When considering how and when to draw down your retirement funds, look beyond the 4% rule and consider sequence of return risk.
Dreaming of the day when the morning alarm clock will be replaced by the morning newspaper and coffee on the balcony overlooking the waterfront? Preparing a sound financial plan for your retirement can help ensure you enjoy your retirement years, but how can you know if your nest egg will last a lifetime?
There are many strategies for how to draw down your retirement funds in order to make them last a lifetime, but here are three designed to protect against market risk in the early years of retirement:
How can these strategies help? They address something financial advisors refer to as sequence of return risk. This is a complicated-sounding name for a simple issue. Sequence of return risk simply focuses on the potential for investment losses early in retirement to weaken the ability of retirement funds to generate income to last a lifetime.
"It's not something you need to lose sleep over if you're still adding to and growing your nest egg. But it should be a big consideration if you're approaching or living in retirement and drawing down on your savings over time," says Matthew Sadowsky, director of retirement and annuities at TD Ameritrade.
Sadowsky explains: "If you are withdrawing from the market over time, it hurts more when your portfolio drops in the early years of retirement. There is less left in the portfolio to bounce back when the market goes up."
There are several strategies retirees can use to hedge against this risk. Let's dig deeper.
Retirees can try to isolate a portion of their retirement income plan from market volatility through the purchase of guaranteed income, such as an annuity. An annuity is simply a contract between a guarantor—often an insurance company—and an individual or couple. Growth annuities are issued with either a fixed or variable rate of return, with a focus on the growth of an investor's portfolio. Income annuities may also include a growth component, but the main goal of an income annuity is to create a guaranteed stream of income that cannot be outlived.
There is another type of annuity—the deferred income annuity—that combines the characteristics of both growth and income vehicles into one product. An individual who purchases a deferred income annuity will receive a steady stream of income, almost like a personal pension payment, starting at some point in the future, that will continue for the rest of the investor's life.
Although cash doesn't offer much of a return, it can act as a welcome liquidity source during down market years. "If you have enough cash to tap into, you can choose when to tap into your nest egg instead of being forced to during an inopportune market drop," Sadowsky says.
Another option to hedge against sequence of returns risk is to plan ahead to be more conservative in your early retirement years. "In the first five or so years you might want to be more conservative with how much you withdraw," Sadowsky says.
As Benjamin Franklin said, an ounce of prevention is worth a pound of cure. And when it comes to retirement planning, those ounces can add up, especially in the early years. Now isn't it time for Zumba?
Planning for tomorrow involves setting financial goals today. Are your plans on track?
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59½, a 10% federal tax penalty may apply. Early withdrawals may be subject to withdrawal charges. Optional riders are available at an additional cost. All guarantees are based on the claims paying ability of the insurer. An annuity is a tax-deferred investment. Holding an annuity in an IRA or other qualified account offers no additional tax benefit. Therefore, an annuity should be used to fund an IRA or qualified plan for annuity features other than tax deferral. Product features and availability vary by state. Restrictions and limitations may apply.Investment and Insurance Products: Not FDIC Insured * No Bank Guarantee * May Lose ValueInsurance products/services are offered through The Insurance Agency of TD Ameritrade, LLC. Brokerage services provided by TD Ameritrade, Inc., member FINRA/SIPC. The Insurance Agency of TD Ameritrade, LLC and TD Ameritrade, Inc. are both wholly owned subsidiaries of TD Ameritrade Holding CorporationAn insurer's financial strength rating represents an opinion by the issuing agency regarding the ability of an insurance company to meet its financial obligations to its policyholders and contract holders. A rating is an opinion of the rating agency only, and not a statement of fact or recommendation to purchase, sell or hold any security, policy or contract. These ratings do not imply approval of our products and do not reflect any indication of their performance. For more information about a particular rating or rating agency, please visit the website of the relevant agency.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.