The Unexpected Risk in Retirement

Risks faced in retirement are different than those faced during while accumulating assets. These varying risks can have a significant impact on a retiree’s possibility of outliving their retirement portfolio.

Investment risk (the returns of the portfolio) is the most impactful risk during the accumulation phase.  In retirement, while investment risk remains, three other significant risks come into play: sequence of returns, longevity and withdrawal rate.  I’d like to focus on sequence of returns risk and longevity risk specific to the decumulation phase.

Sequence of returns is “sneaky”.  While people can understand, and may be thinking about longevity risk and withdrawal rate risk as they approach retirement, they very rarely consider sequence of returns – they tend to focus more on an average return they hope to earn during retirement.  Although sequence of returns can have an impact on a portfolio’s value during accumulation (when there are periodic contributions), during retirement, a poor sequence of returns early on can be devastating. 

The graph below shows the impact of three different sequences of returns on a portfolio that had an initial value of $1,000,000, an initial annual withdrawal of $50,000 (increased by 3.0% annually) and an average return of 5%.

  1. The solid line represents sequence assumptions consistent with returns of 5% annually
  2. The “good” sequence, the dotted line, assumes a cycle of 15%, 7%, 3%, and -5% (resulting in an average return rate of 5%)
  3. The “poor” sequence, the dashed line, assumes a cycle of -5%, 3%, 7%, and 15% (average return is once again 5%)

As you can see, the poor sequence resulted in the portfolio being exhausted about 3 years before the consistent sequence and about 5 years before the good sequence; quite dramatic impacts with equally dramatic ramifications to the retiree.

Then there is longevity. People are living longer – between 1960 and 2015, life expectancy in the U.S. increased an average of two months per year – so their retirement savings need to last longer.  When you combine someone living past average mortality (and 50% will), with a poor sequence of returns, there is real risk that they will outlive their retirement portfolio.

All this said, there are ways to mitigate these risks; one of the best being lifetime guaranteed income streams from annuities.  These guaranteed annuities allow you to kill two birds with one stone.  The obvious one, being that you cannot outlive the guaranteed income stream.  The not so obvious one is that these guaranteed income streams provide protection against sequence of returns risk because a retiree is relying less on their portfolio to produce income.  Additionally, if a poor sequence were to occur and a retiree’s portfolio was completely depleted, they would have a higher income “floor” than they would have without the annuity. Without the annuity, they would only have social security and a pension–if they were lucky enough to have one.

JourneyGuide shows all of this simply and clearly, allowing advisors and clients to develop plans that better mitigate the risks retirees face.

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