Time to retire the 4 percent rule? Research highlights benefits of annuitization

As widely used as the 4 percent rule for retirement income is, it might not offer the best outcome for retirees in comparison to a one-two punch of making systematic withdrawals and buying annuities, according to new research backed by the American Council of Life Insurers.

According to the research conducted by economists Mark Warshawsky and Gaobo Pang – whom ACLI says are solely responsible for the paper's conclusions –pairing annuities with systematic withdrawals from retirement accounts could provide more stable income for retirees than the commonly applied 4 percent rule.

The research stress-tested those differing approaches with a model simulating real-world retirement challenges like market downturns, inflation, longevity risks, and the pricing of investment and annuity products purchased through retail or institutional channels.

For retirees with $250,000 or more in savings, the researchers found better financial outcomes from combining systematic withdrawals from cash or other liquid investments alongside annuities, whether it's through a one-time annuity purchase or a phased “laddered” annuitization process.

In contrast, the widely followed 4 percent rule – which calls for an initial 4 percent withdrawal from retirement savings, with is then adjusted for inflation in later years – faces significant failure rates at older ages, resulting in the lowest income over time. Meanwhile, annuities that guaranteed lifetime income provided a healthy shield against market volatility and longevity risk.

Those with less than $250,000 in retirement savings, the researchers found, enjoyed the strongest benefit by annuitizing larger chunk, if not all, of their savings.

According to Warshawsky, annuities fill a critical role in retirement income planning as the decline of defined benefit plans pushes retirees toward defined contribution models and IRAs. 

“These plans lack built-in means for a retiree to know how to best structure their regular withdrawals to fund their lives in retirement, and annuities fill that gap,” Warshawsky said in a statement.

The study also emphasizes the potential benefits of integrating annuities into a broader retirement strategy, which could include other income sources such as Social Security and employer retirement plans.

The ACLI-backed comes alongside new revelations from Northwestern Mutual's 2024 Planning & Progress Study, which found a modest majority of not-yet-retired Gen Xers (52 percent) and pre-retiree Boomers (51 percent) don't feel financially ready to retire when the time comes.

When asked to estimate how much money they've set aside for retirement as a multiple of their current annual income, 51 percent of Gen X said they've put away three times their annual income or less, while 51 percent of Boomers said they've saved six times their salary – making both groups far short of the 10 times minimum multiple recommended by many financial experts.