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Amy Chain: Hello, I’m Amy Chain, and I’d like to welcome you to this evening’s live webcast about creating and following a retirement plan. I’m joined tonight by two of my personal favorite personal finance gurus, Christine Benz, director of personal finance and a senior columnist for Morningstar, and Maria Bruno, a senior retirement strategist in Vanguard’s Investment Strategy Group. Christine, Maria, thank you for being here.

Maria Bruno: Thank you.

Christine Benz: Great to be here.

Amy Chain: Tonight, Christine and Maria will help us understand the things that we can do to keep our retirement savings goals on track. And based on the questions we received in advance of tonight’s broadcast, we know that we have viewers this evening who are just starting out to save for retirement, those who are spending down from their retirement savings, and just about every phase in between. So, we will try to cover as many of the topics that we received questions about as we can, and we’ll continue taking live questions throughout tonight’s webcast.

Before I begin, there are two items I would like to point out. There is a widget at the bottom of your screen available for technical help. It’s the blue widget on the left. And if you’d like to read more about planning and investing for retirement or view replays of past webcasts, click on the green Resource List widget on the far right of the player. Shall we get started?

Maria Bruno: Please, let’s do it.

Amy Chain: Okay. Before we get into the questions that you sent us, we’d like to send a question to you; and that question should be appearing on your screen now. It is, “where are you in your retirement journey? Are you just getting started? Are you in your prime earning years? Are you within two years of retiring, or are you retired?” Please respond now, and we’ll share your answers in just a few minutes.

Now while we wait for the audience to weigh in, why don’t we take a question that we got in advance of our webcast. Wendy from California writes in and says, “I don’t have a plan; how do I start?” I think that’s probably a pretty broad question, so why don’t we hone in and let’s assume Wendy is sort of on the earlier stages of retiring. How do we get started thinking about a retirement plan? Christine, you want to kick us off?

Christine Benz: Sure. So, for people who are in the early accumulation phase, you want to keep your eyes on a few key things. One is setting a target savings rate, so figuring out how much of your paycheck you should be setting aside for retirement savings. That’s probably the lynchpin. There will be no more impactful thing that you can do for your plan than set aside enough savings. So, use some sort of an online calculator to help yourself get in the right ball park.

Then take a look at what sort of tax-sheltered retirement savings vehicles you have available to you. For many people, that will be some type of a company-sponsored retirement plan. We all can invest in an IRA, too, as long as we have some earned income. So, make sure that you’re taking a look at those vehicles that give you a few tax benefits for investing in them before moving on to other investment wrappers.

And then, finally, you want to make sure you are in a sensible asset allocation plan relative to your anticipated retirement date. For early accumulators, that does mean the bulk of the portfolio should be in investments that have fairly high return rate potential; and right now, or historically, that has been stocks. So, a young accumulator would certainly want to have upwards of 50%, maybe more like 80%, 90% of his or her portfolio in stocks and then only gradually over time reduce that stock allocation.

Amy Chain: Now Howard is another viewer this evening who wrote in. Howard’s a little later in the retirement savings game. Would our counsel be different if somebody was starting a little bit later toward retirement savings? Maria, you want to take Howard’s question?

Maria Bruno: Yes, so not surprisingly, we’ll probably hear similar themes between Christine and myself this evening; but I would echo everything that Christine had mentioned.

You know, it’s never too late to start saving; and certainly, the earlier you start the better, because the power of compounding is on your side. The reality is if you start later, then you’ll have to rely heavier on the savings.

So, to echo Christine’s point in terms of looking for calculators in terms of guidelines for savings rates, one of the guidelines that we tend to use is to target 12% to 15% of your income, your salary towards retirement. And for someone who’s just starting out, that could be lofty; so, it’s always a good planning practice to stretch yourself and then do an automatic increase every year, for instance. And you can do this through your 401(k) if you’re employed. But, you know, the reality is if you’re starting later, then you probably need to be closer to that 15% if not higher. So, you really need to stretch yourself because you don’t have as long of a time horizon.

But I would certainly echo what Christine said in terms of when you think about asset allocation, if you think about someone who’s retiring today at the age of 65, for instance, you’re probably looking at a good 30 years in terms of a conservative estimate for a retirement horizon. You need to think then, also, well how close are you to that goal, and your time horizon could be pretty lengthy. And equities do, when you think about investing for the long term, the goal is out-pace inflation; and traditionally equities play that role significantly. So, equities do play a role, so I would echo everything Christine said but really just focus on the savings piece of it at that stage.

Amy Chain: Very good and we’re going to explore these topics further as we go on, but the results from our first polling question are in. Looks like about 40% of our viewers this evening are retired, but we do have folks across the full spectrum of their retirement savings journey. So, let’s make sure we answer questions that’ll help everyone this evening.

I’m going to throw another broad one out that maybe we can tackle at a high level and then break it down. Folks are writing in, like Julianne from California, Joseph from New Jersey, talking about when are the times to consider changes to your plan? So, you have a plan; what might trigger a reason to make a change? Christine?

Christine Benz: Well, a couple of key things. One would be changes in whatever you have going on in your life. So maybe you’re newly married or birth of a new child or maybe you are thinking about retirement within the next couple of years. So, your own life stage changes should trigger a review of your plan. It’s time to check in and see are there any changes necessary.

And then, secondarily, the contents of your portfolio may have shifted; so, we have had this fairly long-running equity market rally, and so, even if you’ve been doing nothing to your investment program, your portfolio has been getting a little bit more aggressive over the years. So, revisit your portfolio allocations as well because the contents may have shifted over time.

Amy Chain: Maria, it looks like you might have something to add to that. But I want to just add that while we were talking, I know that there’s a polling question out there that some of you have started to weigh in on. I’ll ask the rest of you to continue to weigh in while we continue our discussion.

