The unpredictability of financial markets can disrupt even the best-laid retirement plans. These five strategies may help investors stay on track.
A rule of thumb in volatile markets is to have patience: If you can ride out the market’s ups and downs, asset prices should eventually recover. Unfortunately, retirees don’t always have the luxury of time. If you’re retired or approaching retirement, you may need to tap your investments for income when markets are volatile, potentially locking in losses that can impair your portfolio for the long term.
Fortunately, planning ahead can go a long way toward helping you protect your retirement when market volatility hits. Here are five strategies to consider.
One way to help reduce your retirement plan’s vulnerability to a volatile market is by considering investing in investment-grade bonds and dividend-paying stocks. Investors may be able to collect regular income from these investments to support spending needs, while leaving the principal investments untouched—at least until the market recovers.
However, there are drawbacks to consider. Some companies may reduce or suspend dividend payments during extended periods of market volatility or economic stress. What’s more, depending on the size of your nest egg and your regular spending needs in retirement, the income you can collect from high-quality bonds and/or dividend-paying stocks may not be sufficient to live on.
There are ways you can help protect your hard-earned savings and help keep your retirement plans on track.
Annuities are another way to provide a reliable stream of income that may reduce or even eliminate the need to sell portfolio assets with high return potential during moments of market stress. What’s more, annuities with guaranteed income-protection benefits provide a set amount of income for life, which means you don’t run the risk of ever outliving your savings.
Of course, there are drawbacks to annuities. For example, the most basic kinds are essentially fixed income instruments that have no potential for growth above specified contractual cash flows.
Variable annuities and fixed index annuities are two options designed to address such drawbacks—for example, by providing investors with some exposure to potential equity-market growth. Both may offer guaranteed income and payout rates that are often higher than the yields on certain equity and fixed-income investments, and so may be well-suited for investors concerned about the stability of their retirement income.
Throughout our lives as investors, we regularly use different containers to save for different goals. Funds we need in the near term may be kept in savings or checking accounts, for example, while funds we may need years from now are invested for longer-term growth. This strategy of “time-segmented bucketing” for retirement income isn’t all that different.
With this approach, investors can plan for the early, middle, and late stages of retirement by aligning pools of assets with these different phases. For example, assets that are aligned with short-term needs early in retirement are invested conservatively, in part so that market volatility isn’t as much of a concern as you make withdrawals. Meanwhile, assets aligned with your future spending needs or even gifting plans are invested more aggressively for potential growth.
A principal drawback of time-segmented bucketing is that it can be difficult to implement from a logistical perspective given the complexity of managing multiple asset pools without changing existing account structures.
Another strategy to consider for protecting your portfolio is tailoring your spending to market performance. When markets dip, you can tighten your belt to avoid selling investments when values are low. This might mean limiting distributions from your portfolio to the dividends and bond coupons your investments generate, tapping other income sources, such as an accruing annuity or other pool of assets, or possibly even exploiting an opportunity for some part-time work. When the market recovers, you can consider increasing spending levels or replenishing outside reserves as the value of your assets potentially begins to grow again.
We tested a spending reduction strategy using hypothetical test cases. In our analysis, the retiree was aged 65 and had a $1 million portfolio invested in 60% stocks and 40% bonds. We assumed she would hike or cut her spending by a rate commensurate with the rise or fall in her funding ratio, a measure of an investor’s retirement readiness that measures the value of retirement assets relative to projected spending.
Carefully managing how much you take out of which accounts—and critically, when you take distributions—may help lessen the tax bite and stretch out your savings.
In this case, when our retiree’s funding ratio dipped below 90% – meaning their assets are equal to just 90% of their planned expenses – she would decrease her spending by 10%. In the event her ratio continued to fall beneath 75%, she would cut her spending another 15%. Our analysis showed that, by varying her spending according to portfolio performance, this investor had a 25% higher portfolio value by the age of 90, than it would be otherwise, implying a similar improvement in her retirement income risk.1
This approach is not without potential downsides, as aligning your finances with market performance can lead to less predictable spending and lower overall consumption.
Distributions from qualified retirement plans, such as a 401(k) plan, and traditional IRAs are considered ordinary income by the IRS. Carefully managing how much you take out of taxable, tax exempt and qualified tax deferred accounts—and critically, when you take distributions—is important for if you seek to lessen the tax bite related to such distributions and stretching out your savings. However, individuals must begin taking required minimum distribution (RMDs) from certain employer retirement plans and IRAs, which can substantially limit an investor’s ability to do control distribution timing to minimize tax costs.
One way to get ahead of higher taxes that resulting from RMDs is by deploying an income-smoothing strategy. If you are over age 59 ½, you can consider taking distributions from certain tax-advantaged accounts before distributions from such accounts are required in an effort to lower account balances, so there is less money in those accounts when you reach the age at which you must start taking RMDs. The age at which an individual must start staking RMDs (“RMD Age”) depends on the individual’s date of birth (e.g., if born after 1950, but before 1960, RMD Age is 73).2 Even though you’ll still need to pay taxes on those distributions made prior to reaching RMD Age, you may avoid having larger chunks of your savings taxed at a higher tax bracket once you reach RMD Age and RMDs are required to be made during that tax year if you time such distributions correctly, thereby potentially lowering your effective tax rate in the RMD years.
One downside of this strategy is that tax rates can change, and if they were to go down in the future, that could adversely impact the tax efficiency of the strategy (on the other hand, if tax rates were to increase, benefits would be magnified).
While it can be stressful to see headlines about threats to the value of your nest egg, a volatile market does not necessarily mean danger for your retirement plans. To learn more, you can request a copy of the Global Investment Office report On Retirement: Retirement Income in Volatile Markets and Retirement Income and Sequence of Returns Risk. And ask your legal and tax advisors and Morgan Stanley Financial Advisor how you can help safeguard your retirement income against market volatility.
- What combination of portfolio strategies can help me generate the income I need to support my desired lifestyle and spending needs in retirement?
- How can I implement time-segmented bucketing into my retirement plan so my savings evolve with my needs?
- Which withdrawal sequence across my taxable and tax-advantaged accounts would help manage the impact of taxes on my retirement distributions?