Retirement Planning: Distribution Timing and Pitfalls

April 04, 2022

Retirement Planning: Distribution Timing and Pitfalls

Those of us planning our retirement income strategies are aware of the ongoing financial challenges to a successful and fulfilling retirement:


We really cannot know how long we will live, but lifespans have increased and many individuals and couples are now preparing for a 25 to 30 year horizon.


Increased longevity means a greater need for reliable, secure, inflation adjusted income.


Because longer retirements require predictable income, designing risk adjusted portfolios to both provide income and preserve capital has become increasingly difficult given fiscal and monetary uncertainty.


While presently high, even a mild 2% inflation rate can, over the years of a normal retirement, significantly curtail buying power and may compel retirees to make uncomfortable adjustments to lifestyle.


Because for retirees, it's a question of how much money you keep rather than just what a portfolio earns, an efficient tax sensitive income plan is mandatory.

These are the widely recognized challenges to retirement planning that we all face however there is another often overlooked – i.e., the effect on portfolio longevity and income that the ORDER in which positive or negative returns may have.  Financial advisors define it as, “Sequence of Return Risk.”  

Let's look at this problem in two ways:

First, as we save for retirement during our, “accumulation phase,” the investor will experience years of unpredictable positive and negative returns. Over a period of years, this will produce an, “average rate of return.” In this case, the order of returns doesn't matter - whether good years come early or late, or negative ones late or early - the portfolio return is an average - it will always be the same over a fixed period.

Only when the investor planning their retirement, enters the, “distribution phase,” when he or she is now reliant upon yearly distributions to maintain a secure and healthy lifestyle, does, “sequence of return risk” potentially undermine the plan.  “Average” rates of return no longer apply!  When you are taking income, if a portfolio returns are negative in the early years and positive returns occur later on, there is a danger that the portfolio will not be able to sustain the required income distribution for the life of the retiree.  You could run out of money!

Check the attached illustrations which quantify this concept and give some real-life examples. The bottom line is when planning for predictable retirement distributions/income, never assume an, “average” rate of return!

The order in which you may encounter positive investment returns and negative investment returns - known as the, “sequence of returns” - poses a retirement risk that you may want to consider.

During the ACCUMULATION YEARS, when income is not being withdrawn, the sequence of return has no impact on ending values it's the average return that matters.    

For example, if an investor earned an average return of 4.5% over an accumulation period of 10 years, it makes no difference whether strong returns - or negative returns - are encountered early on. The ending values are the same.


During the DISTRIBUTION YEARS, once withdrawals begin, the sequence of returns can have a long-lasting impact on one's ability to draw income down the road.                                                                                                     

In the example below, the average return over 10 years for both investors is 4.5%. However, when $5,000 is withdrawn each year, the investor who experienced negative returns early was left with five thousand $50,310 after 10 years.  That’s $44,088 or 47% less than the investor who encountered strong returns early on.