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People who are about to retire will often use a lump sum of money to create an income stream to support themselves during retirement. The money is usually from a 401K, IRA, Brokerage Account or some other investment vehicle. A major concern for clients is that they are never sure if the lump sum will be enough to create the needed income stream. Many factors come into play such as the amount they save every month and investment performance while they save.
People in their savings years (30’s, 40’s and early 50’s) also face the problem of not knowing how much they need to save. As a result, most people save up money and simply hope that it will be enough. They are not able to accurately predict investment performance over the course of 20 or 30 years which makes it impossible to know how much they will have in retirement.
The ability to sustain a steady income during retirement years has always been a primary concern for people in the United States. Recent studies have shown that 61% of U.S residents age 44 to 75 are more afraid of running out of savings/income than they are of death. In order to avoid exhausting a savings nest egg, guidelines of been developed. The most popular is the 4% income rule.
The 4% rule was developed in the early 1990's by a certified financial planner named William Bengen. He set 4% as the amount of money a retiree can take out of their investments every year with a high probability that it will last for at least 30years. Since that time, financial advisors have been using it as the benchmark with clients.
Click the chart for a magnified view
The above graph shows how the S&P 500 and a Guaranteed Income account (BAA) would have performed since 2001 with the same initial investment.
This chart was created by plotting the yearly account balance an account would have, if it was started in 2001 with an initial investment of $100,000. The graph compares an investment in the S&P 500, versus an investment in a Guaranteed Income account. The top line is the BAA account amount, and the bottom line is the account that tracks the S&P 500.
Planning for retirement has become a risky business for most. The majority of future retirees are no longer offered a private pension plan. Instead, they will need to rely on their deferred compensation plan such as a 401K to provide the income needed in retirement. Two of the major concerns with relying on a deferred comp plan are trying to determine how much the lump sum will be when retirement starts and how much can be taken as income during retirement.
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