facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog search brokercheck brokercheck Play Pause
3-2-1 Newsletter (6-18-2020)  Thumbnail

3-2-1 Newsletter (6-18-2020)

10-Minute Read

Let’s get right to it. Here are 3 insights, 2 findings, and 1 action to take.


I. How good is your strategy for converting assets into retirement income?

Determining an appropriate strategy for converting assets into income is a crucial piece to any retirement plan. An income strategy should not only provide a regular stream of income but should do it tax-efficiently for as long as required. A successful plan requires a comprehensive analysis to come up with appropriate strategies best suited to sustain spending power through retirement. While no one strategy is right for everyone or better than others, each strategy should be tailored to the needs and challenges of each person. For example, converting a 401(k) account into a life annuity can be an excellent solution for someone with little other guaranteed lifetime income, but less so for someone with a significant pension benefit. 

A starting point for converting assets to income begins with choosing the appropriate way to frame the issue. For some, it's more helpful to think in terms of creating an income floor for essential expenses. And for others, it starts with the question, “How much can I afford to withdraw from the portfolio each year and still make my money last?” Whatever approach is taken, it's important to be familiar with the different ways of framing the issue and be able to pick solutions appropriate for your situation.

Once the strategy is framed, you can begin to build out the details about how it will meet your income goals while managing the risks facing those goals. 

To bring your retirement income strategy into focus, here are a few questions to consider:

  • Do you prefer income stability or wealth accumulation?

  • Do you prefer a constant or fluctuating rate of spending?

  • Are you comfortable spending from a volatile investment portfolio?

  • Do you know how much you spend each year without running out of money?

  • Is outliving money in retirement a concern?

  • How do you plan to fund a longer than expected life? 

The wealth accumulation side of retirement planning (saving for retirement) gets most of the attention. That's unfortunate because income planning (spending in retirement) is arguably the more complicated and important part of retirement. Very few save and invest for the fun of it. They do these things because someday they hope to have done them well enough to be able to comfortably retire. Whether this goal is achieved begins with having a well-thought-out strategy for converting assets into enduring income.

Is your strategy for converting assets to income up to the task? 

 II. Choosing the most tax-efficient distribution strategy 

Are you confused about paying taxes in retirement? Many are, since not all retirement savings assets are equal from a taxability standpoint. Use these questions and strategies to start a conversation about what tax-efficient distribution option will work best for your retirement.

Step 1: Start by asking these 3 Questions:

  1. Do you have money in a Roth IRA, 401(k), or Taxable Brokerage account?

  2. When do you want to start collecting Social Security?

  3. What are your monthly retirement expenses?

Step 2: Review these 3 Simple Strategies:

  1. Pro-Rata: the default and least tax-efficient retirement distribution strategy where withdrawals are taken from all accounts (taxable, tax-deferred, and tax-free) in no specific order.

  2. Sequential: a more tax-efficient distribution strategy where withdrawals are taken from taxable accounts first, tax-deferred second, and lastly tax-free.

  3. Sequential w/Roth Conversion: a distribution strategy where sequential withdrawals are paired with timely Roth conversions to produce the most efficient tax distribution strategy.

Retirement is expensive enough. And taxes are a huge cost. Any steps you can take to keep more money in your pocket and out of the government's coffers will boost income, reduce stress and increase retirement satisfaction. 

III. The Insecurity of Social Security

You will face many risks in retirement. And having a risk management strategy to manage them is crucial to a successful and sustainable retirement. Social Security solvency (it’s ability to pay expected benefits) is a risk to those retirements that depend heavily on it as a funding source. About half of retirees are totally dependent on Social Security.  And for a quarter of retirees, Social Security provides up to 90 percent of their income. Unless Congress takes action to address the current projected revenue shortfall to meet legislated benefits, the trust fund will run out money as early as 2032. When this occurs, benefits will need to be cut by up to 23 percent for everyone.

For those counting on Social Security to fund retirement, a key question is how much should they plan to receive if benefits are cut? While there are no hard and fast rules that apply to everyone, here are a few helpful guidelines you may want to consider in your retirement income planning. How much of a benefit reduction you consider largely depends on when you retire.

  • I'm currently in retirement: assume no reduction but make cutbacks as needed.

  • I'm 10 years from retirement: assume a 25% benefit reduction.

  • I'm 10+ years from retirement: assume a 50% benefit reduction.

Planning for the benefit reduction most likely to your situation is the best approach to managing this risk. Knowing its potential impact and making adjustments as needed to your retirement income plan can make all the difference to retirement success and sustainability.


