"Time is money" is a popular adage, but when it comes to retirement, it's usually timing that matters most. Significant losses or depletions to savings early in retirement can diminish a retiree's nest egg and derail plans. This is known as sequence-of-returns risk, and it's an important concept to discuss and plan for with clients.
There are certain concepts that financial professionals should help their clients understand, so together you can find ways to offset financial risks in retirement.
The order in which returns occur is important. Losses and significant withdrawals occurring early in retirement, after a market downturn, can have
severe consequences for a retiree's portfolio. This is because any possible future gains would now accrue off a smaller base, so retirees may not have time to benefit from a market recovery, particularly if they need to make additional portfolio withdrawals.
Offsetting risk is vital to maintaining a balanced approach. It may seem that a simple solution for
reducing retirees' sequence-of-returns risk would be to encourage them to reduce equity holdings in their portfolios in favor of fixed-income investments. However, this approach compromises the portfolio's upside potential and may even lead to quicker – and premature – depletion of a retiree's long-term savings.
Although there's no guarantee that historical trends will continue, portfolios with higher allocations to equities have typically outperformed over the long term, because downside volatility in U.S. equity markets has historically been relatively short-lived. It's important to consult with your clients on their long-term retirement goals to ensure their assets are protected and allocated accordingly.
Consider Annuities
Effective solutions can manage risk and provide growth potential. Whether you're working with consumers in their 40s or 50s who are looking for upside investment potential, or those nearing retirement who find guaranteed options appealing, annuity solutions can address a range of long-term retirement planning needs.
Income annuities are a useful hedge against sequence-of-returns risk for two reasons: 1) They provide a guaranteed source of lifetime income that is not correlated to market ups and downs or interest rate fluctuations, and 2) annuity income lowers the withdrawals that retirees might need to cover expenses. This is particularly good news when the market performs poorly in the early years of retirement by helping retirees avoid selling at the bottom.
Further, we know that emotions influence investment decisions for retail investors, and fear of losses may leave worried investors sitting on the sidelines. Advisers can explain the importance of closing the risk gap, which is the difference between the exposure clients are willing to take and the exposure that may be needed to potentially grow their retirement nest eggs.
A variable annuity with the purchase of an optional accumulation benefit rider can provide equity exposure coupled with principal protection on the initial investment. This means clients won't be facing sequencing risks during those critical, early years of retirement.
Of course, investors should consider fees, guidelines and risks with annuities, including market risk in variable annuities, which subjects the investor to fluctuating values and possible loss of principal.
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Withdrawals or surrenders may be subject to a surrender charge, ordinary income taxes and, if made prior to age 59 and a half, may be subject to a 10% IRS penalty. Guarantees are based on the claims-paying ability of the issuer.
Your clients should also consider the investment objectives, risks, charges and expenses of variable annuities carefully before investing. Remind them to carefully read the prospectuses, which contain information about the products and underlying investment options.
Without proper planning, the sequence of returns early in retirement can have a significant impact on a retiree's financial well-being later in retirement, including adjusting to a lower standard of living or continuing to invest a larger portion of assets to make up for losses.
Remember: It's important to understand your clients' priorities and introduce strategies that ensure they can enjoy their time in retirement without worrying about timing.
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Phil Caminiti is a managing director at New York Life Insurance Co. and is registered with an affiliate, NYLIFE Distributors.
