Withdrawals While Remaining Fully Invested in the Market

1994: The 4% Rule
William Bengen Co-Authored A Study With Morningstar, Inc. and Recommended A Withdrawal Rate of four Percent.

2013: The 2.8% Rule
Morningstar Revised the 4 Percent Rule Due To:

  • Volatile Markets
  • Low-Interest Rate Environment
  • A More Conservative Investment Mix

Remaining fully invested in the market, subjects’ retirement accounts to market swings creating a sequence of returns risk. If you withdraw income from a depleting account, you could magnify the losses and significantly reduce the income potential of the account.

2: Fixed Index Annuity with Guaranteed Income Rider

2005: The FIA Annuity
Prior to 2005, there were three types of annuities; Fixed or Variable for Growth, and Immediate Annuities for lifetime income. In 2005, the Fixed Index Annuity (FIA) made its way into the marketplace with multiple features such as returns linked to an index, and optional guaranteed income strategies. The primary benefits of the FIA are impressive:

  • Protect the Downside in Volatile Markets
  • Participate in Upside Market Growth
  • Provide an Optional Rider for *Guaranteed Lifetime Income

Protection from downside risk while still participating in the upside is the strongest reason for using an FIA. Unfortunately, many of the carriers have designed products with cap rates which limit the total upside potential of the contract to a percentage that they can move up or down. So, if your selected index earned six percent, but your cap rate was three percent, you would only earn the three percent for that period. We will come back and discuss the solution using our Income Under Management approach.

On the surface, the guaranteed income appears to be the perfect answer when combined with the growth and protection provided by the FIA contract, but as we will discuss in a future post, the real rate of return for Lifetime Guaranteed Income Riders are far less than the promotional material indicates.

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