Freedom Federal Educators Issue 1 - Summer 2021 | Page 15

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Year S & P 500 Return Amount Withdrawn Value After Withdrawal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