The psychological shift one must go through upon the beginning of their retirement can be tricky. An individual has maintained a certain routine throughout a large portion of their adult life, has been in the habit of saving, only spending what they have earned after they have saved, and most importantly; has had the benefit of a direct income source for a number of years. How does one navigate the reality that you must now pay yourself, for possibly another three decades, and how do you structure your assets to meet all your needs?
This post follows part one where I covered accumulation strategy, today I will focus on distribution strategies educators can plan for as they prepare for retirement.
When you think about the distribution of your assets, it can be difficult to take in. You are mapping out a strategy to now take from the pie you’ve worked your entire career to bake. How do you begin planning for your distribution strategy, and how do you ensure your strategy fits what you are trying to accomplish?
I encourage educators to visualize their retirement goals as buckets. There’s always an income bucket, and a long-term bucket, and we continue to add from there to match unique personal situations. A healthcare bucket? Possibly. A bucket to pay for future weddings? We can add that. A family inheritance or philanthropic bucket? Absolutely. There’s no right or wrong answer on the number of buckets necessary – it’s about what you want to accomplish, and how we can effectively establish your buckets, and efficiently distribute your assets.
The first thing we do when planning for distributions is understand what sources of direct income are to be received in retirement. Examples of this include; a pension, social security, rental or business income, or even a part-time job. It is not uncommon for retired educators to take on the role of an adjunct faculty member, publish their writing, give presentations on their subject matter expertise, or start a consulting business. Determining what form(s) of direct income are present is extremely important, as this factors into the construction of your buckets.
After we’ve determined direct income sources, we must understand what assets have been accumulated and in what vehicle. Qualified accounts (403(b)s, 401(a)s, Roth IRAs, Rollover IRAs), brokerage accounts, emergency cash, and real estate are all examples of what must be accounted for.
A Case Study
Below is a specific example of how a distribution strategy, customized to this family, was designed based on their assets, their goals, and their fears, as they planned to enter retirement.
- Clients: Alex (68) & Samantha (67) Doe
- End of Plan: Ages 95
- Children: 3 grown children / 5 young grandchildren
- Retiring: June 1, 2021
- Positions Held: Life-long educators at a higher educational institution in Minnesota
- Desired Salary in Retirement: $10,000/month (net of taxes)
- Primary Home Market Value: $250,000 Debt: No
- Charitable: Very
- Travel: Absolutely – especially the first handful of years, while they have the energy and health
- Long-Term Care Insurance: No – and it is very important to prepare for that scenario
- Direct Income: Each will begin drawing social security upon retirement. Alex’s benefit – $2,000 & Samantha’s benefit – $2,000
- Investments: Alex’s 403(b): $1,075,000 / Samantha’s 403(b): $1,100,000 / Alex’s Roth IRA: $48,000 / Samantha’s Roth IRA: $38,000 / Cash Savings: $11,000
The Most Important Thing About Retirement Planning: Alex > “that we are able to meet all our income needs, without fearing we have to get a job. Samantha > “having the money we need and passing on assets to our children. Leaving a legacy is important.”
The Scariest Thing About Retirement Planning: Alex > “stock market volatility that I can’t handle, which forces us into a position later in life that we aren’t comfortable with.” Samantha > “paying for long-term care later in life, and not being able to leave an inheritance for our kids, or even worse, being in a position that we have to rely on our children for help with costs.”
As I do with all my clients, we took the bucket approach. With each account being assigned to something, we can invest that account according to the goal.
First, we establish their income bucket.
Alex’s 403(b): Total Account Value – $1,075,000 / Alex’s income bucket (in this case) is five-years of their need in retirement. If we are supplementing $72,000/year to fill in their annual desired salary, we need to invest $360,000 accordingly. Alex’s allocation: 65% Equities / 35% Fixed Income.
Samantha’s 403(b): Total Account Value – $1,100,000 / Samantha’s income bucket (in this case) will be five-years of their need in retirement. The math is the same as above and so is the thought process. Samantha’s allocation: 65% Equities / 35% Fixed Income.
Their income buckets are set. They now have a combined ten years of income, outside of their social security, tucked away in assets that are not exposed to the equity markets. This allows them an immense level of flexibility as they distribute their assets in retirement. With a global equity allocation, and $720,000 invested in fixed income, their ability to avoid sequence of returns risk right as they begin retirement is much stronger. Their distribution strategy is nimble – Alex and Samantha can pull from their fixed income bucket if equities are volatile, or if equities are surging, they can pull from their gains and leave their income bucket intact. The idea is to avoid pulling from their investment principal as much as possible, and this risk can be mitigated with an allocation that has purpose.
The next goal for Alex and Samantha was to prepare for long-term care expenses and leave a legacy for their children.
Alex’s Roth IRA: Total Account Value – $48,000. Since we have the income bucket for Alex established, utilizing the Roth IRA and its tax advantages for the long-term is an ideal option. We can allocate this account to a 100% equity portfolio to plan for long-term care expenses down the road. Understanding compound interest, if this account grows by an average real rate of return of 5% and Alex begins to accrue long-term care costs at the age of 85, his Roth IRA will now have a balance of $110,016. This balance can now be relied upon in one of two ways. 1) To help offset the cost of long-term care expenses outside of the funds that remain in his 403(b) 2) As a designated “inheritance” bucket. If long-term care costs are never incurred, and Alex passes away at age 85, he has given a tax-free gift to his beneficiaries. If he lives to age 95 without incurring any long-term care costs, his Roth IRA (assuming the 5% real rate of return) is passed on with an account value of $179,205. The idea here is simple – to allocate the portfolio with a purpose. Alex’s allocation: 100% equities.
Samantha’s Roth IRA: Total Account Value – $38,000. The exact same idea applies. Samantha can designate this as her “emergency health care and inheritance” bucket, too. Using the same assumptions as above, at age 85 Samantha’s Roth IRA is equal to $91,451 and at her age 95 she has $148,964. Samantha’s allocation: 100% equities.
If both Alex and Samantha end up accruing the costs that come with long-term care at their respective ages of 85, they would have a combined total of $201,467 in tax free funds to use, and they have a home worth $250,000 that could be sold to further fund the need. That’s just over $450,000 of assets designed to meet this need, without even considering their 403(b) plans.
Alex and Samantha now have their four investment accounts allocated, with a very specific and distinct plan for distributions. Withdrawing from the income bucket if their equity positions are down or withdrawing from their equities if they can capture gains to keep their portfolio allocation balanced. They can sleep at night knowing they have a plan in place for health care emergencies, and they have over ten years of their income invested away from the equity markets.
Putting together portfolios with a purpose, and understanding every piece of the accumulation puzzle, is required for an accurate distribution strategy.
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Diversification and asset allocation do not ensure a profit or guarantee against loss.
The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
The views expressed are those of BerganKDV Wealth Management. They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm. Investment advisory services and fee-based planning offered through BerganKDV Wealth Management, an SEC Registered Investment Advisor.
 The Alex & Samantha Doe case study has had personal dates & details altered for privacy.
 Roth IRAs grow tax free, and the distributions are tax free. Since you fund a Roth IRA with cash that has already been taxed, you are not taxed on any gains ordistributions of your direct contributions. Account earnings are subject to the 5-year rule. RMDs are also never required with a Roth IRA.
 Real Rate of Return is your gross return minus inflation. In this case, we’ll use annual inflation as 2%