With 330 per hour turning 62 in 2008, is it any surprise that the transition from work to retirement is on the mind of many of the baby boomers? While accumulating, the boomers had learned plenty about saving for retirement. Strategies like dollar cost averaging, deferring taxes and leveraging debt all made sense. However, did you know that many of the accumulation strategies may not apply in retirement? In fact, they may be down right dangerous.
Dollar Cost Averaging (DCA): An accumulation strategy proposes that market volatility provides opportunity to purchase more shares, at a lower average cost per share as investment go through their normal price swings. In the same manner, generating retirement income by systematically selling as shares go through their normal price swings would also result in selling at a lower cost per share. Certainly this is not the objective of a retiree! The misunderstanding of the investment objective (accumulation or income) caused many retirees to reduce lifestyle or return to work as their portfolios were decimated by the combination of the falling stock markets and monthly distributions required to provide retirement income.
A typical retirement calculator will illustrate: if you earn 9% and distribute 5% the remaining 4% is left to grow. Deep down inside you know that this can not work if the distribution rate is fixed while the price of stock based investments could rise or fall at any time.
Many have tried to (sell at the high points) time the market. However, consider this. The Dow was down from 1999 to 2006. An attempt to avoid selling until the investment was up may have resulted in a forced sale, potentially at the markets lowest points.
Face it, once retired, our monthly income requirements go on. We will continue to need monthly income until we die or win the lottery and we will need it regardless of the state of the market, the price of gold or whether were at peace or war. So how do you reduce the risk of funding retirement income? A portfolio of bank accounts, loan portfolios, bonds, REITs and dividend paying stocks may provide the answer. These “income devices” provide annual interest or dividends without liquidation of the underlying investment. A properly funded income portfolio could continue to provide income year after year without selling shares. The secret is maintaining ownership through the volatile markets. Assets not required to fund income can be allocated to a variety of growth devices. From time to time a transfer from growth devices to income devices may be required to help your income keep pace with inflation.
Tax Deferral: we invested into pretax plans based on the premise that tax rates would be lower in retirement, but are they? Ask a retiree! We were told defer, defer and defer. However, without a carefully thought out distribution strategy you could pay a much higher tax rate on retirement distributions or when passing these assets to your heirs, than was provided during accumulation.
Managing taxes while providing cash flow in retirement can be a tricky matter. A focus on eliminating the mortgage and other debt prior to retiring will reduce the demand retirement plan distributions without loss of lifestyle. Employees with the stock of their employers in an ESOP or 401(k) are afforded special tax treatment when separating from service. Capital gains can be managed, retirement income could be augmented with Roth IRA distributions. These strategies not only reduce federal and state and capitol gains, they may also reduce or eliminate taxation on Social Security resulting in a compounding affect of tax savings.
The tax code is passive in the favor of the IRS. To receive benefit of even basic tax strategies requires analysis and action before the end of each tax year. When working within the tax code, saving money on taxes is nearly risk free and certainly tax free.
The strategies and tools we implemented for accumulation are not bad, they are simply for accumulation. The job has changed; a new strategy and suitable tools for retirement are recommended. With proper investment management and income tax planning retirees can retire sooner, spend more or leave more to their heirs.