Creating a tax efficient retirement spending plan


Christine Benz of Morningstar suggests creating a retirement spending plan based on how soon you’ll need to access the funds. 

Other highlights from this webcast:

Notes:
  • All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
  • This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

TRANSCRIPT 

Amy Chain: Great. Christine, you spend a lot of time talking about your bucket approach to retirement saving. We’ve gotten a lot of questions about that this evening. And, in fact, John from Springfield has asked us if you could describe your bucket approach to retirement withdrawals. How do you do that if you have taxable and tax-deferred accounts? First let’s talk about what the bucket approach is and then let’s apply it to our conversation this evening.

Christine Benz: Sure. So first I’ll say I was not the originator of the bucket approach. The bucket approach when I write about it on morningstar.com, the strategy I’m talking about is the one espoused by Harold Evensky, the financial planner, sometimes called the dean of financial planning. Just a great expert on retirement planning. And his simple strategy that he uses with his clients is that he holds a cash component aside to fund their near-term living expenses and he bolts that onto a long-term portfolio composed of stocks and bonds. And his basic finding in working with his clients was that having enough living expenses set aside, apart from the long-term stuff which would be more volatile, was that it gave his clients a lot of peace of mind. That he could manage their portfolio with an eye toward the long term as long as they knew that their quality of life wasn’t going to be disrupted by these periodic volatile periods in the market. So that’s the basic thought, that you’re setting aside 6 to 12 months’ worth of living expenses in cash and that it will be essentially dead money because, as we know, cash yields are so, so low today. But the idea is that that’s providing you a buffer so you can live with some of the volatility that will accompany your longer-term portfolio. So then, when I think about what should the rest of the portfolio look like, I think about putting the next, say, two to eight or two to ten years’ worth of the portfolio in bonds, generally a high-quality bond portfolio. And then the remainder of the portfolio for years ten and beyond of retirement that’s going into stocks. So that’s the basic bucket thesis and then we’re periodically refilling that cash bucket as we’re spending it with whatever has appreciated most in the portfolio. Or we might have our income distribution sent over into the cash bucket automatically. So if we’ve got dividend-paying stocks or income-producing bonds, those are coming over into the cash bucket. So that’s the basic strategy. Sounds simple, but then when you think about what most people bring into retirement, they might have multiple pools of money each with separate tax treatments. So those monies need to be kept separate. You can’t merge them altogether. So people may have those taxable assets, they may have traditional tax-deferred IRAs and 401(k)s, and they may have Roth assets. So those are the three main categories that people will bring into retirement. So it gets back to whatever distribution sequence makes sense for you is the way you want to think about positioning each of those subportfolios. So using Maria’s general rules of thumb, if I’m tapping my taxable portfolios first, those would be where I’d want to be more liquid at the outset of my retirement. I’d want to be holding most of my cash there. Then, if the tax-deferred accounts would go next in the queue, maybe those would hold sort of the intermediate-term component of my portfolio. And then, if I have Roth assets, I’d want to think about those as being the last in my distribution queue. Generally; not always, but generally. And so I would think about holding my most aggressive assets there. So mainly stocks, maybe some junkier bonds if I wanted to hold them as a portion of my portfolio, those would go in the piece of my portfolio where I have the longest time horizon. So, certainly, there’s more art than science and it really does depend on how much you’ve got in each of these kitties. So how much you’re bringing in with taxable, tax-deferred, and Roth. But that’s at sort of a general framework. You’ve got to overlay that distribution sequencing, the tax-efficient distribution sequencing over the bucket approach.

Notes:
  • All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.
  • This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.