The polling question is, “how comfortable are you with your financial plan? Are you very comfortable, do you think it might need some updates, you’re not comfortable, or you don’t have a plan?” It pays to admit it, we’re all friends here, right? We’ll talk about that too.

So, I didn’t mean to interrupt your train of thought, but did you have something to add?

Maria Bruno: No, no, I think that’s fine. I mean I do think rebalancing has been a key theme the past few years when you think about the equity markets and how generous they’ve been. So, for someone who hasn’t been checking their plan, rebalancing is probably one of the first steps that they would need to do.

And then, certainly, you need to go back and validate are you on track? Right, have your goals changed? If so, you need to modify what that plan is to achieve those goals. But if not, go back and revisit and just see if you’re on track and whether you need to kind of ratchet up the savings or if there’s been some other changes along the way that need to be accounted for. So, it’s really not once and done, it’s a continuous process.

You know, the flip side is, when we talk about rebalancing, you don’t want to do that too frequently because there’s costs involved with that as well. So, six months or once a year is usually a good benchmark.

Amy Chain: To what degree do you let what’s going on in the market drive your decision about whether or not to make changes to your portfolio?

Christine Benz: My thought would be to not get too attuned to what’s going on in the market. Do, I would say, a once-yearly, top-to-bottom checkup is plenty for most investors. In my experience, investors can do way more damage by being too hands on, being too plugged into the day-to-day market action. When the market’s good, as it has been recently, that might make you inclined to take more risk than would be prudent; and then we see the opposite. It’s easy to forget, but we had a terrible bear market just a decade ago or even less, and we saw a lot of investors take risk out of their portfolios at what turned out to be an inopportune time. So, they scaled way back on their equity exposure just as stocks were about to recover, so less is more when it comes to monitoring.

Maria Bruno: Yes, I would agree. You know, the other thing is, to keep in mind, year-end is usually, as you gear into year-end, it’s usually a good opportunity to take a look at what happened this year. Are things different in our tax picture, for instance? Is there any fine-tuning that we can do to take advantage of year-end tax planning or, maybe if you’re going through and preparing your tax return early next year, are there things that you can do differently in the year ahead or even maybe a personal anniversary or something like that, some type of target date that you would use every year as a time to go back and check on things.

Christine Benz: I would echo the year-end as being a really opportune time. Not only are there some tax opportunities but, also, with the tax-sheltered savings vehicles that you have for retirement, you have a deadline. If your goal is to max them out, your deadline is the end of the year. So, see if you’re on track. You have a couple months still that you may be able to kind of turbocharge your savings rate between now and year-end to make sure, if you possibly can, max out those contributions.

Amy Chain: Very good. We have our polling results for our second question. Again, we have a wide variety of responses, but about half of our viewers this evening say their portfolio plans could use a little bit of an update. But we have a little bit in every bucket, so we’ve got some confident folks, about 30% confident, 48% needing some updates, and then some others that we will also help get started or adjust to be more comfortable.

Now, Christine, you talked at the outset a little bit about the roles that stocks and bonds play. We’ve gotten lots of questions ahead of tonight’s webcast as well about that. Carl from California is asking about, “Through the backdrop of historic low rates, what role should stocks be playing, what role should bonds be playing, and how should they come together in a portfolio?”

Christine Benz: Yes, a great question. It’s not an easy one because it’s hard to say that bonds will have great returns over the next decade.

The way I think of it though, and certainly the way that people who focus on asset allocation think about it, is that bonds are the stabilizers for your portfolio. So, your stock portfolio will inevitably encounter some volatility, will inevitably lose money. Your bonds are what you’re looking for to hold their ground, maybe even gain a little bit in those periods when your equities are weak. So, I do continue to believe that bonds hold a worthwhile role, especially for people who are getting close to retirement or, I would say, within 10 or 15 years of retirement, you ought to be looking at bonds as playing at least some sort of role in your portfolio.

Amy Chain: And knowing that we have many viewers tonight who are either just getting started or don’t have a plan, maybe we can talk about some of the first steps to take in deciding what your asset allocation should be and how you should be spreading that across particular investments. Maria, you want to kick us off?

Maria Bruno: Sure. You know, when we think about asset allocation, I like to focus primarily on stocks and bonds. And the two key things to think about are time horizon, and we’ve talked about that already, in terms of the longer the time horizon, the focus should be on keeping up with inflation or outpacing inflation, and, traditionally, equities play a role there.

Now, certainly, that may expose you to more market risk, so volatility along the way, but keep the long-term focus. So, for someone who is starting out or even nearing retirement, an equity-centric portfolio, a diversified global portfolio is very prudent. And even as you’re approaching retirement, when we think about spending rules of thumb, it’s all predicated upon having a balanced portfolio. And by balanced, we typically say 60% to 40% equities. So, as you gear into retirement, it’s still important to have that equity-heavy portfolio, yet globally diversified.

Christine Benz: One rule of thumb I often tell people to use is think about your spending needs in retirement and use that to figure out how much you should have outside of the stock market. So, if you have money that you don’t expect to need for another ten years, that’s probably fine being invested in stocks. But if you have part of your portfolio that you expect to spend within the next decade, stocks are too risky. They historically have had big ups and downs over ten-year periods, so you would want to have that portion of your portfolio in the safe stuff like cash, like bonds.

Amy Chain: That’s a great window into a live question that we just got from John who says, “How do I rebalance my nonqualified portfolio and minimize the tax consequences of that rebalancing action?” Maria?

Maria Bruno: That’s a good question; and, actually, it’s pretty timely as we gear into year-end. And there’s a couple different ways that you can do that. I mean certainly to the extent that you have retirement accounts, those can be a first source for rebalancing—

Christine Benz: Absolutely.

