Is Your Income At Risk ?
HOW SEQUENCE OF RETURNS RISK CAN RUIN THE BEST LAID RETIREMENT PLAN .
BY Brian Ross , FRC
YOU HAVE WORK for 30 years to develop a nice nest egg for retirement . You know what your FERS pension will be , and your Social Security income is looking great . You have $ 1 million diversified among the C , S , and I funds in your TSP plan . You have decided to withdraw $ 50,000 a year in annual income from the TSP . Life is good . What could go wrong ?
Mike Tyson once said , “ Everyone has a plan until they get punched in the mouth .” The “ punch in the mouth ” in your retirement plan could be sequence of returns risk . Sequence of returns risk refers to the risk of experiencing a down market at the beginning of the distribution period of your retirement . It can have a major impact on how long your money will last in retirement .
During your early years of working , you are focused on saving money , accumulating that nest egg for retirement . You are not taking any withdrawals from your TSP ; you are adding to it every two weeks . The market goes up and it goes down , and that ’ s okay because you will not need it for 30 years . As you get closer to retirement and begin to plan on taking withdrawals from your account , you need to think differently and consider a new set of risks .
The five years before retirement and the first five years of retirement are critical to the longevity of your retirement income plan . In planning for retirement , it is important that you begin developing strategies to reduce or eliminate sequence of return risk during that five-year period before you retire .
Let ’ s look at sequence of return risk in action . For illustrative purposes , we will consider Mary and Jim in this hypothetical example using real returns of the S & P 500 .
The Sequence Of Returns Matters
Mary Retired At The End Of 1994 Invested $ 250,000 , And Began Taking 5 % Annual Withdrawals From Her Investment In 1995
Mary encounters strong returns in the early years of her retirement . 3 years into retirement her account value is $ 513,920 .
16 years into retirement , Mary ’ s $ 250,000 investment had grown to $ 642,814 .
Year S & P 500 Return Amount Withdrawn Value After Withdrawal
1995 |
37.54 % |
$ 12,500 |
$ 331,350 |
1996 |
22.92 % |
$ 12,500 |
$ 394,795 |
1997 |
33.34 % |
$ 12,500 |
$ 513,920 |
1998 |
28.60 % |
$ 12,500 |
$ 648,401 |
1999 |
21.04 % |
$ 12,500 |
$ 772,325 |
2000 |
-9.09% |
$ 12,500 |
$ 689,401 |
2001 |
-11.85% |
$ 12,500 |
$ 595,401 |
2002 |
-22.10% |
$ 12,500 |
$ 451,317 |
2003 |
28.68 % |
$ 12,500 |
$ 568,255 |
2004 |
10.87 % |
$ 12,500 |
$ 617,524 |
2005 |
4.89 % |
$ 12,500 |
$ 635,221 |
2006 |
15.81 % |
$ 12,500 |
$ 723,150 |
2007 |
15.81 % |
$ 12,500 |
$ 750,350 |
2008 |
15.81 % |
$ 12,500 |
$ 460,221 |
2009 |
15.81 % |
$ 12,500 |
$ 529,541 |
2010 |
15.81 % |
$ 12,500 |
$ 642,814 |
JIM Retired At The End Of 1999 Invested $ 250,000 , And Began Taking 5 % Annual Withdrawals From His Investment In 2000
Jim encounters negative returns in the early years of his retirement . 3 years into retirement his account value is $ 125,246 .
16 years into retirement , Jim ’ s $ 250,000 investment had declined to $ 93,293 .
Year S & P 500 Return Amount Withdrawn Value After Withdrawal
2000 |
-9.09% |
$ 12,500 |
$ 214,775 |
2001 |
-11.85% |
$ 12,500 |
$ 176,824 |
2002 |
28.68 % |
$ 12,500 |
$ 125,246 |
2003 |
28.68 % |
$ 12,500 |
$ 148,667 |
2004 |
10.87 % |
$ 12,500 |
$ 152,327 |
2005 |
4.89 % |
$ 12,500 |
$ 147,275 |
2006 |
15.81 % |
$ 12,500 |
$ 158,060 |
2007 |
5.49 % |
$ 12,500 |
$ 154,237 |
2008 |
-37.00% |
$ 12,500 |
$ 84,669 |
2009 |
26.47 % |
$ 12,500 |
$ 94,581 |
2010 |
15.06 % |
$ 12,500 |
$ 96,325 |
2011 |
2.11 % |
$ 12,500 |
$ 85,858 |
2012 |
15.98 % |
$ 12,500 |
$ 87,078 |
2013 |
32.39 % |
$ 12,500 |
$ 102,782 |
2014 |
13.69 % |
$ 12,500 |
$ 104,353 |
2015 |
1.38 % |
$ 12,500 |
$ 93,293 |
FREEDOMFEDED . COM INCOME RISK 15