As we move into the new year, each and every one of you are either closer to retirement or further along in retirement. The biggest concern for most people is whether or not they will have enough money to last all the way through retirement. Most people have their money invested in a way that will produce growth — which assumes a degree of risk — or invests in income producing investments — which do not usually grow in value — or a combination of both. The challenge with this is the unpredictable long term results.
Sequence of returns
The biggest concern with this method is something called “Sequence of Returns.” This can change your retirement income for the rest of your days if the markets should have a few bad years when you’re early on in retirement.
As an example, if you started with a retirement account of $1,000,000 and took a 4% distribution to live on, that would be $40,000 in income. If the market was flat that year (meaning it didn’t go up nor down), you would no longer have $1,000,000 but instead would have $960,000. If you took out another $40,000 the following year and the market was down 10% you would now have $824,000 at the end of your second year of retirement. If the the market went up 10% in the third year and you still took out $40,000 you would have approximately $860,000.
In 2000, 2001 and 2002 the S&P was down 9.10%, 11.89% and 22.10% for a total of 43.09%. During that time, if you took out 4% from the original amount you would be down 55%! This would give you an account balance of only $450,000 left to last through retirement.
At this point you would have to take a “pay cut.” To keep a 4% withdraw, you would only be able to take $18,000 yr. That is a pay cut of over 50% from where you started.
Planning for volatile markets
The reason you would do this is to make sure you don’t run out of money because if you do, you are in big trouble. Now I’m not saying that WILL happen in the future, but I am saying that DID happen in the past and it CAN happen in the future. I hear people say “Let’s hope that doesn’t again,” but I remind them that “HOPE” is not a strategy.
In order for this scenario to not happen to you, a different strategy must be chosen. One that can assures you of a lifetime of income that is worry free and will never go down even if the market goes down. So how do we accomplish this?
Annuities!
The annuities that are offered today can produce “market like returns” without the risk of the market. They can and do offer double digit returns from time to time and will likely provide you with an income for the rest of your life; they can even go up if the market should go up. That new higher income will never go down, but can only go up. This will give you an income that can help fight off the effects of inflation.
The best thing about annuities is that the income will go on and can increase even if the account goes to $0. Yes, you can use all your money and still have an income for all your days. This is why annuities can play such an important part in a financial plan. When you combine safety and non-correlated investment along with a managed account, you can reduce the risk of having to take a pay cut in the later years of your retired life.
If you have any questions or input please contact me at jim@wsagca.com
I also encourage you to visit The Household Endowment Model for extra credit reading.
Jim Saar 