Retirement Planning: Turning Your Portfolio Into a Retirement Paycheck
May 12, 2022 Author: Tess Downing, MBA, CFP®, Complete View Financial
The Modern Retirement Survey, a recent survey of 1,500 seniors between ages 60 and 75 revealed that the rising cost of living and financial pressures have seniors more concerned than usual about their long-term financial futures.
Inflation has broken outside its normal range. Costs are higher than many retirees projected, and markets are particularly volatile.
For investors on the cusp of retirement, the shift from saver to spender may be more challenging than in years past.
Retirement is the inflection point where you go from income from work to income from investments. You were a determined saver and a riskier investor during your accumulation phase, and now you need to shift to being more cautious in your decumulation phase.
The beginning of retirement is when you create a retirement paycheck that will need to last through all the changes of the next several decades of your life.
The spending phase, or decumulation
While the saving phase had some unknowns (such as market ups and downs), the spending phase adds in a few more, as well as the complexity of not having a source of income to replenish funds if markets turn downward or you make a mistake. These can be summed up as:
- How long you will live,
- If inflation will increase enough to derail your plan, and
- How much health care you will have to pay for.
But that doesn’t lessen the value of planning. If anything, it magnifies it.
Spending patterns
Spending tends to follow specific patterns as you age. However, they won’t be simple extensions of your pre-retirement habits because your wants and needs will change with time.
Some people refer to the patterns as “Go-Go, Slow-Go and No-Go.”
Go-Go is right after retiring, when you may want to take advantage of your energy to travel, check off items on a lifelong bucket list or pursue hobbies you had put aside for decades. As a result, your spending will be high in these early years.
Slow-Go occurs in the mid-retirement years when you slow down and become more sedentary. All that Go-Go activity becomes less appealing or less possible. You’re happier staying home where you are comfortable and comforted, and that is reflected in your lower spending.
No-Go is when you start experiencing medical issues and may be exposed to ever-growing doctor and hospital bills. Spending rises once again and not necessarily at a rate you can control.
If you were to chart this activity, your spending starts high, slopes down as it declines until it bottoms out, then starts back up again with growing health costs. Some call it the “retirement spending smile.”
Matching income to expenditures
Your ultimate goal is to turn your savings and investments into income streams that will fund your retirement living. Once you have defined your financial needs stage by stage, you will want to divide expenditures into “essential” and “non-essential.”
- Essential expenditures are those you must pay. They typically include your daily expenses, taxes, financial commitments, insurances and health care costs.
- Non-essential expenditures include discretionary spending. They reflect your wants and are more lifestyle-driven, such as entertainment, travel, luxuries and gifts to children and grandchildren.
You don’t want to find yourself struggling to cover the basic living costs. One way to ensure that is to classify your income streams into “guaranteed” and “non-guaranteed.”
- Guaranteed income is structured for a defined period, including up to a lifetime. Sources can include Social Security, defined pension plans and other guaranteed private sources (certificates of deposit, bond portfolios and some annuities).
- Non-guaranteed income is affected by market pressures and is not guaranteed for any particular period. Sources can be 401(k)s and IRAs or assets such as real estate, stocks and other instruments.
To the extent possible, you want to cover at least all your essential expenditures with guaranteed income streams for the rest of your life. That will protect your basic living expenses from market and other fluctuations. Of course, should the market fluctuate, you can adjust some non-essential expenditures, but the essential ones will be guaranteed.
Revisiting tax implications
As you consider different assets to fund various expenditures, you will want to determine the tax payment a withdrawal might trigger.
But by working with a financial planner, you can plan to convert the most appropriate asset into cash on a timely basis and with the lowest possible tax implication.
Risk and retirement
Designing your “lifetime retirement paycheck” to meet each stage of activity calls for reviewing the level of risk carried by each asset in your portfolio. You will want to adjust the risk to your need for the asset to grow versus your appetite for risk as the years pass.
Risk assessment is one more puzzle piece needed to align assets with long-term financial needs.
Distribution strategies
Choosing the best retirement distribution strategy can provide a form of longevity insurance. In addition, strategies can be combined and changed as circumstances change, ideally during an annual review. And the input of a financial planner can prove invaluable during strategy selection. Here are a few of the possibilities:
The 4% Rule calls for withdrawing 4% of your nest egg the first year, then inflation-adjusted withdrawals of the balance each year after that. But the rule’s original calculation was designed to sustain a 30-year retirement. Today, we live longer, returns may not be as generous as the rule designer assumed, and an early-retirement withdrawal during a market dip could be challenging to overcome.
Fixed Dollar Withdrawals consider systematic withdrawals of the same amount each period (month, quarter or year). This strategy provides a reliable income, especially if coming from sources such as annuities and other guaranteed income. But if the income comes from market-driven assets, the strategy doesn’t consider the asset’s performance, and you could unintentionally consume principal.
Income-Limited Withdrawals are one way to protect principal if you limit withdrawals to the income generated by your investments. (You would take dividends and gains but leave the principal.) Unfortunately, this doesn’t work for smaller accounts. And while the strategy does protect the principal, annual income will only feel predictable if the account is large enough and the available proceeds are always greater than what you need.
Floor Withdrawals work when you have enough guaranteed income from Social Security, pensions and annuities to cover your basic needs. For example, the market offers various lifetime income products, such as longevity annuities that start paying after age 75 or older or annuities with inflation-adjusted income riders.
Money Buckets entail allocating different assets into different buckets. For example, Bucket #1 might have the cash and bond funds needed to cover the first three years. You won’t get appreciation, but you also won’t suffer losses. Bucket #2 may contain a mix of stocks and bond funds with moderate growth to cover years 3 through 10. And Bucket #3 could have longer-term funds that you invest more aggressively in growth funds. This strategy protects against withdrawing from market-driven accounts early in retirement if the market has plummeted, and it allows you to remain a long-term investor.
Lowest Mandatory Distributions plan for the best use of your 401(k)s and IRAs, particularly those with required minimum distributions or RMDs. Withdrawing RMDs from tax-advantaged accounts can affect tax brackets at tax time, but converting to Roths during low-income years will allow funds to grow and be withdrawn tax-free.
Account Sequencing finds the optimal order for withdrawing funds from different accounts. You are looking to minimize taxes while allowing money in long-term buckets to grow. You may draw from savings when it is inconvenient to access investment accounts.
Two factors determine when you withdraw from which investment account: (1) you must follow the investment’s withdrawal rules, and (2) you want to see how each withdrawal would affect your tax bracket.
Wrapping up
A well-designed plan can identify the right strategy for you that will provide tax-efficient withdrawals and a safe withdrawal rate. In addition, you can balance your risk and align income sources to types of expenditures – all geared to provide income for life, no matter how long you live.
If you don’t feel you have achieved this with your existing plan – or don’t have one at all – call Complete View Financial for your complete retirement analysis.