Retirement Income Planning ... 5 Principles to Keep you from Running out of Money
Photo by Cory Weaver from Bellbrook, OH
30 years ago, planning for retirement wasn’t too complicated. That generation of Americans had pensions and social security guaranteeing their monthly spending needs. On top of that, retirement was shorter as the average person did not live as long into retirement. Today’s retirees may live longer than 30 years in retirement and generally have no pension plan, which leaves many of them perplexed on how to manage their own retirement.
We have two tongue in cheek rules for retirement planning...
- 1. Don’t run out of money
- 2. Don’t forget about rule number 1
All joking aside, in a perfect world everyone would have a pension, social security, and dividends/interest that met their standard of living. This would protect their principal, making retirement very secure. Most people will need to invade principal to meet retirement income goals and keep up with inflation. More fortunate families may also find value in using principal while alive, allowing them to experience more of life on their terms. This could be a lifestyle, helping with grandchildren’s education, or redirecting money the government would tax towards a charity of their choice. In either situation, the principles below will help ensure that our clients don’t outlive their money or leave this world never having lived, leaving money behind because of the fear of the former.
5 Principles to Manage the Best Retirement Outcome
1. 2 years of annual spending need in cash. This is the need beyond what Social Security and other income streams provide. Keep 2 years of that spending in cash.
2. A properly allocated portfolio will keep 6-8 years of the spending need in bonds and is allocated with a preference for smooth and predicable – rather than chasing the highest possible return.
-a typical retirement portfolio (for someone drawing 4%) with have 60% diversified stocks, 32% diversified bonds, 8% cash
3. Never sell equities in a down market. This is made possible by principles 1 and 2 above. “Never” is a strong word and there are many wise exceptions like rebalancing, tax loss harvesting, or repositioning within equities.
4. Disciplined spending. If average spending rate is higher than 4% (for a 30 year retirement), considering buying a “pension”. Today’s retiree can buy their own pension, normally called an annuity. Even today’s academics have become comfortable with modern low cost annuities as a hedge to avoid running out of money. Another strategy is a dynamic withdrawal strategy that adjust spending withdrawals in the future if market conditions are poor.
5. Taxes matter and should be managed. The following strategies can significantly minimize the bite taxes take of your retirement:
• Bracket Maximization – wisely using the tax brackets each year when deciding which account to withdraw from. Every dollar is not equal once taxes become involved.
• Tax Loss Harvesting – We’ve written about this strategy before, so perhaps a metaphor for this issue. When the battery in our smoke detectors get low, we replace them. Each asset class that has declined in value is like that dead battery. By changing them out, you still maintain the overall protection that asset class was giving you, and by taking the loss, it can offset gains. We’re still looking for a benefit for those dead smoke-detector batteries however.
• Asset Location – Instead of holding the same portfolio across all account types, we can look at where an investment’s return is likely to come from. Investment return can come from income (dividends and interest) or from appreciation in value. Matching the likely return type to the appropriate account type (taxable, retirement, etc.) can help lower the taxes paid.
• Cross Billing – During our working years, the average person simply pays investment management fees from the account in which they are incurred. But during retirement, it is likely that AGI falls to a level where it makes sense to have those fees for IRA accounts be paid from taxable accounts.
• Opportunistic ROTH Conversions – Conversions can be especially effective at helping to avoid large Required Minimum Distributions from the Traditional IRA. Converting any portion of a Traditional IRA to a ROTH is a taxable event. So converting during a market correction, when the market is down, means less taxes paid.