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Pension and Employee Benefits: Code, ERISA, & Regulations
This series provides an authoritative and comprehensive reference to the full text of benefits-related provisions of the Internal Revenue Code, the full text of ERISA, and related proposed and final regulations, as well as the official IRS and DOL preambles, and Committee Reports.
from Spencer’s Benefits Reports: The stock market declines since 2008 have been a reminder of an additional risk that could cause retirees to outlive their savings – the risk of poor market performance just before or soon after retirement.
For most of the past 30 years, recent retirees have faced only three challenges: inflation, increased health care costs, and longevity. Annual returns for a portfolio consisting of 50% stocks and 50% bonds generally were steady from 1979 to 2008, permitting portfolios to grow in the early years of retirement.
Someone who retired in 1979, when market gains were steady in the 1980s and very good in the 1990s, would be able to easily withdraw 4%, adjusted for inflation, of the beginning account balance for the next 30 years. In that scenario, a $500,000 portfolio actually would have grown to more than $600,000 within three years, and would have fluctuated around that amount for the next 22 years.
Principal Financial Group suggests that an entirely different scenario would play out if the 30-year period from 1979 to 2008 had been reversed. If the market performance had been reversed (i.e., if the decline of 2008 took place in the first year of retirement instead of the last year), an inflation-adjusted 4% withdrawal rate would draw down the portfolio in 14 years. In this scenario, a $500,000 portfolio would drop to about $250,000 in two or three years and would remain at that level for another five years before beginning a steady decline to zero in the 14th year.
Guarding Against Risk
In its October 2009, issue of ThoughtCapital, Principal suggested a number of ways that someone approaching retirement can postpone the depletion of his or her retirement portfolio beyond the 14-year period caused by poor market performance in the early years of retirement. First, scaling down retirement spending from 4% to 2%, adjusted for inflation, would help sustain retirement income from 14 to 30 years. Second, delaying retirement by five years would help sustain retirement income from 14 to 23 years, assuming that the retirement spending rate stayed at 4%, adjusted for inflation.
Third, Principal suggested that purchasing an income annuity with 50% of the portfolio at retirement without postponing retirement or reducing the withdrawal rate would help sustain retirement income from the remaining portfolio from 14 to 25 years. Principal noted that the purchase of an income annuity solely in reaction to market losses would not be beneficial because the purchaser simply would be locking in the losses.
The authors of ThoughtCapital acknowledged that using only one of these recovery strategies might require the individual to make uncomfortable changes, but combining the strategies could make the changes less extreme and still might be effective. For example, a three-year retirement delay plus a 3% withdrawal rate and buying an income annuity with 30% of the portfolio (termed “3-3-30”) would result in a 30-year period of income sustainability, plus there would be $354,000 remaining. If, instead, a “0-3-30” strategy were used (no retirement delay, a 3% withdrawal rate, and 30% of the portfolio used to purchase an income annuity), there would be a 30-year period of income sustainability, with $52,000 remaining. A “3-4-30” strategy (three-year retirement delay, a 4% withdrawal rate, and 30% of the portfolio used to purchase an income annuity) would result in a 27-year period of income sustainability.
For more information, including the assumptions used to arrive at these conclusions, visit http://www.principal.com/about/news/research.htm.
For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.
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