TEST Episode 217: The Annuity Debate: Smart Strategy or Overpriced Product?

Introduction and Overview

Briana Corbin 00:00

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Alex Murguia 00:41

Hello, everyone. Alex here. I’m here with Wade, and in this episode, we’re going to be discussing the Retirement Planning Guidebook. Wade has a new edition coming out, and we want to discuss the nuts and bolts of it to see how this book will be able to bring value to your retirement income plan.

Why the 4% Rule May Be Too High

Alex Murguia 01:01

Wade, now to build off of that — what are the reasons why the 4% rule may be too high or maybe too low? Whatever number you say, you’re going to have a group of people that will talk their book and say, “No, this is too high because of this, or this is too low because of that.” What are the usual suspects in terms of variables?

Wade Pfau 01:25

That’s a big part of Chapter Four — walking through these issues. Reasons why the 4% rule might be too high include, first, the international experience. That was the first study I did in financial planning. Bill Bengen’s 4% rule studies were based on US historical market data, and I found that using market data from 20 developed market countries, essentially the 4% rule worked with US and Canadian data, but rates were much lower in the other 18 countries. So if you’re concerned that the international experience may be relevant, then the 4% rule may not look as safe as you thought based just on US historical data.

Alex Murguia 02:13

So if you’re in Czechoslovakia listening to this podcast, you’d be worried.

Wade Pfau 02:17

Potentially. Australia is an interesting case — the US had a really great 20th century, but Australia actually had higher average stock returns and less stock volatility, with really good financial market performance. But with the stagnation around 1970, with the high inflation and stagnant growth, the US maybe got lucky that 4% survived that period. In Australia, it was closer to 3%. I think there’s just the element of randomness with how things work out.

Inflation’s Impact on Withdrawal Rates

Alex Murguia 02:59

Remember, in our interview with Ben, he pointed out inflation drives all of this.

Wade Pfau 03:04

I talk about that in the book now, because I think that was the most intriguing insight from his 2025 updated look at his research — how important inflation is. For countries that experienced hyperinflation, the withdrawal rate is 0.1%, 0.3%. That’s actually on the list of reasons why the 4% rule may be too low: if you retire at a time where inflation is moderate. In his new book, he talked about the 4.7% universal safe max, but then more specifically — if you retire at a time where inflation is between two and a half and 5%, he’s comfortable talking about a 5.5% safe withdrawal rate. The sequence of inflation, or the inflation risk, is more significant than the market risk, and just being able to retire at a time with moderate inflation should set you on a path where you don’t have to be as worried.

How Taxes Affect Sustainable Spending

Alex Murguia 04:28

What about return assumptions? A lot of the research is done without tax considerations, without fees. They assume you can get the S&P returns. What are your thoughts?

Wade Pfau 04:51

The basic research assumes you earn the underlying index market returns. No fees to reduce the withdrawal rate, and you have to rebalance to a relatively aggressive asset allocation. Bill Bengen, in his original studies, said retirees should hold as close to 75% stock as possible. In his 2025 book, he was using 55% stocks as a baseline, but since publishing, he’s talked about maybe 65% should be the stock allocation of choice.

Alex Murguia 05:47

When you’re talking about 65% allocation, it doesn’t mean 50% of that is in Nvidia or Meta. It’s in a relatively indexed, non-forecasting approach.

Alex Murguia 06:20

So if you’re an active investor thinking 4% is good, it may actually be too high. You could think of yourself as the next Warren Buffett. But the reality is, if you’re looking in the mirror and the image looking back at you isn’t Warren Buffett — that’s not you. Tread lightly.

Wade Pfau 06:45

Taxes have an impact. If all your money is in a Roth IRA, then taxes don’t have an impact. If all your money is in an IRA, the assumption is you can take out 4%, but your tax bill has to be covered through the 4% distribution. The 4% rule assumes you want inflation-adjusted spending in retirement. What that really would mean is you want after-tax inflation-adjusted spending. Nobody’s going to have an inflation-adjusted tax bill. Taxes are going to eat away at what you can spend.

In a taxable brokerage account, every year the portfolio is kicking off interest and dividends, and any taxes you’re paying really would have to be incorporated into your spending rate. I look at examples in Chapter Four of how with $1 million, $2 million, or $3 million in either an IRA, taxable brokerage account, or Roth IRA — alongside a Social Security benefit — what is the sustainable withdrawal rate on an after-tax basis.

Time Horizon: Is 30 Years Enough?

Alex Murguia 08:48

One more point on why the sustainable withdrawal rate may be too high — let’s talk about time horizon.

Wade Pfau 09:02

The 4% rule was specifically calibrated to a 30-year retirement. Naturally, the longer the retirement, the lower the withdrawal rate. I’ve had financial advisors ask me, “I have this 85-year-old client, am I supposed to use the 4% rule?” At that point, your time horizon is probably not 30 years, so you could probably use a higher withdrawal rate. But the other way — 30 years may not be all that conservative. Especially for the FIRE community, financial independence retire early, or even if you’re retiring in your mid-60s: 40 may be the new 30 for the number of years you might enjoy in retirement.

Portfolio Diversification and Higher Rates

Wade Pfau 10:14

An important reason why the 4% rule may be too low is portfolio diversification. The 4% rule assumes a pretty basic portfolio — S&P 500 and intermediate-term government bonds. If you start to diversify beyond that, you get a better risk-reward trade-off. You don’t necessarily have to increase the portfolio’s return — if you can reduce the volatility through diversification, that starts to get the number higher. With the asset classes Bengen used in his new book, he got it up to 4.7% as the universal number.