Maria Bruno: —because you can make transactions within those accounts without incurring a tax liability. Similarly, since we have some retired folks in the audience tonight, if you’re taking distributions from your tax-deferred accounts, RMDs, using that as a way to rebalance the portfolio could be prudent. But the reality of it is that many of us have assets outside of retirement accounts, so you want to be targeted in terms of trying to minimize any type of capital gains that you might have to incur there.

So be mindful in terms of when you need to rebalance the portfolio, look to where you’re overweighted. That may very well be equity since equities have been on a pretty generous run over the past several years, so don’t be surprised if equities are the one place where you need to pare back. So be strategic in terms of rebalancing while trying to minimize the tax transactions that would go along with that.

The one thing that I like to talk about as well too, if someone is charitably inclined, going after, and if there’s securities that may have low basis, for instance, and this is a general rule of thumb, but you could take a look at that in terms of if you’ve got assets that might have low basis.

Amy Chain: Can you define low basis for us?

Maria Bruno: Cost basis is the amount that you’ve actually paid into the security or the fund. So, it’s the amount that you paid and the difference between what you sell is considered a gain, and you would be taxed at capital gains rates. If you use those types of securities as a gifting opportunity, it escapes the capital gains taxation. So, there’s some maneuvers there that if you are in a situation where you have a lot of taxable or nonretirement accounts that you might be strategic in terms of how you rebalance if you’ve got other goals in mind.

Christine Benz: Using a donor-advised fund can be really effective in that context as well, so you can take those positions where you have built up a lot of appreciation and steer those directly into the donor-advised fund, and that, again, is another strategy that people who are charitably inclined might consider.

Amy Chain: Christine, for those that might not be familiar, can you define a donor-advised fund for us?

Christine Benz: Sure, and Vanguard and other financial providers do have donor-advised funds. But the basic idea is that you steer the investment into the donor-advised fund. You’re able to take the tax deduction on the amount that you’ve donated; but then you can have the money invested, and you can take your time in getting that distributed to the charities of your choice.

So, it’s a nice tool because you don’t have to decide right away which charities the money’s going into. You can even let it grow and build a little bit if you want, but you are able to take the tax deduction at the time you make the donation.

Maria Bruno: And there’s just one other thing that I like to talk about, although it’s not as immediate in terms of rebalancing, but directing cash flow. So, if you get maybe a year-end bonus or if you get some type of cash, to use that strategically and target those cash flow investments into the underweighted asset class.

Christine Benz: That makes a lot of sense.

Maria Bruno: And also redirecting dividends. So, you know, if you have a cash infusion, certainly, you can be strategic in how you direct that. But you may be able to direct dividends. So, bonds, for instance, pay monthly dividends. Perhaps you could redirect those automatically or have your equity dividends swept over into the bond account. So, there’s some things that can help you there in terms of more of a maintenance. It’s not something that directing dividends will get you there at day one.

Amy Chain: Jim is asking us about bonds again. He’s wondering, “What’s the argument for investing in bonds. If the argument is that it’s safety and it’s a volatility buffer for your portfolio, why not just invest in cash?”

Christine Benz: Well, you know, that was a question we were hearing even seven years ago. And people said, “You know, well, the Fed’s going to start raising rates. That’s bad for bonds. They don’t want to be in bonds.” Well guess what, bonds have performed pretty well over the past, well, 30 years now. As rates have generally been declining, that has been a strong tailwind for bond prices. So, the bond investor has actually been ahead of the cash investor. The poor cash investor has had to settle for ever-lower yields whereas bond investors have been able to take advantage of the price appreciation.

So, I think you want to be careful about market timing and saying, “I’m not going to invest in bonds. I’m going to hunker down in cash and wait for this whole interest rate worry to blow over.” It could be a period of years. So, I do think that bonds still make sense as a strategic allocation and you do have an opportunity cost of having all of your fixed income assets in cash.

Amy Chain: And investing in bonds is different than investing in bond funds, right? Maria, do you want to talk a little bit about how a bond fund operates differently than a straight bond investment?

Maria Bruno: Sure, I mean if you purchase an individual bond, you know the price that you’re purchasing the bond, you know the amount at maturity, and you know what the coupon is. And you’ll get that coupon typically every six months.

When you buy a bond fund, you’re purchasing in a basket of bonds; and it depends upon how the mutual fund is being managed. So, if you think about a broad U.S. bond market index, it’s the goal of the portfolio manager to replicate that basket of securities.

So, you have bonds, potentially, across the maturity spectrum: short, intermediate, long-term bonds. And these will tend to, you know, as they mature or the portfolio manager in actively managed funds may make buy and sell decisions accordingly.

So, with bond funds, you actually get a monthly coupon typically, and you can reinvest those. If you’re someone who’s saving for the long term, you would reinvest those; and much of the return from bond funds in that situation would be through the reinvesting of the coupon and the earnings on those coupons as well.

So, you might want to add to that, Christine, as well, too. That’s fundamentally the difference in how they operate. Now there’s reasons why you might have one over the other.

Christine Benz: Right, and I do hear from a lot of investors who say that they like that noble coupon. They’re worried about where interest rates might go, and I get that. I think that investors just have to understand that they’re forsaking a couple of advantages that come along with a bond fund.

One is all the diversification you get by having the fund, the professional management that you receive, and then the foregone opportunities that might occur. So, if you buy a bond that has a 2.5% yield today and you hold it till maturity, well guess what? Your yield is 2.5%. If you buy a bond fund, the advantage is that the fund can take advantage of higher yields as they come online. So, if yields trend up over your holding period, you will actually benefit from those higher yields. That’s not a benefit you’ll necessarily have with holding the individual bonds.

So, it’s an individual-specific decision. There are certainly areas where I would say do not do this on your own, buy a fund. In terms of corporates, I would say you definitely want a fund. And municipal bonds is another area—

Amy Chain: And that’s because of the risks that could be associated.

