By Mike Berry, CFP®
You’ve worked hard all your life and accumulated savings and investments so you could retire, and now that day is nearing. There are lots of questions, but the biggest one is likely, “how do I draw income to live on from my retirement accounts and other investments?”

Because you have to deal with so many variables and uncertainties, distribution planning can be a complex issue. A few questions that routinely come up are:

  • How much money will I need each month?
  • Will what I have last? How do I plan when I don’t know how long I’ll live?
  • How do I handle large expenditures such as car purchases?
  • What will my income tax situation be like?
  • How conservative do I get with my investments?

Like financial planning in general, distribution planning is an ongoing process that must be continually monitored and occasionally adjusted. This article is designed to give you some basic information to distribution planning and provide you with issues and questions that you can discuss with your financial advisor.

Spending in Retirement

A common rule of thumb is that during retirement you should plan on spending about 75% of your pre-retirement wages. That’s probably a good starting point to estimate how much you will need. However, everyone is different.
Generally, people tend to spend more in their early retirement years because they are still active. Travel and other recreational activities play a more important role during this time. Then in mid retirement, that spending seems to go down some as “home” becomes more comfortable. Travel and recreation take up less and less of the annual expenses. Finally, in the later stages of retirement, we see spending increase, most often due to medical expenses. We also see people wanting to gift to family members at this stage of life which increases annual outflows.

We see that spending in retirement is not a linear function where you increase your income each year by some inflation rate, but rather a series of fluctuations.

A good exercise for retirement spending is to estimate what your retirement income will be (approximately 75% of your current income) and then while you are still working, live on that income for about six months and see how it feels.

Investing in Retirement

During the last 30 or 40 years, while you have been in your accumulation phase, you have been investing for “growth”. You’ve assumed some level of risk so that your principal would grow and you would have sufficient assets for retirement. Now, as you near retirement, your investing persona will have to alter to one that looks for “income and growth”.
Income is important during retirement, because you will be taking money out of your investments each month, and since you’re not working anymore, you won’t be putting any money back in. Therefore, you want investments that pay consistent dividends and capital gains so you can replenish a portion of the money you are taking out. Growth is still important however, because your life expectancy is increasing. That means your nest egg needs to last longer, so especially in early retirement, we need to get some growth of principal.
Managing risk during retirement is also critical. The best way to manage risk is through diversification*. You don’t want to leave your nest egg all in one basket. Other investments such as real estate; commodities, timberland, etc will reduce the risk of your portfolio and many times can enhance the yield.
A portfolio that can average a return that is 3% to 4% above the inflation rate will likely meet both your income and longevity needs.

Taxes in Retirement

Taxes are certainly an area of unpredictability. Legislators are continually tinkering with the tax code, which means over a 30 year retirement period, there are likely to be some changes.
Hopefully, your financial advisor has helped you build not only your pre-tax retirement fund but also an after tax pool of investments. The after tax pool of investments can be a very important piece of your retirement income. The money you take out of this pool is only subject to tax on the earnings or capital gains; anything attributed to principal has already had taxes paid. Under current law, the capital gains tax rate is 15%. Now compare that to how the money coming out of your pre-tax retirement accounts is taxed. Every dollar, whether it is principal or earnings, is subject to tax at ordinary income tax rates. If you are in a high tax bracket, you could be paying 28% to 31% in taxes on every dollar you take out of your pre-tax retirement money.
Minimizing taxes is important in retirement because it translates to more money in your pocket. Depleting after tax investments first and then tapping into your pre-tax retirement dollars is a good strategy to employ.
*Diversification and asset allocation strategies do not assure profit or protect against loss.

Frequently Asked Questions

When do I start my “distribution planning”?
Two to three years away from retirement is an excellent time to sit down with your advisor and make them aware of your plans. It will give your advisor plenty of time to convert your portfolio from the “growth and accumulation” style to the “income and growth” style.
What do I do with my various retirement plans?
The answer to that question really depends on the individual and their needs.
Can I determine what day I get my income on?
The answer here is generally, yes. Some places will only process distributions on certain days, but they have several days each month, so you can likely get close to the day you want.
How frequently can I receive retirement income?
Monthly, quarterly, semi-annually, annually, or whenever you need it.
Mike Berry is a Registered Representative offering securities through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge does not offer tax advice.
Copyright ©2010 Mike Berry. All Rights reserved. Commercial copying, duplication or reproduction is prohibited.