Financial planning can generally be broken down into two phases: accumulation and decumulation.
There is ample consumer information about accumulating assets (for retirement, higher education, a home etc.) but, while there is a lot of research for financial planners on helping clients in the decumulation phase, there doesn’t seem to be much for consumers—aside from the “4% rule,” which has never applied to everyone (especially not for those with small retirement nest eggs) and has been disproven in numerous studies.
There isn’t a formula that is applicable to everyone because there are so many variables, but here are the things I consider when developing a retirement income strategy for my clients:
Income need – This is the starting place. I know how tiresome it is to track your spending (it is) but it’s the most important aspect of your financial life that you need to know.
It doesn’t matter how many (or few) arrows you have in your quiver if you have no target at which to aim them.
Income Sources – This includes earnings (from a work, self-employment, garage sales etc.), Social Security (when to apply for benefits will be addressed in a future post), any pensions and annuities, and also interest and dividends.
Assets – Savings, investments, retirement plans (Pre-tax or Roth IRA, SIMPLE, SEP, 401(k)/403(b)/457(b), non-qualified deferred compensation plans), cash value of life insurance policies, home equity, personal property, etc.
Risk Profile and Asset Allocation – You must be clear on the level of risk you can tolerate (which is a preference) and how much risk your financial picture can absorb at any given time (which is risk capacity). Knowing these facts, your assets should be allocated accordingly.
Tax profile – (Note: I am not qualified to give tax advice.) Knowing your marginal tax bracket is helpful but it’s important to know the current tax laws and how you can best use them within your financial plan.
For example, Social Security benefits may or may not be subject to income tax, and your retirement income plan might be developed to minimize the taxation of your benefits (not always).
Also, under our current tax structure, people whose income is below a certain limit pay 0% long-term capital gains, which may allow someone to sell an investment at a profit without paying taxes.
Giving/Charitable/Legacy goals – We must both be clear on how much and when you want to share your resources with your loved ones and organizations that are important to you.
Once we know what we have to work with, it’s a matter of looking at the whole picture and then also drilling down into the details to develop a plan to generate the income you need.
For example, I have a client 64 years old. She needs about $50,000 per year income to meet her current living expenses. She is receiving Social Security for $24,000 per year and receives a pension of $8,000 per year and also qualified dividends of roughly $2000 per year. These dividends are typically reinvested (an expenditure) but I am recommending she have them sent to her bank account so she can withdraw them as part of her income stream.
Using just these three sources of income, her Social Security benefits aren’t subject to federal income taxes (and our state doesn’t tax them at all). In addition, her income allows for 0% long-term capital gains and also for qualified dividends.
We need to generate another $16,000 (net of taxes) to meet her income needs. I am recommending she sell some of her stock mutual funds in her brokerage account (the gains on which may not be subject to tax or cause her Social Security to become taxable), take a small withdrawal from her 401(K) (still avoiding taxes on Social Security), take a small withdrawal from her Roth IRA (no taxation since it is a qualified withdrawal), and draw from her savings to make up the difference.
This is just one example, of course.
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