Income Risk

INCOME RISK

Income planning has become the next frontier of making sure you have addressed the risks of retirement.  I want to focus on one specific portion of that and that is really Sequence of Returns’ Risk.  And because this is where indexing and IUL can really help.

Sequence of Returns’ Risk is the risk that comes from the order in which your returns occur.  You may not have been aware of or considered this sequence of returns risk previously because it doesn’t matter very much when accumulating funds, but it does matter a lot when decumulating your funds in retirement. That’s why it is important that you understand this facet of income risk.

Let’s just assume that if you had $100K and you put it in the S&P 500 and it just grew this century along with the market, as the end of this century this is how your account would have done as of 2022   You would have earned $485K.  But what if I made one change and simply reversed the sequence of returns such that in 2000, we’re going to get the returns in 2021 and in 2001 we’ll get 2020’s returns.  In 2002, we’ll get 2019 s returns going backwards and so on and so on.

Well now what happens is the pattern of returns looks very different, but you end up in the exact same spot.  When accumulating funds, the pattern your funds come in does not matter.

It’s a different story when we come to decumulation: when we actually have to take those funds out in retirement.

So this is just a sample client. Let’s say Jane has a $500K IRA growing at the rate of the S&P 500.  I’m going to assume that she retired in 2000 and needs to take out $30K annually for income from this account.  Well now, suddenly money is coming out and the pattern matters greatly.

If we had engaged the true experience of the market, Jane would have run out of money in 2017.  What happens if I just make one change?  I’m not going to change the returns.  I’m just going to change the pattern they occur.  So again, if I flip the pattern of returns, suddenly Jane does not run out of money in 2017, but she actually has nearly a million and a half dollars in her account.

The sequence of returns matters greatly.

The other way IUL’s help you address income risk is by giving you a different kind of income risk.  So imagine that we have a spectrum of risk from high to low.

At the lower side, were gonna have a guaranteed income from an annuity.  At the higher end, we may be have income that comes from a managed account that is completely variable.

IUL is so important to the income story because it adds predictable income to the spectrum.  It’s not guaranteed like an annuity, but it’s far less variable than a managed account.  So it further diversifies the kinds of income you can rely on in retirement.

Now, we’ve looked at how IUL from indexing can help overcome market risk.  It can help you focus on the scenery rather than look at that gas gauge.  And we’ve looked at how an IUL can help mitigate that sequence of return risk and help you access more predictable retirement income.

But for a complete retirement approach, we also have to see how IUL s can help you overcome tax risk and legislative risk.  That’s what we’ll dive into in the next podcast.