Hello everyone, we’re going to stick with Vanilla and Chocolate, of the mythical Banana Bread Land, with their financial professional Walnut. Previously, on the adventures of Vanilla and Chocolate, we showed how they could have unlimited paychecks for life.
In this post, we’ll introduce the Power of Zero to improve your financial results. We’ll show how a fixed indexed annuity leverages the Power of Zero. All of this is related to retirement ruin, the possibility that under many scenarios you run out of money in retirement. The lower your chances of retirement ruin, the better chance you can enjoy your retirement, of doing what you want to do, the way you want to do it.
Here’s where we are. Chocolate and Vanilla, our power duo, have saved up the 1.5 million muffins they need to retire. Walnut is showing them how their money will generate income under four scenarios. In each scenario, their portfolio goes up 10% for the first three years, and tanks 5% every year for the next 7 years. Every year, she assumes they take out 4% of their portfolio as income. Let’s take a look. The first example, the couple managers their money themselves.
This is not what we want, both of them say! The risk of retirement ruin is high! Walnut agrees. Here’s the scenario where they withdraw 60,000 muffins a year, fixed every year. They are left with close to 900,000 muffins after 10 years.
At this rate, we’ll exhaust the remaining assets we worked so hard to build in 15 years. No no, we want another option. Walnut shows them the Power of Zero. This example doesn’t really exist, she says. Think if every year you had a negative return, you don’t lose any money! You replace the negative return with a 0, zero percent. I explained how that works when we last met. Here’s how it looks.
This looks better, say Vanilla and Chocolate. Not ideal, but better. I think you mentioned something about fixed income annuities last time and how fixed income annuities harness the Power of Zero while investing. Can you show us how that works? Walnut agrees. She shows them how their income increases the first three years, then stays steady, until their investments do well again.
This is more like what we expected, says Vanilla. Chocolate is happy, less stress in retirement and more enjoyment. Not only do we get the 5,000 muffins a month, but if the returns do well, we will increase our income every month. This is a big question, what happens when we run out of money, says Chocolate?
I’m glad you asked, says Walnut. I ran a simulation for 50 years, with possible annual returns between -5% and 10% every year. This is how the income looked over time. When your investments go down, your income stays the same the following year. If your investments increase, the life insurance company credits your income with the amount of growth from the previous year, subject to some restrictions on how much it can grow. This is a hypothetical example, but I’m including a spreadsheet you can download to plug in different scenarios.
In this case, you run out of money after year 22. At that time the life insurance company would be paying you 110,000 muffins a year. Since the life insurance company is on the hook for unlimited paychecks, they’ll keep paying you, even if the amount of money you have runs out. Isn’t that great? Walnut is pleased. She sees the excitement in the eyes of Chocolate and Vanilla.
If you’re interested in seeing different retirement withdrawal scenarios, download our spreadsheet below and plug in your own amounts. The below calculator shows you how we got the charts for the four example above. This is the difference in managing your retirement income risk yourself, and offloading the risk to someone else, in this case a life insurance company.
If you have to retire, hope you retire in a sustained bull market in your invested assets. Sequence of returns risk is the risk your investments go down exactly when you retire. This depletes your assets, making retirement ruin a larger possibility. A fixed income annuity can reduce the risk of running out of assets, allowing you to sell invested assets at a better time, instead of when they are down. You want to talk to a qualified professional on if a fixed index annuity makes sense for you. As we have mentioned before, consider fixed index annuities as part of your secure retirement plan.
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Warmest regards,
smilingdad
smilingdad 