Recession In Retirement

Recessions have been compared to forest fires . . . small ones are healthy for the forest, as they get rid of dead wood and convert it to fertilizer. Larger fires can erupt with more devastating and long-lasting effects.

The U.S. National Bureau of Economic Research (NBER) defines a recession as "a significant decline in economic activity that is spread across the economy and that lasts more than a few months." Since the 1850s, only the 2010s decade has progressed without at least one recession - so Americans who are retiring now may have experienced six recessions within their four-decade working lives, and are likely to endure additional recessions in retirement.¹

Americans in their 20’s and 30’s who are still in the accumulation phase of their working lives still have time on their side, so weathering a recession is primarily a function of maintaining a 3 to 6 month emergency savings cushion, minimizing debt, and continuing to save and invest for retirement if they are able to maintain an income during these inevitable downturns in our economy. At the so called peak of their earning years, Americans in their 40’s and 50’s may have accumulated a lot more financial commitments - caring for children, caring for parents, maintaining a mortgage, saving for college as well as retirement. The accumulation of debt and obligations can severely compromise these individuals, especially those who have not maintained their 6 month emergency fund or who have not been diligently pruning their unnecessary expenses during the times of plenty.²

Emergency cash reserves become increasingly more important as we age, and particularly during the "fragile decade" that lies five years before and after someone’s retirement. Some experts advise setting aside as much as 4 years’ worth of emergency living expenses to help navigate this time period. ³

It can be harder to make up for any portfolio market losses in the fragile decade.

Hitting a recession within 5 years of retirement can make it harder to recover from market losses. Near-retirees simply don’t have as much time to recover as their younger contemporaries. Retirement funds may be depleted faster than expected when savings are tapped without adequate market growth to offset some or all of the withdrawals. This can expose the recently retired to sequence of returns risk, when significant enough losses occur that a portfolio cannot recover and continues to shrink. The volatility and potential loss of portfolio value can motivate those near retirement to delay their retirement plans when recession looms. They can then continue to contribute to retirement accounts, build up savings, and delay withdrawals.⁴

Tapping into retirement savings during a downturn essentially means taking out money without putting any back in. This type of retirement-timing risk is commonly referred to as a sequence of returns risk. Some people may choose to postpone retirement during a recesssion, so they can continue to contribute to retirement accounts, build up savings, and delay withdrawls.² With enough time, retirement accounts can recover if they have not been tapped. A T. Rowe Price survey of American retirement portfolio performance after retiring into bear markets in 1973, 2000 and 2008, found that portfolio values eventually rebounded or exceeded their original value around 10 years later. ⁵

Recessions can sometimes force older workers to retire earlier than they planned, as companies slash their workforce to help cut costs.

Forced retirement, before employees are adequately prepared, can put a lot of strain on retirement plans. While some companies may offer early retirement packages to senior employees, they should fully understand the potential benefits and drawbacks before accepting an offer. Those who do accept an offer may still need to tap into their emergency fund to make the transition into retirement. A person with an adequate emergency fund will have more options in this situation.³

Many strategies exist for maximizing retirement during a recession.

Retirees with adequate emergency funds, low debt, and income that exceeds their expenses are ideally situated, but with flexibility and willingness to adapt to the new circumstances, new retirees can survive and even thrive during the challenge of a recession. One primary focus for this timeframe is on INCOME.

As pensions from employers have all but gone extinct, an ideal situation may be to collect royalties or rent as a passive stream of income for retirement. A part-time job can also provide an income stream to reduce retirement account withdrawals, allowing the balance to recover from a market correction.

Being able to tap savings or a regular income stream can help new retirees postpone collecting Social Security for a few years. This will increase their benefits later on and help to insulate them from future downturns in the market. However, according to the Center on Budget and Policy Priorities, the Social Security benefit for a person with average lifetime earnings only amounts to 37% of their pre-retirement income. This means that individuals need to look beyond Social Security payments to adequately fund their retirement needs.⁵

As savings and investments are withdrawn through retirement, they will not be replenished. The risk of outliving one’s savings becomes even more concerning as portfolio values decline due to recessionary market forces. An annuity can help to create a steady stream of income, and some retirement funds can be transferred to purchase an annuity. With lifetime guaranteed income riders, these types of income streams become even more attractive.⁴

Citations.

1 - https://www.nber.org/research/business-cycle-dating

2 - https://www.forbes.com/advisor/retirement/recession-retirement-planning/

3 - https://www.kiplinger.com/article/retirement/t047-c000-s004-retirees-need-emergency-funds-too.html

4 - https://www.marcus.com/us/en/resources/retirement/retiring-during-a-recession

5 - https://www.cnbc.com/select/retiring-into-a-recession-what-you-need-to-know/