Our last article explained the principles of constructing a sensible investment plan during your working years to help you accumulate a retirement nest egg. Once you retire you face the challenge of converting that nest egg into a source of annual income that will last for as long as you live. While many of the same principles apply, investing during retirement is more complicated than investing for retirement because you are taking withdrawals from your accounts. The bottom line: your new circumstances will probably require some adjustments to your plan. This article highlights the issues that need to be addressed in constructing and managing your retirement portfolio. We will discuss each of them in greater depth in the next few articles.
Withdrawal method and withdrawal amount- The decision of how and how much to withdraw from your assets each year to meet your spending needs without exhausting your portfolio prematurely is one of the most important you will make. It will have a major impact on the success of your retirement plan. There are two basic approaches, the “Dollar Amount Plus Inflation” method, and the “Percent of Portfolio” method. Each has its own advantages and disadvantages.
Goals for the portfolio- During your accumulation years, the investment goal has primarily been long-term growth. In retirement however, instead of accumulating assets, you’ll be spending them. For most people, that means balancing the need for current income with long-term growth to provide some protection against the corrosive effects of inflation and to enable them to meet future spending requirements. While inflation is a major threat retirees face, another risk is beginning your retirement during a severe or prolonged “bear” market because it can cause serious damage to an investment plan. Therefore, one of the most important goals for a “distribution” portfolio is to provide protection against severe market downturns, especially during the early years of retirement.
Portfolio spending plan- Investors typically employ one of two approaches. The first is called the “Income Only” approach where the retiree typically spends only the interest, dividends, and capital gains distributions generated by the portfolio. The second method is called the “Total Return” approach where the investor spends the portfolio’s income first and then taps the principal if it becomes necessary to do so.
Order of withdrawals consistent with your goals- For most retirees who have taxable accounts, tax-deferred accounts, and tax-free accounts, it is important to determine the proper sequence of withdrawals to improve the portfolio’s tax efficiency and longevity. The general rule is to first withdraw from taxable accounts, then from tax-deferred accounts, and finally from tax-free accounts. The rationale behind this is that you want to allow tax-advantaged accounts to grow for as long as possible. However, this is not a hard and fast rule and there are several reasons why a retiree may choose to deviate from this sequence. These reasons are specific to an individual’s personal and financial circumstances, including their estate planning goals and current versus future tax rate assumptions.
Pulling it all together- Once you have addressed these important issues, the next step will be to incorporate them into an effective and workable investment and distribution plan that gives you the best chance of achieving your goal of a secure retirement.
This article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.