Christine Benz: Exactly, of choosing the wrong issuer that cannot make good on its obligations. With municipal bonds, one of the big advantages you get with a fund is that you get the institutional level trading costs that that fund has. As a smaller individual investor, you do not benefit from those very low institutional trading costs.

Maria Bruno: And there’s also other perks to owning a bond fund in terms of ease of liquidity, you might potentially even have checkwriting opportunities against the fund and things like that too. So, all in, there’s pros and cons, I guess, to both of those.

Amy Chain: And every investor is different, right?

Maria Bruno: That’s right.

Amy Chain: So choose based on your own circumstances and situations.

Okay, Kristy from Colorado is asking us about how to balance retirement savings against everyday spending decisions. Can we offer her some thoughts?

Maria Bruno: Sure, I mean we talked a little bit around cash and the role that cash plays. Certainly, you want to prioritize retirement savings, but everyone needs some type of rainy day fund or an emergency reserves. I like to think of a good guideline as having three to six months’ worth of living expenses in a cash investment. Cash can be a checking account or a money market mutual fund, something that’s very liquid and stable. So, anything more than that, Christine had mentioned, there’s an opportunity cost to not being invested, so you certainly want to prioritize retirement.

Now there’s one thing to think about; and, Christine, I would appreciate your thoughts on this as well, because I know that you’ve written on this in terms of some multitasking accounts, you call them.

So, one of the things I like to talk about are Roth IRAs. So, for someone like Kristy who is saving for retirement, you can maybe accomplish both goals. So, if you prioritize retirement and invest in a Roth IRA, for instance, since the contributions are being made with dollars that have already been taxed, because you don’t get a tax deduction when you make a Roth IRA contribution, those dollars, actually, the contribution dollars can be access income- and tax-penalty free.

So, there’s a liquidity feature to a Roth IRA that you really don’t get with any other type of tax-advantaged retirement account; and I want to be clear, the priority should be retirement, and you invest accordingly. But there’s a flexibility there that if you are pinched a bit, you can strategically have access to those monies as well.

Christine Benz: I like that strategy a lot. The Roth, I think, is a great starter, multitasker vehicle and one that you can use, really, throughout your accumulation years, so I think it makes a lot of sense.

Maria Bruno: Yes, particularly for young investors.

Christine Benz: Absolutely.

Amy Chain: We’ve got, in fact, a lot of questions coming in. Gene is asking about how to consider retirement savings in relation to college savings. We’ve got Meredith asking about how to prioritize retirement savings versus buying a first house. What do we think?

Maria Bruno: But the reality, I mean that’s a reality to investing, right? I mean we all have multiple goals.

Christine Benz: Absolutely.

Maria Bruno: Yes, so it’s, and it doesn’t have to be all or nothing. In many situations it shouldn’t be. But the fact of the matter is retirement should be a priority. We are responsible for subsidizing our own retirement. The days for defined benefit plans or pensions probably are going by the wayside, right?

Christine Benz: Right.

Maria Bruno: So, taking advantage of employer-sponsored plans, company match, those types of vehicles and starting the retirement clock, the retirement investing clock, early are the keys to long-term success.

But, you know, many of us have other goals in terms of either shorter-term goals of funding a child’s education or purchasing a house, or a marriage or things like that as well. And it’s a balancing act. It’s not necessarily all or nothing, but in terms of a home purchase, the thing to think through is, “well, how much of a house can I afford?” There’s some guidelines there in terms of a debt-to-income ratio.

Christine Benz: Right.

Maria Bruno: And that should probably be between 20% to 30%, right. So really think about what type of house and what that mortgage would look like, and can you really afford to do both? If not, you might need to make some decisions in terms of scaling back a bit, at least initially on a first home purchase, for instance.

Christine Benz: I think that’s right, and the other point I would make about homes is that you really need to think of this as, first and foremost, a home versus some sort of investment vehicle. So even though homes maybe in certain communities have appreciated perhaps even ahead of the equity market, you need to be careful because there may not be a time when you are able to tap that equity. So, you might get used to living in a home of that type, and even when retirement rolls around and you want to move to a condo or something like that, well you might find that a lateral move where you’re taking all of your home proceeds and moving it into the new home is, it’s just going to be an even split. So, you need to be careful about thinking about the home as a savings vehicle. It’s really not.

Amy Chain: Brad just asked us a great question that goes along with that statement very well, “What about if you’ve paid off your home? If you have your home as a straight-up asset, how do you consider that in your financial plan?”

Christine Benz: It’s a tough question. I think a couple of things. One is that if you’ve done that, that should be an impetus to turbocharge your savings rate; or if your savings rate for retirement is on track, then maybe you can think about pursuing other goals, whether it’s a second home or whatever it might be.

So, examine the impact for your savings rate and see if whether you can redirect the funds that you were previously putting into your mortgage to some other goal. And then you can also think about the role of real estate on your total balance sheet. So, make sure that you aren’t overexposed to real estate in other aspects of your financial life. So, you probably don’t want to be owning rental properties, for example, and you also want to watch the real estate holdings in your investment portfolio because you would hate to have too much riding on that asset class.

Amy Chain: I guess the point there is to look at all of your assets in concert with one another and understand the role that they all play together.

Christine Benz: Absolutely.

Amy Chain: Very good. Christina from Philadelphia, right around the corner, Christina. Thank you for your question. Christina says, “My company is offering a health savings account starting next year, as well as high deductible health plans.” As we all head into open enrollment season. This is on the minds of many. “The HSA seems like a great way to save for future medical expenses, even after Medicare. What are the potential pitfalls I need to look out for?” Christine, you want to kick us off?

Christine Benz: Sure, and maybe we should just outline what high-deductible plans are, what HSAs are before we go any further.

