Market Plunge During Early Years of Retirement Can Cause Portfolio Death Spiral

Withdrawing money from a falling portfolio can be deadly for retirees. To guard against that, you might want to consider the guaranteed payments that annuities offer.

A skydiver takes a dangerous plunge.
(Image credit: Getty Images)

If you’re a retiree with an equity-heavy portfolio and have to make a withdrawal in a bear market during the early years of your retirement, you can dig such a hole that your savings will never recover.

Consider a retired couple with a $1 million portfolio. During their first year of retirement, the market drops 26% and they also make a $40,000 withdrawal, or 4% of their original principal, at the end of the year. Now their portfolio is down to $700,000. In year two, the market is up 4%, but because their second $40,000 withdrawal is at the end of the year, their portfolio will shrink to $688,000.

Unless there’s a big multi-year market rally soon — or they cut way back on their lifestyle by reducing their annual withdrawals — the portfolio could enter a death spiral. Even several years of good returns might not stem the decline, and eventually it can vanish.

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Could Bad Luck Hurt Your Retirement?

Having to make early withdrawals during market downturns can decimate a portfolio. In contrast, if an investor enjoys strong returns during the early years, his or her portfolio will continue to grow despite withdrawals. It can withstand bear markets later on.

It’s just a matter of luck if a down market strikes early or late in your retirement. But you can’t rely on luck.

What’s the answer? Completely avoiding equities isn’t a good choice for most retirees, because that would preclude growth. Achieving the right balance between volatile equities and stable investments is a calculation that’s different for every retiree. The challenge is to get the best combination of yield and liquidity from the guaranteed portion of your retirement savings.

Having some cash is OK, but a large allocation isn’t wise. Yields on money market and savings accounts are running well behind the rate of inflation, even before taxes. Certificates of deposit pay more but are largely illiquid, and yields aren’t impressive these days, either.

Luckily, Annuities Can Take Luck Out of the Equation

If you are worried you may retire into a down market, guaranteed annuities offer a good solution for a portion of your retirement money. Several types can be deployed to meet virtually any retiree’s needs.

Various types of fixed annuities all guarantee your principal. But their characteristics are quite different.

Immediate income annuities

A retiree can choose an immediate annuity, which produces an immediate stream of income for either a set number of years or a lifetime. The monthly payments provide a cushion so that the owner won’t have to sell equities to raise cash in a down market. Meanwhile, the money remaining in the annuity is earning a much higher internal rate of return than cash equivalents.

Deferred fixed-rate annuities

Retirees can also invest in deferred fixed-rate annuities, which act much like a CD by providing a (usually higher) set rate of interest for a set period, plus tax deferral and some liquidity. These annuities often permit the owner to withdraw up to 10% annually without penalty. The accumulated interest portion of amounts withdrawn, however, is usually fully taxable.

Fixed-indexed annuities

Another good option is the fixed-indexed annuity, which is immune to stock-market downturns while offering a share of the gains when the market goes up. It gives you an opportunity to earn more interest than you can get from a fixed-rate annuity or a bank CD. You can shelter some of your money from market risk without locking in a lower interest rate.

Fixed indexed annuities, however, are less liquid than other investment alternatives, so it wouldn’t be a wise choice to put all of your retirement money into them. But they do help buffer a portfolio from severe ups and downs while offering potentially higher earnings than fixed-rate annuities over the long run. Many also offer lifetime income riders that can further reduce income uncertainty during retirement.

And the surrender terms of fixed-rate and fixed-indexed annuities can be laddered so that at least one is maturing each year and can be tapped if needed.

The Bottom Line

The stock market has been on a big upsurge for the last year. It’s natural to think the good times will keep rolling forever. But sooner or later they won’t. Maybe an uptick in inflation or a rise in historically low interest rates or an unforeseen crisis will cause stocks to tumble. To prevent the possibility that your retirement portfolio could enter a fatal tailspin, consider adding vehicles that are immune from stock-market downturns. Income annuities, fixed-rate annuities and fixed-indexed annuities can all be good choices.

How much should you allocate to annuities? It’s an individual calculation that must take into account all your savings, sources of income and risk tolerance.

A free quote comparison service with interest rates from dozens of insurers is available at (opens in new tab) or by calling (800) 239-0356.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Ken Nuss
CEO / Founder, AnnuityAdvantage

Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. Interest rates from dozens of insurers are constantly updated on its website. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. More information is available from the Medford, Oregon, based company at (opens in new tab) or (800) 239-0356.