You Don’t Need An Investment Strategy in Retirement: You Need An Income StrategySubmitted by Reby Advisors | Certified Financial Planners | Danbury, CT on May 31st, 2019
By Devone, McLeod, CFP®, May 31, 2019
In my last article, I wrote about The Wealth Accumulation Phase of retirement planning. I discussed the importance of systematic saving and tax planning, and how developing the right temperament, remaining disciplined, and being persistent in your quest to build wealth throughout your working career is absolutely critical to ensure that you really do retire a millionaire.
In order explain the next phase of retirement, The Distribution Phase, we’ll bring our old friend James back into the picture to illustrate how Distribution Phase strategies work – how you can make your money last through retirement even as you use your savings to pay for your lifestyle.
Retirees Need Predictable Streams of Income
No matter which way you choose to look at it, retirement is always going to be about creating income to live your lifestyle. You need to replace the steady paycheck you received during your working career with income from your assets.
Let’s take a look at James’ situation:
Forty years after his first paycheck, James finally retires! If he withdraws all of the money from his retirement account on that first day of retirement, going back to that $1.597 million figure that we mentioned in my last article, James would owe approximately $743,000 in Federal and State taxes (New Jersey).
“Wow,” would be an understatement.
So, why does this happen?
Because James’s 401k or IRA assets have never been taxed, that money counts as ordinary taxable income. He saved it pre-tax, and it grew without tax consequences. However, when it’s time to finally use that money as income, the distributions get taxed the same way that his W2 wages get taxed.
So, by withdrawing all of those funds at once, he’s announcing to the government that he just earned nearly $1.6 million! This would fling him into the highest tax bracket in no time at all and cause him to lose almost 50% of his assets in his first year of retirement.
Of course, James shouldn’t do that!
He should only withdraw what he needs to live his lifestyle. Just as he never received a massive lump sum of money during his working career – he lived off predictable paychecks received at predictable intervals of time – in retirement he’ll be using his assets to create an income stream to support his lifestyle.
In order to remain financially independent through retirement, he needs that income to be just as predictable as it was when he worked for a living.
“You Can Be Young Without Money, But You Can’t Be Old Without It.”
This quote by Tennessee Williams hits the nail when it comes to the The Distribution Phase of your financial life. Because if you ever run out of money, you lose the ability to generate income and all you’re likely left with is Social Security or the prospect of returning to work.
How can James find the right balance between generating enough income to support his lifestyle and never running out?
Here are a few key principles:
4 Rules for the Distribution Phase
- Build an investment portfolio designed to continue to grow even as you take income from it. Otherwise, you’ll either slowly outlive your money or lose your ability to pay for your lifestyle due to rising prices and taxes.
- Know your “speed limit” and stick with it. Your speed limit is the amount of money you can withdraw from your portfolio each year without being at risk to run out. Being hyper-mindful of your spending is going to ensure that your funds last.
- Have a strategy to address sequence of returns risk, the danger that the market crashes within the first few years of your retirement. Hedge against the risk by having enough money in cash or low-risk investments so that you won’t have to sell your stocks at a loss just to live your lifestyle.
- Have discipline. Just as systematic savings is what helped James become a millionaire in the first place, his ability to stick with his investment strategy and spending budget is what will help him remain a millionaire through retirement.
If James can follow these rules, he will be in a much better position to generate the income required to enjoy his retirement. If not, all of his hard work and savings during The Accumulation Phase may be squandered.
The Road Map to Retirement Success
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