How important is it that your money lasts for the duration of your retirement? Most people would answer that it is the essential consideration. Yet, few people are aware of one of the most severe threats to their retirement wealth.

The Problem

Sequence-of-returns risk involves the order in which investment returns occur. In the accumulation (saving) stage, the investor can recover from a few bad years with a few good years later on. The situation is quite different during the period in which one is no longer working and saving, relying solely on investments for income.

If the first couple years of retirement happen to land within a declining market, the retiree may have no choice but to sell into losses. This depletes the principal they are depending on to grow within their retirement accounts. It is quite possible that the portfolio may never recover. This would result in either the retiree running out of money or having their lifestyle reduced from what they had planned on.

The bad news is that there is nothing an investor/retiree can do to control the timing of the market’s ups and downs. The good news is that retirement income planning tools exist that can mitigate this threat.

A Solution

To address the sequence-of-returns risk, a retiree should have a pool of money apart from their investments from which to draw income. A cash-value life insurance policy is an example of such a source. This allows the retiree to withdraw income from the insurance policy instead of selling investment assets in a down market. The retiree can leave his regular retirement funds untouched so he can recover as the market moves back up.

Consider the difference between the hypothetical scenarios of Client A and Client B. Both clients retire with $1 million in the same year. Although they experience the same market returns, the balance of their portfolios after 20 years is vastly different. Client A withdraws $70,000 each year, including years with down markets. Client B also withdraws $70,000 per year, except for five years when the market was down, during which he leaves the $70,000 invested and instead withdraws it from the cash value of his life insurance policy.

At age 85, Client A has a balance of $382,644, while client B has $4,004,003 — nearly ten times as much! 

Mike Marion sequence of returns chart

In this example, the normal benefits of life insurance will also still be in place. The insured’s loved ones will be protected with the policy’s death benefit and the insured will own an asset with special tax treatment.

For an individual who is still in his working years and is concerned about what might happen in the event the market declines during or just prior to retirement age, cash value life insurance could be a viable retirement income planning solution.

See also:

5 major risks to a client’s retirement income

The obvious retirement risk that’s not in the models

2 factors contributing to the growing problem of elder debt

 

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