So, a high-deductible plan will typically have lower premiums, so that’s an advantage. But the out-of-pocket costs are higher. So, typically, such a plan, if you have a choice between, and usually the choice is between the high-deductible plan and a PPO, sort of a traditional healthcare plan.

So, the benefit of the high-deductible plan with the health savings account is that you’re holding the health savings account on the side to help fund out-of-pocket healthcare costs as you incur them.

If you have the wherewithal, and this is where HSAs can be really interesting, is if you have the wherewithal to not spend from that HSA and instead just use other assets, like taxable assets to fund your healthcare expenses, that HSA has some really attractive tax advantages. So, you’re putting pretax contributions into the account, you’re enjoying tax-free compounding on your money, and then when you pull the money out for qualified healthcare expenses, or in retirement, you will not pay taxes on any accumulation. So, it can be a really attractive vehicle. You sometimes hear people joke, “Well, it’s best for people who are healthy and wealthy, but that’s generally true.” The strategy can be really attractive for people who are looking for an additional retirement savings vehicle, in addition to 401(k)s and IRAs.

Amy Chain: Is there a timeframe like IRAs where you’d have to start taking money out of the HSA or anything that would require you to have to start taking money from it?

Christine Benz: No, actually, not, there aren’t required minimum distributions on HSAs. So, it’s an attractive vehicle to pull into retirement, actually. You can use it to fund any number of healthcare-related costs. And then the other thing to know about HSAs is worst-case scenario, and it’s kind of a good-case scenario, but you don’t have that many healthcare expenses in retirement. Well in that case, the HSA is treated as an IRA, a traditional IRA would be, and you are taxed at your ordinary income tax rate on those withdrawals.

Amy Chain: Okay. Christopher is asking about those who have both a Roth IRA and a traditional IRA, “If you max out, do the max-out rules apply to both or one or can you—“ Let’s talk about the balance between those two types of accounts.

Maria Bruno: I’ll start, Christine. The nature of the accounts are different, so to the extent that you have earned income, you can contribute to an IRA. The question then is whether it’s a traditional deferred IRA or a Roth IRA.

So, with a traditional deferred IRA, anyone can contribute as long as they have earned income, of course. The question is whether or not the contributions are tax deductible. And there are income phase outs there. The other is there’s a Roth IRA where you make contributions with dollars that have already been taxed so you don’t get the tax deduction in the year of contribution, but the account grows tax free. And there’s income eligibility requirements there.

So, it’s best to think about it in terms of what your long-term goal is. For many, a Roth IRA offers, you know, a lot of perks in terms of you don’t have to take required minimum distributions from Roth IRAs when you’re in retirement. Having both offers tax diversification. And what I mean by that is having different account types that are taxed differently affords flexibility and strategic decision making later in retirement when you’re going to either draw down or if you’ve got different types of goals such as legacy goals or whatnot. So, both are excellent retirement savings vehicles and should be maxed out. The question is whether it’s a traditional or a Roth IRA.

Amy Chain: Is there a rule of thumb about what you contribute to first or is there a percentage that you split between the two? How should you think about using both or either a Roth or a traditional?

Maria Bruno: I don’t think there’s a specific percentage between the both. I guess I would start with a couple things. One is, if you are someone who is covered by an employer-sponsored plan, look to the employer-sponsored plan first to see, you know, if you get a company match and if you have the option to do a Roth or a traditional deferred, you could split those contributions up, for instance. But the employer match is made to the traditional deferred account. So, if you invest in a Roth in your 401(k), for instance, if you have that option, the match goes into the traditional deferred account. You get instant tax diversification there. So that’s one way where you can be strategic.

I like the Roth IRA for those that are saving outside of the company plan because of the fact that you don’t have to take lifetime distributions and you can access the contributions income tax free or penalty free, as we just discussed, to the amount that you’ve contributed. So, there’s some flexibility there which can be beneficial for investors down the road if needed.

The one thing to think about is, as I mentioned, there are phaseouts. And someone can go to our website and actually look at, we’ve got a handy table that talks about the differences between the two types of accounts. You can do a two-step process to get into a Roth IRA if you’ve exceeded the eligibility thresholds. And by that, I mean you can make a contribution to a traditional IRA and then subsequently convert that to a Roth, so it’s a two-stepped process for contributing to a Roth IRA.

Some things to think about if you have other IRAs, other nondeductible, traditional IRAs that you’re not converting, there’s some things to think about there in terms of aggregating accounts for the purpose of calculating any tax consequences. If someone’s interested in learning more about that, I would suggest the website is a good place to get started because I think we’ve got a lot of good information there.

You can add to that. I know I talked a lot about Roth.

Christine Benz: Well, no. I have been hearing a lot about the backdoor Roth IRA maneuver since the income limits on conversions were lifted back in 2010. And this is something that only high-income people would care about. If you are below the thresholds for contributing to a Roth IRA, you can go in through the front door. You don’t need to do this backdoor maneuver.

But, as Maria said, there are some caveats to keep in mind. One is, if you’re someone with a lot of traditional IRA assets, as Maria said, and you are also opening this new little IRA that you plan to do the backdoor with, just be careful because when you do that conversion, more of it would be taxable than you might be planning on. So, get some tax help there before you undertake this maneuver. But it can be a way for high-income folks who had heretofore been shut out of Roth contributions to make them and get some money over into the Roth column.

And I would agree with Maria, too, that if your company offers both a Roth 401(k) as well as traditional 401(k) contributions and you’re not sure what to do, think about doing some splitting of contributions and kind of split the difference between the two account types.

One profile, though, that I’d like to address before we leave this question is for people who are later in their accumulation careers and have not yet amassed much in terms of retirement savings and maybe can earn a tax deduction when they make a traditional IRA contribution, they may be better off doing that because their tax rate now when they make the contribution may well be higher, and, therefore, the tax benefit of making the contribution may be better now than it is later on. So that would be a reason to look at making a traditional contribution.

