Retiring and saving for retirement during a bear market can be challenging. This is, unfortunately, the case as we head into 2023, as many retirees and workers are concerned about the rising cost of living, inflation, and other economic challenges. According to Forbes, 2023 could be one of the worst years for retirement since the Great Recession from 2007 to 2009.
Still, it's worth noting that while the S&P 500 was down 17 percent in December 2022 from January, it was up 10 percent since 2020 and about 50 percent since 2017. Hoping the markets treat you well in retirement is not a plan, because the S&P 500 and other stock indexes typically correct themselves over time. For instance, the average bear market is just 289 days, but there are regularly periods when no progress is made in the stock market for a long time. For example, after the big crash in the fall of 1929, it took until 1954 for investors to break even, and of course, that is not including any cost-of-living increases that occurred over that long period of time. Then there was another long period in which investors made no real progress from early 1966 to the late summer of 1982, and more recently, investors endured a zero total return from the spring of 1996 to the spring of 2009 (and worse than 0% if they were paying fees of course). So, it is important for people nearing retirement or recently retired, to not have too much exposure to the markets, as one of these prolonged painful periods could spell serious trouble over the long run, especially if the retiree needs to withdraw income for living expenses during this period. This makes the changes of running out of money much higher, unless there is a very large pool of capital to start off with.
Regardless of whether you're retired or just beginning to save for retirement, here are five things to know heading into 2023.
Sequence of Returns Risk
An investment term coined by William Bengen in 1994, sequence of returns risk is of particular importance to those planning to retire soon. This is because those who begin withdrawing from retirement accounts during a bear market won't enjoy the maximum benefits of compound growth.
In an April 2022 blog post, Charles Schwab presents a scenario that highlights the impact of the sequence of returns and the importance of timing as it relates to retirement.
In this scenario, two investors retire with $1 million in their retirement portfolio and withdraw $50,000 each year to cover living expenses. Assuming a 15 percent market decline during the first year of retirement for Investor A, they would run out of savings within 18 years. If Investor B was 10 years into their retirement when this market decline hit, they would still have $400,000 left in their 18th year of retirement.
There are real and easily obtainable solutions to overcoming market declines, and a retiree can assure themselves of never running out of money by utilizing one or more future income annuities, or “private pensions”. These contracts keep the investor’s principal protected against all market declines, but also allow for significant upside through index funds when the markets are positive or strong, thus allowing the investor to enjoy very respectable returns, without ever needing to suffer through a steep market decline or crash, or even prolonged period of underperformance. Most pre-retirees and recent retirees should aim to minimize principal withdrawals during bear markets, especially if it's early in their retirement, and instead use the guaranteed income for life features of the fixed indexed annuities as a foundational source of income, to be layered on top of their Social Security and/or pension. They could also consider a part-time or consulting job to supplement their income, if need be.
Auto-Portability Gaining Momentum
Every year, millions of Americans experience retirement-saving setbacks when they switch jobs. Workers with balances of less than $5,000 in employer-sponsored retirement accounts have to begin taking distributions from the account if they switch jobs. If they're unable to transfer the savings to their new employer's plan, the account balances are either automatically cashed out or transferred to a Safe Harbor IRA account, where they will earn almost no interest.
Auto-portability, one solution to retirement account leakage, has been gaining traction in recent years with both Democratic and Republican senators in favor of provisions. In 2019 the Department of Labor gave the Retirement Clearinghouse (RCH) clearance to transfer employee account balances to the new employer's plan without needing consent from the employee.
An example: A 30-year 401(k) account belonging to a worker with a $40,000 salary, 3 percent annual increase, 6 percent annualized ROI, and 6 percent deferral rate would be worth $204,587, assuming there was a $16,000 withdrawal at some point. However, that same account with zero leakage would be worth $273,257.
Moreover, a joint study conducted by RCH and the Employee Benefit Research Institute (EBRI) found that over the next four decades auto-portability could reduce cashouts from $320 billion to $164 billion for those with small-balance accounts.
The Inflation Rate
Inflation was at a four-decade high as of December 2022. This is a concern for the millions of people who have had to tighten their monthly budgets due to rising prices for gas and other commodities. The most recent BMO Real Financial Progress Index showed that one-quarter of Americans intend to delay their retirement because of inflation.
However, this shouldn't be as big of a concern for retirees because they often have the option not to drive as much or at all. Retirees also may have smaller grocery bills. With proper planning, a retiree can receive regularly occurring boosts in their income to help address inflation. Also, allocating a small (10-15%) portion of their portfolios in non-dollar holdings, such as farmland, commodities, and precious metals, can help them keep up with inflation over time. Those who are retired shouldn't let inflation dictate their financial decisions and should instead pay closer attention to healthcare costs and property tax rates.
Reconsider Your Dream Retirement Destination
If you've always dreamed of retiring in Florida or other warm-weather states, you might have to rethink your decision based on rising mortgage rates and housing costs. In an analysis of the Tax Foundation's 2022 sales tax rates and the Council for Community and Economic Research's July 2022 Cost of Living Index, Bankrate concluded that Michigan was the most affordable state to live in. Tennessee, Missouri, Mississippi, and Kentucky rounded out the top five. Florida, meanwhile, ranked 17th.
Early Retirement
While it's always necessary to plan for the unexpected, this is especially true given the current market conditions. According to an EBRI survey, one-third of respondents cited health problems as a reason for early retirement. Others have to retire early to take care of family members and, in some cases, are forced into retirement by their employer.
Start planning and saving as soon as possible to mitigate the negative effects of early retirement. Otherwise, you might have to consider part-time work.