Contributed by: Nick Defenthaler, CFP®, RICP®
In a prior article, I focused on the popular 4% rule and discussed safe portfolio distribution rates over the course of retirement. While the percentage you are drawing from your portfolio is undoubtedly very important, other factors should also be taken into consideration to ensure the income you need from your portfolio lasts a lifetime.
Asset Allocation
It's common for retirees to believe their portfolio should become extremely conservative when they're in retirement. But believe it or not, having too little stock exposure has proven to do MORE harm than holding too much stock. While having a 90-100% stock allocation is likely not prudent for most retirees, maintaining at least 50-60% in equities is typically recommended to ensure your portfolio is outpacing inflation over time.
Reducing Your Withdrawal Rate
Spending less during market downturns is one of the best ways to preserve your portfolio's long-term value. When I think of this concept, I always go back to March 2020. When the global pandemic hit, the U.S. stock market fell 35% in only two weeks, resulting in the quickest bear market in history.
Due to the COVID-19-induced recession we were living through, we were all forced to dramatically reduce activities such as travel, entertainment, and dining out. This reduced spending for many, which helped tremendously while portfolio values recovered. This highlights the importance of reducing fixed expenses (e.g., mortgage, car payments, etc.) over time to provide flexibility. In years when markets are down significantly, having the ability to reduce variable expenses will prove to be an advantage.
Impact of Fixed Income Sources
Often, we recommend delaying Social Security into your mid-to-late 60s to take advantage of the over 7% permanent annual increase in benefits. It's also fairly common to have pension and annuity income start around the same time as Social Security, which could mean several years of drawing on your portfolio for your entire income need. In many cases, this means a significantly higher portfolio withdrawal rate for several years.
To plan for this short-term scenario with elevated distributions, you might consider holding at least several years' worth of cash needs in highly conservative investments (i.e., cash, money market funds, CDs, short-term treasuries, and bonds). Doing so helps reduce the likelihood of being forced to sell stocks while down considerably in a bear market, something we want to avoid at all costs — especially in the first several years of retirement (also referred to as a sequence of return risk).
Intentional Withdrawal/Distribution Strategy
Being highly intentional about what accounts you draw from and when you draw from them throughout retirement could be a game changer for your long-term financial plan. Chances are, our tax code will change several times throughout your 25+ year retirement. When it does, it's imperative to work with an adviser who understands how these changes could impact your situation and help you plan accordingly.
In some years, drawing from IRAs and 401(k)s and less from after-tax brokerage accounts will make more sense. Then, in other years, it will be the exact opposite. Prudent spend-down strategies, implementing Roth IRA conversions when tax rates are low, and strategically realizing capital gains at preferential tax rates have been shown to increase the "lifespan" of an investment portfolio by 2-3 years.
Part-time Income
Let's be honest – most of us don't want to think about work after retirement. That said, I'm seeing more and more retirees take the "retire from working full-time" approach for several years. In these cases, someone might work 15-30 hours per week at a job they enjoy (or can at least tolerate). This helps reduce distributions from their portfolio during a time when the sequence of return risk is at its peak. I find that most folks dramatically underestimate how valuable even earning $15,000 annually for 2-3 years can be in the long-term sustainability of their overall financial plan.
While working part-time in retirement certainly has its financial benefits, I've also seen it help with the emotional/lifestyle transition to retirement. Going from working full-time for 40+ years to a hard stop can prove challenging for many. Phasing into retirement through part-time work can be an excellent way to ease into this exciting next chapter of your life.
If you're within five years of retirement, I would encourage you to discuss these concepts and ideas with your adviser. Having these conversations early is advisable to ensure a well-thought-out plan is in place to help with your retirement transition.
Nick Defenthaler, CFP®, RICP®, is a Partner and CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® Nick specializes in tax-efficient retirement income and distribution planning for clients and serves as a trusted source for local and national media publications, including WXYZ, PBS, CNBC, MSN Money, Financial Planning Magazine and OnWallStreet.com.
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The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Nick Defenthaler, CFP®, RICP® and not necessarily those of Raymond James. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
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