Alex Murguia 11:10

These things aren’t done in a vacuum. You’re not playing a game of chicken with the markets. You’re looking as you go and making course corrections. There may be an asset class that’s investable today that wasn’t available 20 years ago. Through the magic of diversification, you get a smoother line, which means higher annualized returns, which means higher ability to take a withdrawal.

Financial Derivatives and Structured Outcomes

Wade Pfau 11:48

Financial derivatives can overlay on your investments to change the trade-offs between downside risk and upside growth. By removing some of the downside risk — even if you sacrifice some upside growth potential — it might help support a higher sustainable spending rate. The traditional asset classes have a bell curve distribution. The idea of financial derivatives is you change the structure of that bell curve.

Bucketing and Time Segmentation

Wade Pfau 14:22

Bucketing, or time segmentation, looks at the investing problem quite differently from total returns. Instead of saying “I’m going to be 60/40 stocks and bonds,” bucketing would say: if I put 40% into bonds, it’s because that’s what I need to fund the next eight years of fixed income expenses. Then my stock allocation is whatever is left over. When you do that, you’re no longer tethered to a particular asset allocation.

With most bucketing strategies, if markets are going down, you stop extending your fixed income buckets, you stop rebalancing from stocks into bonds, and that creates a window where hopefully those stocks can recover before you’re forced to spend from them again. It can lead you to have a higher stock allocation when markets are going down — and behaviorally, we know that’s not what people usually do.

The Rising Equity Glide Path

Alex Murguia 16:48

What about changing your allocation throughout retirement? You’re picking a certain number year one and then just making inflation adjustments. Can the same be said about allocation? I’m thinking about glide paths.

Wade Pfau 17:07

The 4% rule generally assumes a fixed asset allocation throughout retirement. Michael Kitces and I did research on the rising equity glide path — the idea that to manage sequence-of-returns risk, you start with a lower stock allocation at the beginning of retirement, then gradually increase it over time. The true worst-case scenarios are bad markets in early retirement, and then hopefully markets eventually recover. If that’s the worst case you face, a rising equity glide path helps manage that risk.

Alex Murguia 18:09

Sometimes it gets misinterpreted as getting to an aggressive allocation. If the conservative allocation for you is 50/50, the rising equity glide path doesn’t get you to 70/30. You start maybe artificially low, like 30/70, to effectively get to what that natural allocation is for you, 50/50. I don’t see that as aggressive. It’s just getting to your baseline.

Variable Spending Strategies

Wade Pfau 19:47

Variable spending strategies are the longest part of Chapter Four. Some of the strategies we look at include Bengen’s floor and ceiling rule, the Guyton-Klinger decision rules for guardrails around spending, an inflation rule about when you take inflation adjustments in retirement, Michael Kitces’ ratcheting rule, and using an RMD-based approach where you spend a percentage of what’s left each year that increases with age to account for a shorter remaining time horizon.

Alex Murguia 20:47

Reading that brought to light that there are levers you can pull — a floor, a ceiling, previous year’s returns — and depending on how you like to deal with it, pulling certain levers can give you a very effective strategy. You made it conceptually clear. My takeaway was: there are certain levers, and if I pay attention to these levers, I can understand how to make my own variable withdrawal strategy.

Buffer Assets in Retirement

Wade Pfau 22:11

Buffer assets are the fourth way to manage sequence risk. A buffer asset is something outside the portfolio, not correlated with the portfolio — which is just a fancy way of saying, if your portfolio is down, your buffer asset is not down. It provides a temporary spending resource to avoid having to sell from the portfolio at a loss, giving your portfolio a chance to recover.

The three buffer assets are: cash — the original buffer asset from the 1980s. Cash value of permanent whole life insurance. And the growing line of credit on a variable rate Home Equity Conversion Mortgage, better known as a reverse mortgage.

They’re usually expensive. Reverse mortgages and life insurance are both expensive. But the synergies you create by giving relief to the investment portfolio — so you’re not selling from it when it’s in trouble — let the portfolio get back on track, so the long-term growth to the portfolio sets you up to repay the loan balance and still have a net positive.

Alex Murguia 23:30

Having buffer assets opens up windows of liquidity, which frees up your ability to have a portfolio geared for higher returns. You don’t need to have the conservative ideation around that.

Optimal vs. Safe Withdrawal Rates

Wade Pfau 25:08

The safe withdrawal rate question is: what’s not going to cause you to run out of money? That inherently leads you to think quite conservatively. But with the optimal withdrawal rate idea — if you have lots of reliable income outside the portfolio, if you have flexibility to adjust your spending without disrupting your lifestyle, if you have other reserve assets — you might have the capacity to spend at a much higher rate. It might lead you to run out of money from your investments. But in the right circumstances, that may be okay to get the maximum lifestyle in those early retirement years. It may not be the “safe” withdrawal rate, but it may be the optimal withdrawal rate for your plan.

Wade and Alex are both principals of McLean Asset Management and Retirement Researcher. Both are SEC registered investment advisors located in Tysons, Virginia. The opinions expressed in this program are for general, informational and educational purposes only, and are not intended to provide specific advice or recommendations for any individual or on any specific securities.