Sequence risk is the worst returns happening at the worst time when you need to sell some investments to provide pension payments. If you had no withdrawals (or additions) then you would get the same end value no matter what the sequence of returns in that period were. One can avoid having to realise investments at depressed prices if you have cash in a CMT. However, the catch is the return on a CMT will (on average) be lower than (say) from equities. So how much is just the right amount of liquidity?

It will be a different answer for every different situation. Let’s consider Anne and Bruce who retired a year ago and are very busy going out to breakfast, looking after the grandkids and escaping on holidays. Currently, they have $740,000 in assets being $31,000 in a CMT and the rest in equities. Both are eligible for the Centrelink Age Pension. They have based their retirement income planning duration on a 70% adequacy basis i.e. 17 years for both of them being alive and another 10 years during which there is a survivor. For the sake of brevity, we will not consider here other measures they are taking to control longevity risk.

They have used the NetActuary sustainable income calculator to work out that $71,943 p.a. plus 2.5% increase can be paid. Of this, $14,502 initially comes from the Age Pension, but as assets run down it increases with the passage of time. At 7% p.a. earnings, the $740,000 they have initially will have decreased to $626,949 after 10 years.

Now we have the facts on which a liability investment strategy can be determined. The table below shows the probability of having this amount left from a portfolio of equities and a TCorp Waratah fixed term indexed annuity.

Percentage |
TCorp $0 |
TCorp $100k |
TCorp $200k |
TCorp $300k |

10% | 1,572,304 | 1,445,435 | 1,208,086 | 970,736 |

20% | 1,353,736 | 1,362,713 | 1,071,916 | 915,181 |

30% | 1,138,911 | 1,178,153 | 971,858 | 791,233 |

40% | 1,021,701 | 1,138,845 | 879,438 | 764,834 |

50% | 982,592 | 1,027,694 | 855,346 | 690,186 |

60% | 805,853 | 906,505 | 728,175 | 608,797 |

70% | 603,331 | 791,216 | 596,932 | 531,371 |

80% | 520,976 | 693,963 | 426,155 | 444,681 |

90% | 46,850 | 437,955 | 270,825 | 256,968 |

Above $626,949 | 69% |
83% |
68% |
58% |

This outcome is at first sight a little surprising. One may have to expect that one would buy enough annuity for the structured payments to cover the cashflow difference between private pension amount and dividends received. In fact, it is lower. We need to take into account that the equity return is higher.

This is not dissimilar to a TTR strategy. Initially, you might think the optimum point is a 10% drawdown. In fact, often it is lower. This de-risking strategy is very worthwhile.

I feel sorry for retirees who don’t have access to these calculations. Give Brian a call on (03) 6223 2320 if you would like more details.

**The NetActuary Team**

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