Walking the Tightrope

The pummeling of retirement portfolios suffered during and since the recession of 2007-2009 and continuing high volatility in the equity markets has many still-employed older Boomers asking whether they can recover their losses; and if so, what approaches they need to adopt to get back on track to a comfortable retirement.

Sources interviewed by National Underwriter say that retirement goals established before the downturn remain in many cases. But realizing these aims entails developing, and sticking with, a retirement and wealth management plan grounded in realistic investment objectives. Undertaking a risky “Hail Mary” strategy, they stress, is inadvisable.

“You can’t recover you’re market losses all at once,” says Ray Harrison, a principal of Harrison Financial Group, Roseville, Calif. “Building a nest egg for retirement is akin to a marathon, not a 100-yard dash. Rather than reacting to every market swing, clients need to proceed with intelligence and, in consultation with an advisor, a sound financial plan.”

A Diminished Retirement Pie

A wealth and retirement study published by the National Bureau of Economic Research, Cambridge, Mass., observes that retirement wealth held by 53- to 58-year olds in 2006, before the onset of the most recent recession, declined by 2.8 percentage points by 2010. Among individuals in that age group in earlier generations, an additional 5 percent of retirement wealth would have been saved during a four-year period.

The loss of wealth in the years immediately preceding retirement can be bad enough. But they can be catastrophic when the market goes south post-retirement. A particular hazard for clients who are on living on distributions from their retirement accounts, say experts, is sequence of return risk: the possibility of outliving one’s assets because of the timing of losses on equities invested in the market.

During the wealth accumulation phase of planning, such timing is inconsequential: If a client suffers portfolio declines of 6% annually on a given investment in years 1-5, then a 3% annual rise in years 6-10, the final portfolio value will be the same as when the sequence of returns is reversed: positive returns in the early years, and negative returns in the later years.

But, sources warn, negative investment returns during the early years of income distribution can severely impact the portfolio. As illustrated in the accompanying charts, a hypothetical 65-year-old client who starts with a portfolio value of $566,337 secures by age 90 $2.6 million in assets given one sequence of returns and an average annual return of 8%. But when the sequence is reversed, the portfolio value at age 90 is zero—though the average annual return is the same.

“There are definite risks in taking systematic withdrawals from a pile of money,” says Martin Higgins, a certified financial planner and principal of Family Wealth Management Advisory LLC, Marlton, N.J., “If the market goes into free-fall soon after you start taking distributions, you may not recover.”

To guard against this outcome, many advisors recommend adopting a time segmentation or annuity laddering strategy that divides retirement assets among several “buckets,” each carrying a unique risk level and time-frame for income distribution. In a typical scenario, a portion of the client’s assets will be invested in a single-premium immediate annuity (the first bucket) that guarantees a fixed rate of rate for, say, the initial five years of retirement — the period when the sequence of return risk is greatest.

For the second bucket, also of 5-year duration, the client elects a deferred variable annuity with a living benefit rider that, while allowing clients to capture stock market gains, also protects in some measure against market drops. Popular among the various riders are the guaranteed minimum accumulation benefit (GMAB), guaranteed minimum income benefit (GMIB) and guaranteed withdrawal benefit (GMWB).

Additional buckets, say experts, might also call for a deferred variable annuity, albeit with a riskier asset allocation in the VA’s subaccounts — say, 60% in equities and 40% in bonds, as opposed to a 40% in equities and 60% in bonds ratio for the second VA bucket — because the client has more time with the third bucket than with the second to make up for market losses. Alternately, the client might opt for a comparable asset allocation in a separately managed account under the aegis of a registered investment advisor.

Higgins says he favors this three-tiered laddering strategy for clients who have shifted from accumulation to distribution. Such an approach is particularly needed now, he adds, because equities, while enjoying a recent rise in values, remain prone to steep declines.

“What we’re facing now is a short-term, cyclical bull market within the late stages of a long-term secular bear market,” says Higgins. “These secular bear markets are characterized by significant up-and-down swings. That’s tough for people to stomach who are taking income. Given the prospect of additional market slides, it seems prudent to  be cautious.”

Also subscribing to an annuity laddering strategy for clients in or near retirement is Tilden Sowdon. A producer for Legacy Financial Advisors, Orlando, Fla., Sowdon often recommends as part of a laddered solution attaching an GMIB rider to a VA. In his example, the VA provides an annual reset of the account value based on the higher of the market performance or a guaranteed 8% increase in the account.

To secure the guarantee, says Sowdon, policyholders of the annuity (from Ohio National Financial Services) must put at least 50% of their funds in a hedging program available from the subadvisor Milliman Inc. Investing primarily in exchange-traded funds and exchange-traded futures contracts, the program allocates assets to ETFs using a proprietary TOPS (The Optimized Portfolio System) methodology that aims to mitigate market risk and reduce investment return volatility.

“The TOPS portfolio offers a defensive mechanism against market gyrations,” says Sowdon. “By reducing volatility risk, we’re better able to achieve our ultimate goal, which is to provide a reliable stream of income, regardless of market performance.”

Still other advisors use tactical asset allocation strategies, or short-term adjustments to a portfolio’s asset allocation, to improve the risk-adjusted returns of passive management investing. Harrison says such tactical investing is integral to his firm’s planning process — including plans that call for a VA guaranteed living benefit.

The reason: Though these riders may assure the policy holder of an annual income, withdrawal or accumulation benefit within the terms of the contract, they may not meet liquidity needs if, say, the client needs to withdraw an annuity’s account balance to fund medical expenses.

“The client may need to take a [pre-annuitization] lump sum distribution rather an income stream,” says Harrison. “So we endeavor to maintain liquidity at a level approximating [the contract-guaranteed] income level by dialing down equity market exposure when market risk is higher and increasing exposure when market risk is lower.”

Benefits of Guaranteed Income