To have a sound retirement plan, you need to make the most out of the things you can control but also evaluate factors that are somewhat or completely out of your control within the comprehensive retirement plan.
The retirement equation includes the following factors:
- Saving vs. spending: You have total control over this.
- Asset allocation and asset location: You have total control over this as well.
- Employment earnings and duration: You have some control over this.
- Longevity: You have some control over this.
- Market returns: This is out of your control.
- Tax and benefits policy: This is out of your control.
In retirement, you must focus on what you can control (saving vs. spending, asset allocation, and asset location):
1. Saving vs. spending:
- You have complete control over spending.
- Cash flow is king in retirement.
- You need to budget and plan for fixed expenses, variable expenses, and wants. These will change throughout retirement and your plan should change along with them.
2. Asset allocation:
- Asset allocation refers to the breakdown of your portfolio between cash/cash equivalents, stocks, bonds, real estate, commodities, etc.
- How you structure your portfolio in retirement maybe completely different than how you structured it during your working years.
- Considerations for structuring your portfolio to match your goals in retirement:
- Stable spending: How much do you regularly spend each month? Consider social security, pensions, and protected life income for these expenses.
- Variable spending: How much of your total spending varies each month? Consider cash/cash equivalents, dividend paying stocks/funds, bond/fixed-income securities, and muti-asset solutions for these expenses.
- Legacy and long-term spending: What is the time horizon for use of these assets? What is the appropriate planning strategy for your heirs and your estate goals? Consider growth-oriented portfolios, capital preservation strategies, and alternatives for these goals.
3. Asset location:
- Asset location is all about putting the right assets in the right accounts based on tax considerations. If you want an 80/20 portfolio (80% stocks, 20% bonds), you will not want each account to be allocated 80/20.
- In tax deferred accounts, you will pay tax on distributions at your income tax rate (the highest rate you could pay). Therefore, you may want your lowest growing assets located here along with income producing assets since they are tax-sheltered.
- In Roth accounts, assets inside of here grow tax free and distributions are tax free as well. Therefore, you may want your highest growing assets in Roth.
- In taxable accounts, you have to pay taxes on capital gains realized and dividends paid this year. Therefore, you may want your most tax efficient assets inside taxable accounts such as ETFs and municipal bonds.
While you need to focus on what you can control, you must also be aware of the other factors in the retirement equation. When factors somewhat or completely outside of your control change, you may need to alter your retirement plan to meet these changes. Doing so will provide confidence in your retirement plan and peace of mind to stick with your plan when changes occur outside of your control. The best retirement plan is one you can stick with.
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