I. Which Makes More Sense for Retirees: A Total-Return or Income Portfolio?

A retirement income strategy can be based on one of two things: total return or income. A total return strategy seeks to maximize growth and provide a steadier amount of income by consuming earnings and principal to fund retirement spending. An income return strategy focuses solely on interest and dividends to support spending without the need for principal draw-down. 

If your asset allocation is designed from a total-return perspective and you can live off the income provided by the portfolio and any additional income (e.g., Social Security), then everything is fine. The problem is what to do when the total-return portfolio does not generate the desired income. In such a situation, a total-return perspective would have you maintain your strategic asset allocation while consuming your principal. This isn't a problem since the focus is on increasing principal and growing earnings. With an income perspective, the last thing you want to do is consume your principal, so you would instead position your investments to provide enough income, so you wouldn’t have to sell any assets to meet spending needs. In other words, you chase higher yields (in the form of dividends and bond interest) than a total market portfolio can provide. 

An income strategy comes with many risks. For dividend stocks, the investment portfolio becomes less diversified relative to the total stock market, due to the need to limit the portfolio to companies that only pay a dividend and preferably those that pay the highest. Considering roughly 61 percent of companies pay a dividend, effectively 40 percent of companies are excluded. This strategy relies on interest payments as well, and this introduces other risks namely higher-yielding bonds. These typically have a longer maturity and/or greater credit risk. Longer-term bonds leave investors more exposed to capital losses if interest rates increase. And higher-yielding corporate bonds expose investors to default risk; when the stock market drops, corporate bond prices tend to do the same, as increased default risk works its way into higher interest rates.

Takeaway: There are clear risks to an income investment strategy in retirement. By reaching for yield, you trade higher current income for a greater risk to future income. This risk must be accepted when moving away from a total-return portfolio, on which balance comes with steadier income and less risk to future income. In most cases, a total return investment strategy is superior to an income return investment strategy.

 Source: Which Makes More Sense for Retirees: A Total-Return or Income Portfolio?

II. 5 Retirement Planning Wrinkles for Couples With Big Age Gaps

Retirement decisions are always complex. But they can be doubly so when a big age gap exists between spouses means wide variations in retirement dates, life expectancy, health, and other factors. Much of the standard retirement advice may not work for age-gap couples. According to the Pew Research Center, about 9% of all married couples have an age gap of 10 years or more, but large age differences become more common in later-life second marriages. About 20% of heterosexual remarried men, for example, have a spouse at least 10 years their junior, versus 5% of men in their first marriage.

When it comes to retirement planning, these couples often feel they’ve fallen out of step. The five common problems that age-gap couples face range from agreeing on a retirement date, when to claim Social Security, choosing an appropriate draw-down strategy, avoiding running out of money, and selecting the right health care choices for both spouses. 

Takeaway: When there is an age gap you really have to think outside the box and throw out the playbook that you would use for couples retiring at a similar age.

 Source: 5 Retirement Planning Wrinkles for Couples With Big Age Gaps


I. Deciding how to invest in retirement.

Prudent retirement income planning begins with identifying and implementing the actions necessary to support the goals while protecting against risks that stand in the way of those goals. Undertaking the right actions consistently before and during retirement is crucial to your golden years. 

We’ll look at one action item to take and reveal a new one each week.

This week’s smart habit: Total-returns vs. Income return investment strategy

Choosing how you will invest in retirement is arguably as important as how you invest before retirement. The options are a total returns strategy that seeks to maximize growth and provide a steady stream of income by spending both principal and earnings or an income strategy that focuses on spending earnings (dividends and interest) without drawing down principal. 

Each strategy has risks, but on balance, the total return strategy has less than an income-focused strategy. The chief risk of the total return strategy is that when earnings don’t cover spending needs, principal has to be sold. Contrast that with an income-focused strategy, which has numerous risks from reduced diversification, as stocks that pay dividends are selected over those that don’t, and a reliance on riskier bonds to produce higher interest payments. 

Spending from a volatile investment portfolio will always be precarious. There are just some risks being invested in the market you have to accept. Funding retirement should be first and foremost about having stable, sufficient income to meet spending goals in the least risky manner possible. Of the two strategies, the total returns investment strategy is the least riskier of the two. 

Choosing how you invest in retirement will go a long way to the quality of your retirement.


Have a Question? Want to chat about it?

Get In Touch

Until next week,

Mark Sharp, CFP® RICP® EA

Mark Sharp Retirement