A New Approach to Evaluating Plan Wellness
When optimizing their participants’ retirement outcomes, most sponsors wish to do so in a cost-effective way.
A significant market decline near retirement could have a negative effect on your retirement.
The riskiest financial time for a working individual is the first day of their retirement, as their balances are typically biggest, they begin to withdraw money and are no longer contributing to retirement savings. Should there be a significant market decline during this time that caused their retirement savings to lose value, they may be forced to make a difficult decision between three possible outcomes to make sure that their savings can last them in retirement. These three potential outcomes may have potential negative effects for individuals and, in the event they decide to postpone retirement, for employers as well.
Three Possible Outcomes if Your Nest Egg Takes a Hit
Let’s consider, for example, a retirement plan participant set to retire with a balance of $300,000. He may expect to receive $1,800 per month ($21,600 annually) throughout retirement, which would stretch his savings over 30-years1. Should a 16.3% drawdown occur (the average annual max drawdown of the S&P 5002), that balance would decline to $251,100, presenting the individual with these three options to choose from:
- Maintain Lifestyle, but Risk Running Out of Money Early
One possible outcome that our participant could choose would be to maintain the lifestyle he was expecting when his beginning balance was higher, by taking a $1,800 monthly income. If he decided to take this approach, his $251,100 savings would run out early, 20 years into retirement.
| Pre-Decline | After Decline | Difference | |
|---|---|---|---|
| Balance | $300,000 | $251,100 | ($48,900) |
| Monthly Income | $1,800 | $1,800 | Data not available |
| Annual Income | $21,600 | $21,600 | Data not available |
| Years of Income | 30 years | 20 years | -10 years |
| Total Income | $648,000 | $419,400 | ($228,600) |
2. Live on Less
Another possible outcome is to reduce his lifestyle in retirement to ensure that his savings will last. By taking $300 less in monthly income, totaling $1,500 per month, he would be able to make his savings last 30 years in retirement without running out of money early.
| Pre-Decline | After Decline | Difference | |
|---|---|---|---|
| Balance | $300,000 | $251,100 | ($48,900) |
| Monthly Income | $1,800 | $1,500 | ($300) |
| Annual Income | $21,600 | $18,000 | ($3,600) |
| Years of Income | 30 years | 30 years | Data not available |
| Total Income | $648,000 | $540,400 | ($108,000) |
3. Work Longer
A third option that he has is to continue working beyond his expected retirement age so he can continue to save money for retirement and build his nest egg for a few more years. Not only is this undesirable for the individual, who was not expecting to have to continue working, but it also comes at a cost to his employer. It could cost an employer an additional $50,000 per year3 should just one employee delay retirement by one year.
Help Insulate Your Nest Egg from Significant Market Declines
While you may not be able to predict when market declines will happen, one of the best ways to protect wealth as retirement draws closer is to begin to “de-risk” your portfolio, shifting it towards less volatile investments like bonds, and away from stocks. By decreasing your exposure to the market's ups and downs as you approach retirement, you may help to lessen the impact on your retirement savings. You may also want to consider an investment designed to automatically make these de-risking changes for you as you approach retirement, like a target date fund.
Read Dial-Down the Risk to learn how reducing equity exposure and allocating more to fixed income as retirement approaches can potentially result in better outcomes.
1Assuming 6% annual return for 30 years after retirement.
2Source: Bloomberg as of 12/31/2017. Calculated by PGIM Investments based on the annual calendar year max drawdowns of the S&P 500 Index from 1928 through 2017.
3Source: “Why Employers Should Care About the Cost of Delayed Retirements,” Prudential Financial 2017. Represents the cost differential between the retiring employee and a newly hired employee.
Risk: A target date fund should not be selected based solely on age or retirement date, is not a guaranteed investment, and the stated asset allocation may be subject to change. As with all investments, there are a number of factors and risks to consider in selecting a target date fund. In addition to anticipated retirement date, relevant factors for Fund selection may include age, risk tolerance, other investments owned, and planned withdrawals. In addition, participants should carefully consider the investment objectives, risks, charges, and expenses of any Fund before investing. It is possible to lose money in a Fund—including near or following retirement—and there is no guarantee that the Funds will provide adequate retirement income. Investments in the Funds are not deposits or obligations of any bank and are not insured or guaranteed by any governmental agency or instrumentality.
The S&P 500 Index is an unmanaged market capitalization-weighted index of 500 stocks of large U.S. companies.
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