Generating retirement income – even in an uncertain financial environment – is still possible. But it won’t likely happen if you use traditional stock and bond strategies that rely on assumptions and hope as part of the planning process.
For many retirees, going to sleep at night and waking up the next day worried about how long income will last has become more of the norm than the exception. Given an extremely volatile stock market over the last dozen years, coupled with historically low-interest rates, it can be difficult at best to garner any type of guarantee for how long your money will last at a time you need it the most.
So, how is it that some retirees are able to live their lives completely unconcerned about their retirement income running dry?
It’s likely that they’ve found a way to skirt around the damage that sequence of returns risk can produce by NOT relying on traditional retirement income strategies like the portfolio drawdown or going “all in” with low-paying, fixed-interest investments.
Primary Risks to Your Retirement Income
Unlike many retirees in the past who could depend on a lifetime income from an employer-sponsored pension plan and Social Security in retirement, those who are leaving the workforce today will have to devise a significant portion of their “decumulation” (i.e. retirement income generation) strategy on their own.
Gone are the days of getting a gold watch and a retirement party on your 65th birthday, and they’ve been replaced by a list of retirement income risk factors, including:
- Market Volatility – Stock market volatility is nothing new. Since the recession of 2008, though, daily up or down swings in the three or even four-figure range have become much more common. But that doesn’t mean that losing money in the market is any less risky. For a retiree and someone who is quickly approaching that time in their life, even a slight “correction” can have devastating effects on your long-term financial security.
- Inflation – Another big risk to your retirement savings and income is inflation. Although the average annual inflation rate has hovered at just over 3% for many years, with “safe” fixed investments only paying 1% (or less), future purchasing power could decrease substantially over time.
- Increased Healthcare and Long-Term Care Expenses – As people age, it is common that the need for healthcare and long-term care services will increase – and even with Medicare as your health insurance provider, you can still face significant out-of-pocket charges by way of copayments, deductibles, and coinsurance requirements.
- Longevity – Longevity may be the most dangerous risk of all because living a longer life means that you will have to face all of the other financial obstacles for a longer period of time. It also requires your assets and income to be stretched to a point where they will eventually be depleted.
A Closer Look at How Sequence of Returns Risk Can Cut Your Retirement Income Short
Another key risk is sequence, or order, of returns. This represents the impact that a negative return in your portfolio can make, based on when it is received. As an example, let’s say that Bob and John each have $100,000 in their portfolio. They each decide to draw down 9% every year to supplement their retirement income, while leaving the remainder of the funds inside of the account to continue growing.
Over the next three years, both of the men generate a 7% average return. But they have very different results when it comes to keeping their portfolio intact. That is because in Year 2 Bob attained a negative 13% return, while John got a positive return of 27%.
And, even though Bob attained a positive return of 27% in Year 3 – while John’s return was a negative 13% – because Bob experienced the negative return earlier than John, his portfolio was depleted six years before John’s was.
|Year 1||Year 2||Year 3||Average Return||Years Until Depleted|
Source: Government Accountability Office, June 2011
How to Keep from Running Out of Income in Retirement
While there are a multitude of withdrawal strategies that use equities and/or fixed rate investments, the only financial vehicle that can ensure a guaranteed lifetime income – regardless of what stock or interest rates do – is an annuity.
If you’d like to learn more about how an annuity can provide your portfolio with ongoing income stability, we can help. At Annuity Gator, our focus is on educating consumers and financial advisors on how annuities work, and where they may – or may not – offer a viable income-generating solution.