Maria Bruno: That’s a good point, and then, also, to add to that would be for individuals that are young and in their early earnings phase, their tax bracket may feasibly be much lower than it would be later in retirement or postretirement.

Christine Benz: Absolutely.

Maria Bruno: So, the value of a tax deduction with a traditional deferred account is most likely outweighed by the benefit of the tax-free growth of the Roth account. So those are a couple guidelines. So, it’s not so much a percentage, but more of where are you in your investing journey and what does your tax picture look like now, your time horizon, and then your tax picture potentially later?

Christine Benz: Yes, that seems like the young accumulator. Sometimes I talk to new grads who say, “Yes, I’m starting my new job, and I’m starting an MBA program at the University of Chicago.” And I’m like, “Okay, you’re a good Roth candidate. Let’s move on because you are a young accumulator who’s likely to be in a higher tax bracket in the future than you are today.”

Amy Chain: That’s wonderful. Thank you. Do you all see why these two are my favorites? We could talk all night.

Christine, let’s throw another one to you. Kate and Mike from Scottsdale are asking us about an appropriate withdrawal percentage for those in retirement. What do you think?

Christine Benz: It’s a hot topic. People may have heard about the 4% withdrawal guideline, and there’s a lot of confusion about what exactly this means. Sometimes people think that it means that you can safely take 4% of your portfolio year-in and year-out through retirement, and that’s what we’re saying. That’s, actually, not the underpinning of the 4% guideline.

The 4% guideline assumes that retirees want a more or less steady stream of income or cash flows from their portfolios. So, it assumes that in year one of your retirement, you’re going to take a 4% withdrawal and then you’ll give that dollar amount a little nudge up to account for inflation as the years go by. So, the idea is that retirees want that steady cash flow in retirement.

The 4% guideline was originally developed by a financial planner named Bill Bengen. His idea was to look at someone with at least 50% of his or her portfolio in stocks. He assumed a 25- to 30-year time horizon. So, I think that it’s a decent starting point for figuring out how much you can safely take out of your portfolio, but you have to think about those levers.

So, say you are a young retiree, you’re 55, well, you need to be planning on a longer than 25-year time horizon. You need to be planning on more like a 40-year time horizon. So that type of profile should be more conservative in terms of withdrawal rate.

The same goes for the portfolio’s complexion. So, say it’s someone who can only sleep at night if they have a lot of their portfolio in cash, a lot of the portfolio in bonds, and way less than 50% in stocks. Well there again, you need to be more conservative than that 4% initially. You should be more in the neighborhood of 3% or perhaps even lower. So, 4% is a decent guideline, a decent starting point, but you do need to think about your own situation.

You also need to think about how the market is behaving, so it’s not just kind of a set it and forget it thing. You need to revisit it periodically as the years go by. So even though the 4% guideline has been stress tested over a variety of market environments, all of the indications point to being willing to ratchet in your spending a little bit in those years when your portfolio is down. That can be very valuable in terms of making sure that your portfolio is sustainable throughout your whole retirement time horizon.

Maria Bruno: And I would echo everything Christine said. At the Vanguard team here, we’ve done some research around, one, looking at forward-looking projections on the asset classes, for instance. And we get this question a lot, like, “Well, is the 4% spending rule dead given where we are today with the market environment?” Not necessarily. I like to look at 10 plus year projections on a balanced portfolio. Inflation adjusted, could be within the 4%, 4-1/2% threshold, so it’s conceivable that 4% could be a reasonable starting point.

But you do need to think about, well, if there’s some market volatility, for instance, flexibility is key. Potentially, you know, having a ceiling and floor around that. And that means, well, if the markets are very generous, then you don’t have to spend everything. And I think many retirees actually do this in practice. They may or may not be realizing that they do, but you may reinvest some of the surplus back into the portfolio. That then gives a buffer during those periods where there’s a market downturn, and you might have a floor there too. So, there’s some guidelines around, you know, thresholds around that that you want to be flexible during different market conditions.

Amy Chain: And Kathy’s asking us about where to start drawing down from and what order should you start taking from which account in retirement? Christine, you want to kick us off?

Christine Benz: Sure. And I know, Maria, you and your team have looked a lot at this issue. So, kind of the standard sequence of withdrawals starts with anyone subject to required minimum distributions. Well, you have to take those because the penalty for not taking them is 50% of the amount that you should have taken but did not. So, start there if you’re subject to RMDs.

Assuming you’re not yet subject to RMDs or you need additional cash above and beyond what your RMDs provide, there the next in the queue would be your taxable accounts, so your nontax-sheltered retirement accounts. Those would be next in the withdrawal queue, mainly because you just get less benefit from holding the assets there. You have to pay, at a minimum, capital gains taxes on your withdrawals. If you’ve got bonds or something that’s kicking off ordinary income, you will owe ordinary income tax on money that you have housed within that account. So taxable accounts next, followed by tax-deferred accounts, followed by Roth accounts.

So, if you have Roth accounts, it’s important to remember that those are the most valuable to you from a tax standpoint. Their tax benefits are the greatest, there are no required minimum distributions, and they’re also really valuable assets for your heirs to inherit. So, you would probably want to put those further down in the queue.

But there are also reasons to sometimes think about bending these rules. There may be situations where, in fact, you’d want to put Roth assets ahead of other account types. So, these rules aren’t meant to be rigidly adhered to. They’re just kind of guidelines that people can use when thinking about positioning and sequencing.

