In a previous blog, I’ve written about how pensions and social security are becoming less reliable as sources of retirement income.
More than ever, personal savings and investments—plays the central role in retirement planning. People are expected to be in charge of investing for their own future and creating the income they will need for the rest of their days.
That income will need to grow over time to cover the increasing cost of living. Eventually, retirees will find themselves spending less, which will cover part of the damage that inflation inflicts. As the years go on, people tend to travel less, buy fewer new clothes and furniture, and have fewer other discretionary expenses. Generally, retiree spending tends to be highest in the age range of 60 to 75. It’s not always the case—I have a client in his 90s who just completed an around-the-world cruise. That, however, is the exception to the rule. Discretionary spending tends to decline until the point when expensive long-term care may be needed.
The design of an income plan for retirement involves the interplay of assets with three primary characteristics: liquidity, safety, and growth. You need a certain amount of accessible, liquid money; you need to grow assets to cover inflation; and you need some degree of safety so that you will not worry about where you will get the money to pay monthly expenses.
A major consideration of income planning is to balance the sources for tax efficiency. Some people consider income planning to be as simple as turning 62, switching on Social Security and perhaps a pension, and away we go.
In reality, through proper planning you have a window between 60 and 70 where you can minimize taxes if you draw assets from the right pockets while possibly doing Roth conversions for tax savings even further down the road.
In your working years, you may have put a lot of thought into the value of deferring taxes until retirement. Now, in retirement, you still want to think about deferring taxes but also need to look at what tax bracket you will be in when you turn 70 and-a-half. Most of our clients will be in the 25 percent tax bracket at that point. As a result, we want to use up the 15 percent bracket in the early retirement years to move assets to Roth IRAs that we can later take out tax-free.
Not surprisingly, when needed, individuals who live conservatively are often more successful at reducing their spending than others. Spenders perceive many expenses as a need. They feel that they must spend and do not easily see opportunities to cut back. Spenders often have fixed obligations that savers avoid, like mortgage payments in retirement. Savers, in contrast, need to be encouraged to live a little and to spend their money. The mind-set is very different. We seldom run into retirement cash issues with savers. With spenders, it may be just a matter of time before they start to deplete cash. If you are a spender, you need to either accumulate a great deal of wealth or work on becoming more of a saver to avoid money issues in retirement.
Whether you are a saver or a spender, bonds serve two important primary functions in portfolios:
- A counterweight to stocks that historically have gone up when the market goes down
- An income generator to help provide retirement income
Ultimately, a strong income strategy requires investors to balance taking risks to generate more income with keeping bonds as a stabilizing factor in the portfolio. High-yield bonds, MLPs (master limited partnerships), and floating-rate bonds have all shown a tendency to act more like equities in periods of market stress. As a result, these higher-income investments are only appropriate for a smaller slice of an income portfolio.
For more about creating a lifelong plan, check out my book, The Power of Persistent Planning: A Review of Successful Financial Planning Strategies, here.
All opinions are those of Douglas Gross and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.
Diversification and asset allocation do not ensure a profit or protect against a loss. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. 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.