The Retirement Income Myth: Income Riders and Sequence of Return Risk
Income Riders and Sequence of Return Risk
The following is an excerpt from the book, Momma’s Secret Recipe for Retirement Success,” by Dan Ahmad, Jim Files, and Jack Canfield, with contributions from other leading professionals from around the world. This excerpt was written by Dave Lopez, a recognized retirement planning speaker, and writer.
Retirement Income Myth:
You shouldn’t buy an annuity because the stock market is the best place for you to invest for dependable retirement income that will last for as long as you live.
You are retired and want a high level of dependable income from your savings that is guaranteed to last for as long as you live. You research on your own. You talk to your Advisor. You even ask friends and family what to do, because you desperately want to know the truth about how to protect your principal and guarantee you won’t run out of income late in life.
You may have been told that the best way to succeed with your investments in retirement is to try and get the highest rate of return, because this will allow you to draw the highest level of income during retirement, keep pace with inflation, and provide you the highest probability your money will not run out. While this sounds good, historical data does not support this in any way shape or form.
The more volatile an asset is, the less you can confidently withdraw if your goal is to make sure it lasts for as long as you live. The stock market can be very volatile and you should assume it may continue to be so. Since 1929, once every seven years on average the stock market crashes approximately -40%. If you are withdrawing money from retirement accounts that lose -40% on average once every seven years, how do you expect your funds to last? You are right, you can’t!
Then in Your Research Someone Tells You About an Annuity
And you immediately recoil at the thought of buying an annuity, because you remember things you have read or been told in the past. You may have heard from an Advisor, the internet, or a family member that annuities are bad tools in all circumstances for all people. Following this advice could end up putting your retirement security in jeopardy.
I have found that the vast majority of Advisors that push the agenda that, “All annuities are bad in all circumstances,” are often Advisors that have set up their practice to sell only market-based products like Stocks, Bonds, and Mutual Funds. As such, they do not, or cannot, offer annuity products. That’s a lot like a car salesman who only sells cars telling you that pickup trucks are a waste of money. The truth is both cars and trucks are useful but for different needs. The same is true for investment tools, and the same is true for annuities.
So, why is it that using Stocks and Mutual Funds to guarantee your income in retirement may not be the best tools for the job?
SEE ALSO: Annuities 101
Let’s examine the time period from 1979 – 2008, a period of 30 years. Assume we receive these returns in retirement. Let’s keep it simple:
- You invest $1,000,000 in a portfolio—a combination of stocks and mutual funds.
- You receive an average return of 7.23% per year after fees.
- You draw out 5% per year, ($50,000) for income in retirement.
That sounds like a perfect scenario. You grow your money at 7.23% yearly. You only take out 5% ($50,000) yearly. You are confident you will:
- Protect your principal.
- Guarantee you never run out of money.
- And even grow your nest egg by 2.23% yearly. (7.23% growth less 5% withdrawals).
But, That is Probably NOT What Would Have Happened
Not only would you not have protected your principal, but you could also have run out of money.
That’s right, you could have gone broke! Now how is that possible? How could you average 7.23% yearly over a 30-year period, take out only 5%, and go broke?
The answer? Because of an investment risk that many of us have never been told about and never discussed with our Advisors. It’s called, Sequence of Return Risk, and if not planned for, it could cripple your retirement plans and leave you broke late in life—with no income stream and no remaining savings.
When withdrawing money every month from your retirement accounts, the “average rate of return” on your investments no longer matters. Consider two scenarios:
- If your annual returns had happened in the same order they did (with the S&P 500) from 1979-2008, you may have been able to withdraw your 5% each year and still end up with over $2.6 million dollars! The average rate of return over the 30-year period: is 7.23% after fees.
That’s great. You took out the money you needed and still grew your account to over $2.6 million dollars for your heirs. That, you think to yourself, is how I was told it would work.
But, what if the returns are different?
- If the order of those annual returns to your retirement accounts had simply been reversed, you would have gone broke by year 15! That’s right, by receiving the exact same returns but simply reversing the order of those returns you would have run out of money in 15 years and your account would be depleted. The average rate of return over this 30-year period? The same 7.23%!
The stock market carries principal risk, a high level of a sequence of return risk, and with these, a tremendous amount of dependable income risk.
The stock market cannot provide dependable income as evidenced by the lowering of the “Safe Withdrawal Rate” from 6% back in the 1980’s down to 3% currently.
On the other hand, fixed index annuities with income riders provide principal protection, an opportunity to participate in stock market appreciation, and consistent, dependable income guaranteed for as long as you live.
SEE ALSO: What is a ‘Safe’ Income Withdrawal Rate?
When you create your retirement income plan, I believe it is prudent to take “Sequence of Return Risk” into consideration. Stocks and Mutual Funds have never given the same rate of return year after year. As a result, “Sequence of Return Risk” could cause your plan to fail, and you run out of money.
A second lesson here is that you need to be clear about your goals. Once you have identified your goals, you can begin to look for the investment strategy that best accomplishes them. In our example, if your goals were principal protection against stock market losses and guaranteed income for life, you would look for an investment strategy that is specifically designed for that purpose, such as a fixed indexed annuity with an income rider. Regardless of stock market performance or losses, your income is guaranteed, reducing your worry.
Building out your retirement plan is like building a house. Before you begin, you want the right tools for the job, knowing each tool has a purpose. Using the wrong tool can cost you time, money, and a big headache. Investments, like any tools, are all different. Each investment tool is designed for a specific job, with each having its own advantages and disadvantages. And just like building a house, you will want the right tool for the job.
By limiting yourself to just a few financial tools, namely Stocks, Bonds, and Mutual Funds, you drastically limit your options to guarantee your principal against stock market loss and get a high level of income guaranteed for as long as you live.
A fixed indexed annuity with an Income Rider is only a tool, it’s neither good nor bad. And like any financial tool, it has advantages and disadvantages. But, it is a tool designed for two main purposes:
- To protect your principal against stock market losses
- To generate guaranteed income for life
Don’t risk your retirement or limit the income you can take because you have limited yourself to only a few investment tools.
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