Maria Bruno: Yes, I think that’s the conventional spend down. Christine and I were talking earlier today about this in that, you know, I think there may be more reason to think about does the conventional become less conventional going forward? When you think about retirees today leaving the workforce with large traditional deferred balances, they could be facing some pretty substantial required minimum distributions when they reach age 70. So, there could be some unpleasant tax surprises on those withdrawals when they’re made at a time when you’re also taking Social Security and that could trigger Social Security to get taxed if it wasn’t otherwise. So, some things that may be going on once you hit age 70 that you may want to plan for before that.

So, for instance, maybe someone who’s retiring at age 65, well, maybe it makes sense to, if you’re going to be in a relatively lower tax bracket, to draw down from those tax-deferred accounts first because it could presumably be taxed at a lower marginal tax rate. So, you’re accelerating the income tax, but you’re paying taxes at a lower rate. That’s a good thing.

The other thing is maybe a series of partial Roth conversions. So, taking advantage of those years when you may be in a lower tax rate and accelerating some income tax there to the benefit of being taxed at a lower rate. So, I think there’s some opportunity for some annual tax planning before you reach age 70 to think through whether it make sense to alter that.

Christine Benz: I love that research that you and your team have done, Maria, on what you call the preretirement sweet spot or the postretirement—

Maria Bruno: Oh, the Roth conversion zone, frankly, the sweet spot?

Christine Benz: Yes. It makes a lot of sense to me that people should look at that period from whenever they retire, whether it’s 65 or 66 or whenever, until those RMDs kick in as maybe a period to do some good tax planning.

Maria Bruno: It’s a little difficult sometimes because you really are in that situation accelerating an income tax liability. And that’s tough sometimes to think through, but it’s really understanding, well, I’m doing this, but it’s actually benefiting the longevity of the rest of the portfolio, or I might have multiple goals in retirement. Maybe have some legacy planning or charitable giving strategies. And you can be strategic on an annual basis. And that’s a highly personalized decision.

Christine Benz: Another thing in the mix is this issue of the years immediately following someone’s retirement, those are oftentimes high spending years. My colleague, David Blanchett, has done work on what he calls the retirement spending smile. And what he is seeing and observing [about] actual retiree expenses is that, that’s when people are feeling good, they might want to do their travel that they weren’t able to do so much when they were working; and so, from a practical standpoint, that might be when they want to spend more than they would in the sort of post-75-year period.

Amy Chain: Now, Christine, you’ve talked and written and spoken much about the bucket approach. We’re getting lots of questions about that. Can you explain the bucket approach to us?

Christine Benz: Sure. And I always take pains to say I did not originate what’s sometimes called the bucket approach. The person I look to when thinking about this bucket strategy and the person who’s been influential to me as a financial planner named Harold Evensky. And he told me many years ago that he was using this strategy with his clients. And the way that he positions his client portfolios, it’s simply a cash component that gets bolted on to the long-term portfolio. So, you’ve got this cash bucket, bucket number one I call it in the model portfolios I’ve done. And the basic idea is that it’s there to tide you through any number of bad situations that might happen with your long-term portfolio. You’ll know that you have your near-term income needs earmarked in true cash investments.

So, it’s a way of thinking about, well, how do I segment my portfolio based on my spending horizon? Very near-term income needs, like money that I might expect to need within the next one or two years, well, I want to hold that in cash because I don’t want that money to fluctuate in value. And then from there, for money further out in my retirement, I can gradually step out on the risk spectrum. So, for money that I might need in say years three through ten of retirement, well, bonds over a time horizon like that have historically been quite stable. They might not go up a lot, but they probably won’t go down a lot over say a five- to seven-year time horizon. So, you can earmark the next segment of the portfolio, the next spending portion of the portfolio in bonds.

And then after that, for the long-term assets, the assets that you don’t expect to need or spend for the next ten years, that’s your growth engine of your retirement portfolio. That portion of the portfolio should go into stocks. So, it’s kind of a way of segmenting your portfolio by thinking about, well, what’s the probability of having a positive return in this asset class over this particular spending horizon? I think it’s an intuitive way for retirees to back into an appropriate asset allocation.

Amy Chain: We’ve talked a lot tonight about employer-sponsored plans. We’ve got a great question from Trisha, who’s self-employed. Trisha is curious to know if her approach should be any different if she’s her own employer. Maria, would you like to answer Trisha’s question?

Maria Bruno: Well, if you are self-employed, you really need to think about what options you have in terms of creating your own retirement plan. And there’s a couple different options. It depends whether you’re self-employed or whether you have employees or whatnot. So, the reason that you want to look to these types of accounts—small 401(k)s, for instance, or SIMPLE or SEP IRAs are some of the options that are available. And, again, we do have information on our website if someone is interested in learning more, and it’s certainly something you may want to talk with a tax professional about, but the contribution limits are much greater than you would have with an IRA. And with some of them you can actually do an IRA as well. So, you want to take advantage, as Christine had mentioned earlier, to max out those tax-advantaged accounts.

The other thing, too, is that you don’t have potentially an employer who’s making a company match. So, you need to think through, well, what is my target savings rate and make sure that you’re saving toward that. And that may be higher because you don’t have a company match per se that you would if you have an employer who’s making contributions on your behalf.

Christine Benz: Yes, I would echo Maria’s comments. For me, for self-employed folks, first up would be do the IRA. So, if you are contributing the full max to the IRA, then look at some of the other vehicles.

One vehicle that I’ve been impressed with is the Solo 401(k) that historically people had said, “Oh, there are administrative tricks to setting these up.” Well, it’s gotten a lot simpler.

Maria Bruno: A lot easier. Yes.

Christine Benz: So that’s a vehicle that in a lot of ways, especially for someone who’s moving out of the context of having that employer-provided plan to being self-employed, there’s a lot of familiarity there. I think it can be a nice next step. But, again, as Maria said, if you have employees, that would not be an option. You would need to look at some of the other vehicles.

Amy Chain: Now we’re getting a lot of questions about annuities. Maria, maybe you could talk a little bit about the role annuities might play in a retirement plan.

