Retirement is top of mind for many of us, especially those of us who can see the finish line less than a few years away.  You’ve likely saved your entire life and developed a nice nest-egg of assets.  You’re modestly confident you have enough money to retire comfortably, but you’re still unsettled. Why? You haven’t quite figured out how to turn your life savings into a lifetime of income.

We’ve created this case study to demonstrate how Shakespeare helps clients create a Retirement Income Plan that will work through various market cycles and provide income for the rest of your life.  We’ll also touch on a few issues to consider as we navigate into retirement.

• Retirement Income Planning
• Social Security
• Pensions
• Investments
• RMDs
• Taxes

Meet Bob and Mary:
Bob is Vice President of a local company and Mary is a nurse working 30 hours per week at a local hospital. They both plan to retire this year; although Bob plans on working 20 hours a week for a few years into retirement for one of his key customers.

A little about the couple:

Age
Bob: 66 | Mary: 62

Income
Bob Salary:  $175,000| Mary Salary:  $45,000
Hobby Job:  $40,000 | Mary Pension:  $18,000/year

Assets 
Bob IRA:  $50,000 | Mary IRA:  $250,000 | JT Brokerage Assets:  $750,000
Bob 401k:  $1,100,000 |  Mary 401k:  $160,000 | JT Bank Assets:  $100,000
Deferred Comp:  $150,000

Real Estate
Home Value:  $450,000 | Property Taxes:  $6,000 | Mortgage:  $200,000
Cottage Up North:  $250,000 | Property Taxes :  $3,000 | HELOC:  $20,000

Net-worth                                         
$3,060,000

Desired Living Expenses 
$175,000/year (gross)

Bob and Mary have 4 primary life goals:

1. Generate a reliable income stream in retirement to maintain their current lifestyle
2. Moderate risk to protect against a significant market downturn
3. Minimize taxes where possible
4. Keep pace with inflation.

Let’s review Bob and Mary’s financial situation and the retirement income strategies we deployed to prepare for life in retirement.

Retirement Income Strategies

Wage & Pension Income

Bob’s willingness and desire to work in retirement provides an added cushion and confidence to their financial plan. The $40,000 of income he will make working part-time the first few years of retirement relieves added pressure on their financial assets and defers distributions from their assets into future years.  Mary’s pension, which had been frozen years ago, will contribute $20,000/year. These two income sources total $60,000, which will put Bob and Mary on their way to reaching their goal of having $175,000 of gross income in retirement.

Social Security Planning

Bob has reached full retirement age of 66.  Mary is eligible to take a reduced benefit now that she is age 62. After reviewing their earnings history and benefit projections we elected to begin Mary’s reduced benefit right away, which is $15,000/year. Bob’s benefit at age 66 is $26,000/year. We elected to defer Bob’s benefit until he reaches age 70, when it will be $35,000/year. His benefit will grow by 8% each year of the deferral; and the larger delayed benefit will last the longer of Bob or Mary’s life. This will provide longevity protection, in addition to tax planning benefits, in the event one of them lives well into their 80s or 90s. Their good health, plus Mary’s younger age, contributed to this decision.  Adding Mary’s Social Security to the equation, they are up to $75,000 of gross income. This leaves $100,000 of income that they will need to come up with each year.

Income from Portfolio

Bob & Mary need to supplement the above income sources with $100,000 from their financial accounts. Their investment accounts exceed $2.5mm, so drawing $100,000 from their portfolio results in a 4% withdrawal rate.  There has been strong academic research that has shown 4% to be a safe withdrawal rate, ensuring that they won’t run out of money if their initial distributions do not exceed this percentage.

Their financial accounts are invested in a diversified portfolio, with 60% invested in equities and 40% in bonds (see householding below). The holdings in their accounts produce approximately 2% income in the form of dividends and bond interest. The remaining 2% will be generated each month using a rebalancing strategy, where assets that have grown outside of the targeted range will be sold so the portfolio remains within the appropriate risk tolerance even after the withdrawal. Generally, if equity markets are doing well, we sell equities. If equities are doing poorly, we utilize fixed income securities to provide the needed proceeds. Whether we sell securities from their brokerage account or from their IRAs is a function of their tax situation in a given year (see tax section below).  We have successfully attained Bob and Mary’s $175,000 income goal using all of their available income sources!

Logistics

Shakespeare will establish a monthly transfer from their investment accounts to their bank account totaling $8,500/month ($102,000/year). From Bob and Mary’s perspective, they will receive the monthly amount needed to facilitate their lifestyle; they own sufficient fixed income assets to protect them during a prolonged market downturn, and sufficient equities to keep their assets growing at a rate above inflation.  Of course, we coordinate and manage all of the above behind the scenes so Bob and Mary don’t have to worry about it.

Tax Management & Householding

After Bob retires from his career job, his income will drop significantly.  In reviewing their tax situation, we identified they will be in the middle of the 22% income tax bracket from the date he retires until he begins his Required Minimum Distributions (RMDs) at age 70 1/2.  To take advantage of this low income tax bracket, and recognizing that they will be in a higher bracket once their RMDs begin, we will facilitate partial Roth Conversions to the extent we can maximize their 22% tax bracket. This strategy will reduce future RMDs, and lower their lifetime taxes.

Householding is a sophisticated strategy that helps lower lifetime taxes.  It entails the placement of tax inefficient asset classes such as bonds and REITs into retirement accounts and then allocates tax efficient assets such as equities (via ETFs) into brokerage accounts.  Bob and Mary will achieve their goal of maintaining a moderate risk portfolio, with each account holding different securities based on their tax characteristics.  This is a complex strategy, but when coupled with other strategies, is another tool in controlling taxes, moderating risk, and providing income. A knowledgeable financial advisor with sophisticated software is required to implement this strategy efficiently.

Note:  An additional tax strategy that will be utilized includes the gifting of appreciated securities from their brokerage account to facilitate charitable intentions until Bob turns 70 ½.  At 70 ½, future gifts will be made via Bob’s IRA which will lower their Adjusted Gross Income.  Several other strategies will be utilized related to the timing of their Social Security and Pension benefits; but we won’t cover that in this case study.

Investment Performance

Having investments that provide competitive returns, at low cost, and in a tax efficient manner is critical to a successful retirement plan. Shakespeare assembles and manages portfolios that meet these specific needs. Notice, however, that none of Bob and Mary’s primary objectives are related to beating the S&P 500 or outperforming the markets. Their main concerns relate to providing needed income, protecting principal, growing faster than inflation, and minimizing taxes where possible.  Having a portfolio geared toward outperforming the S&P 500 violates several of these goals – and isn’t suitable for most clients looking for a secure retirement.

 

Bob & Mary have the confidence in knowing their lifestyle won’t change in retirement. This provides peace of mind and allows them to focus on the most important things in life.

Note:   A comprehensive financial review must be done to properly analyze your retirement readiness. If you’re serious about your retirement and would like to learn more about our financial planning process, give us a call at 262-814-1600.