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Critical Retirement Decisions

With your help, clients don’t have to work during retirement.

By James P. Ruth, CFP

Many older Americans are working because they did not make financial desicions that maximized their chances of enjoying a secure retirement. These decisions are made more difficult by the ever-changing tax code and the dynamic nature of retirement itself (changes in health, life expectancy, residence, etc.).

Let’s look at the three critical decisions that must be made concerning a retirement nest egg.

1. The first decision is to determine how much money is required each month, including income taxes, to maintain a comfortable lifestyle throughout retirement. There are three income choices.

  • Level dollar amount. After considering pension and Social Security income, a retiree needs to select a specific dollar amount that satisfies his projected budget. He could exchange his nest egg for an annuity offered by an insurance company or choose to manage his investment portfolio so that his money will last as long as he does. This approach does not make adjustments for the future impact of inflation.
  • Level percentage of retirement assets. Taking a certain percentage of a retirement nest egg every month or year will cause retirement income to rise or fall with the portfolio’s market value. This can work well in a rising market but could be painful during a long market decline. Ideally, the percentage withdrawn should be less than the average total return on the portfolio as an inflation hedge or to offer the opportunity to boost income in the future.
  • Variations of 1 or 2. A consumer could start with a smaller amount and increase it over time as his portfolio grows. Conversely, he could start with a larger amount—assuming a more active lifestyle initially—and then reduce spending as he transitions into his 70s and 80s.

2.The second decision involves the order of liquidation of assets in an investment portfolio. From a tax point of view, investors have three types of accounts—taxable, tax free and tax deferred. Which should be taken first?

  • Taxable accounts. Personal investment accounts usually generate dividends, interest or capital gains distributions that are taxed currently. Drawing from these accounts first allows a longer period of tax-deferred growth on assets held in tax-deferred accounts. On the other hand, if growth stocks are held for lengthy periods and are not actively traded, there could be substantial tax deferral under this approach as well.
  • Tax-free accounts. Income and distributions from municipal bonds and Roth IRAs are free of federal income tax. Should the income be taken annually or reinvested and withdrawn later?
  • Tax-deferred accounts. Many people draw down assets from tax-deferred accounts (IRAs, 401(k)s, 403(b)s, annuities, etc.) after taxable accounts have been exhausted. Doing so allows the assets to continue to accumulate on a tax-deferred basis for longer periods of time. Others feel the benefits of tax-deferred growth are greatly diminished because withdrawals attract current income taxes and remaining assets are subject to possible estate and inheritance taxes after death. And what if the goal is to reduce taxes for children when they eventually inherit a tax-deferred account? Is it better to make withdrawals early and pay the tax and let the assets grow to pass on a step-up in basis to the kids? Withdrawals from tax-deferred accounts prior to age 591/2 may result in a 10 percent tax penalty.

3.The last element is determining the proper asset-allocation strategy for investment holdings during a long retirement. Asset allocation is more than just diversification. It is the combining of multiple asset classes (fixed/guaranteed, bond, growth and income, growth and aggressive growth). Then you incorporate into those asset classes various investment styles such as value, growth or blend. It also includes consideration of company size (small-, mid- or large-cap) and geographic region (foreign or domestic). For bonds, you must consider additional style characteristics (types, duration, ratings, industries, geographical locations, etc.). Of course, asset-allocation strategies do not guarantee a profit or protect from loss in declining markets.

While there are no guarantees, considering these multiple asset-allocation elements can help mitigate risk, based on an investor’s tolerance for risk, his stage in life and his goals and objectives.

Once the asset allocation is set, it must be determined if it will be static or dynamic.

  • Static asset allocation. A static allocation keeps the same asset mix throughout retirement. Often, this approach is riskier since it doesn’t consider the impact of aging on one’s ability to tolerate risk.
  • Dynamic asset allocation. A dynamic allocation adjusts asset classes, maybe every three to five years, by dialing down risk as a client ages.

James P. Ruth, CFP, is president of Potomac Financial Group and offers securities through Mutual Service Corporation, member NASD/SIPC. He also offers advisory services through Potomac Financial Services Inc., a registered investment advisor. Contact him at 301-948-3900 or


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