Maria Bruno: Okay. I think when we start with annuities, it’s best to focus on income annuities. Traditionally, when you think about funding retirement or retirement expenses, an income annuity is traditionally the first thing to think through. And they’re a form of guarantee. So, I’d like to first talk about Social Security in terms of a guaranteed income stream. It’s essentially an annuity. It’s a lifetime annuity. There’s spousal benefits for those that are married for when the first spouse dies, for instance. So, there is a continuous income stream that is adjusted for inflation, for instance.

The question then becomes if, as an investor, you have other income needs, potentially baseline income needs, be it housing, set nondiscretionary retirement expenses that you feel you want to guarantee. And if so, then a low-cost income annuity might be viable. And what I mean by that is you actually use a portion of your portfolio to purchase that guaranteed income stream. So, you’re giving up that pool of money in exchange for a lifetime income stream or you could get a joint and survivor where the benefits would be payable to your spouse as well. So, there’s a security there of having your guaranteed income floor, and that potentially could give you more discretionary spending or flexibility around the remainder of your portfolio.

So, income annuities can play a role, but there are tradeoffs to it. They are a form of insurance. That insurance does come with a cost, so you want to make sure that as an investor, you do your homework and understand what the payment features are because they can vary pretty widely among the providers. And then just make sure you understand that when you purchase an income annuity, you’re giving up those assets. So those liquid assets may not be there later in retirement, but the tradeoff is you’ve got this fixed income floor.

Christine Benz: I think another thing to think about is, as Maria said, take stock of your other certain sources of income. So Social Security is certainly one, will be one for many of us. Also, if you’re a person who has a pension, probably have less of a need for an annuity in addition to the pension. So, think about your own profile, think about what you’re looking for in terms of stable sources of income.

Another point I would make is some of the other annuity types of variable products, for example, can be very complicated. The features can be complicated. It can be difficult to do your homework. And so, my advice is to ask all of your “stupid” questions. Make sure you fully understand this product before you turn your money over to the insurer. Make sure that you’re fully onboard and understand all of the features and the costs that come along with the product before buying it because they can be terribly complicated.

Maria Bruno: They can, and there are more products hitting the marketplace to overcome some of these challenges of loss of liquidity. But those are all additional features, and they all come with a cost. And it may not be clear as an investor how those costs are accounted for, so you do want to do your homework.

Annuities, I mean I think they can be very attractive. They can play a role in a retiree’s portfolio. It’s just a matter of if so, how much? And it can get complicated. And I think we have a webcast coming up on this very topic. We’re dedicating a whole webcast to this particular topic.

Amy Chain: You took the words out of my mouth. If you click on the green Resource widget on your screen, you can actually register for this webcast where we’ll spend a full hour talking about the topic, covering as many questions, of course, as we can. There’s also plenty of other resources available in that Resource list—it’s the green button. If you click on it, you can both register and see more about some of the topics we’ve been talking about this evening.

We probably have time to cover one more question, so I’m going to throw it out to both of you and ask you to give us your quick thoughts on it. And this is, “When you are at the moment of retirement, what should you do?” What should you do with your portfolio? How should you think about—Should you be making changes? Should you be changing your—Does your discussion about goals change? Go!

Maria Bruno: Okay. Not necessarily. If you’ve done your homework to get to that point, then, no, not necessarily. So, the key is to, one, make sure you’ve defined what retirement means. So, if you’re a young retiree, well, what do you want to do with your time? Can you afford to do those things? So, the planning for retirement happens before you actually pull that trigger because then, at that point, you’ve got your plans in place and you can go ahead and enjoy your shorter-term goals, for instance, and then just monitor that going forward. So, my recommendation would be to do your homework beforehand, get the plan in place, and then enjoy your retirement.

Christine Benz: One point I would make is just make sure that you have adequate liquidity in that portfolio. Make sure that you have enough in the boring stuff. My anecdotal experience in talking to retired investors or people getting close to retirement is that people have gotten really comfortable with their equity portfolios. It’s nice to see our portfolios going up every year. Just make sure that you don’t have too much staked in the equity market. You still need plenty of stocks, but you also need to set aside money in case there is a downturn, because one of the worst things that can happen in retirement is that a bear market hits right at the beginning of your retirement and you have to spend from the stuff that has gone down a whole bunch. So, you need to lay in some reserves to protect yourself against that scenario. So new retirees need to be especially cautious on that front. They need to make sure that they aren’t staking too much in stocks. They need to have more in the safe and boring stuff.

Amy Chain: All right, well, I wish we could go on, but it looks like we’ve run out of time. Thank you so much for your questions this evening. Thank you so much for sharing your wisdom. Any parting thoughts before we sign off for the evening?

Maria Bruno: No, thank you. I mean I appreciate this topic and being here with Christine. I think we’ve got a lot of good questions. And I think when you think about retirement, I mean, you know, it’s a journey and things will change throughout retirement. And the keys to success is to make sure that, much like on the savings side, that you’re investing appropriately, low cost investments, and you’re revisiting your plan throughout the years.

Christine Benz: One other point I would make is get some help. It’s never been more economical to get some kind of advice. Whether you’re a starting investor using a target-date fund to help appropriately, asset allocator; whether you are someone getting close to retirement who wants to see can I retire, check in with a planner who charges on a fee-only basis. You may be even able to pay for hourly advice. So, getting good advice has never been more economical.

Amy Chain: Very good. Well thank you to the fab Maria, the fab Christine, and our fab audience for staying with us.

In a few weeks, we will send you an email with a link to view highlights of today’s webcast along with transcripts for your convenience. And please be sure to sign up for our next webcast. As we said, the topic is Annuities, and you can register by clicking on the link in the green Resource list widget.

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From all of us here at Vanguard, we’d like to say thank you for joining us this evening.

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