How to Tap Your Assets in Retirement

For example, I assume that my Social Security and defined-benefit programs represent a conservative core of retirement income. Thus, I see no need for investments in fixed income/bonds. Since Social Security and defined-benefit payments represent 90% of income in our retirement budget, I have pursued fairly aggressive investments in tax-sheltered programs (i.e., 100% in a diversified portfolio of mutual funds). How do other retirees conceptualize and handle this issue in estimating their investment needs for retirement?

In addition, what are the patterns among current retirees regarding the required minimum distributions to be taken at age 70 1/2? Are retirees spending the funds, reinvesting distributions into other instruments (e.g. Roth or traditional IRAs), or transferring the withdrawals to others?

Finally, how do retirees typically handle health-care insurance in retirement? And, specifically, what are they doing to cover the younger spouse--when the older spouse is or could be covered by Medicare? In the case of my wife and myself, I have Medicare but have to remain on my former employer's health-care policy because my wife was on that policy prior to my retirement--and cannot be covered as a single. The joint cost for us is more than $10,000 annually ($1,500 deductible). How do other retirees address this issue until the younger spouse reaches 65 and Medicare?

Although you may not want to devote space to such topics, I would personally find it interesting to read how other retirees are addressing these and other retirement issues.

--Ken

These are important and very relevant observations and questions, and you've covered a lot of ground. I'll give you my take on the issues you've raised, but I'd invite other readers to tell me how they are handling these issues. In my private financial advisory practice, about one third of my clients are retired and many more are about to retire. So I consider these issues all the time.

Phasing into Retirement
I'm seeing more and more individuals who are opting to work part-time while transitioning into retirement. Sometimes the part-time work is planned and sometimes it's not. My clients who have continued to work part-time even though they're of retirement age seem happy and more comfortable transitioning to other interests in life. Plus, they seem very pleased with themselves for earning a little extra "pocket money." And let me say this--most of my retired or semi-retired clients tell me they are even busier than they were in their primary working years. They find all kinds of fascinating ways to spend their time, whether that be rewarding work or personal pursuits.

Sequence of Withdrawals
The issue of how to sequence your withdrawals in retirement is a particularly important one. It almost always involves careful tax planning. It's not uncommon for retirees to have many different streams of income (pensions, Social Security, nonqualified distributions, etc.) and pools of assets (taxable accounts, retirement accounts, etc.).

You can read more on sequencing withdrawals in my article, Smart Ways to Tap Your Retirement Accounts. Here's a synopsis of what it says:

• Set up a cash pool that will cover two to five years' worth of expenses. Take your regular distributions from this pool and periodically fill it up.
• As a general rule, make withdrawals from taxable assets before tax-deferred assets. If you have a particularly large IRA, there may be exceptions.
• If you're in your late 50s and must tap a retirement account, take distributions from your company retirement plan instead of your IRA.
• At retirement, consider taking out company stock held in a retirement plan (not rolling it over) to potentially convert ordinary income tax to capital gains tax.
• Use substantially equal periodic payments from IRAs to avoid the 10% early withdrawal penalty.
• Tap your Roth IRA last.

I'd add a couple more caveats to that list:

• If you are still working, delay starting Social Security payments.
• If you are under age 59 1/2 when you retire, consider taking out any aftertax contributions before you roll over a company retirement plan to an IRA. You can use those aftertax dollars to spend currently. (Technically, you can also pull out your aftertax or nondeductible contributions from an IRA without penalty, but you may find it simpler to just take the aftertax dollars as you are leaving your employer.)

The issue of when to start taking pension payments may be particularly complex. You will usually have a variety of options--taking payments over the course of your life or over the course of your life and your spouse's, choosing a guaranteed period of payments, deciding how much a spouse would get in the event of your death, etc. For more on these topics, read Don't Crack Your Retirement Nest Egg.

I find the best way to figure out how all of these pieces fit together optimally is to use some type of retirement calculator. I like the ones that allow you to see cash flows and compare bottom lines. Then you can run varying scenarios and compare the results. (You may also want to hire a qualified advisor to help you with these complicated decisions.)

Valuing Streams of Income
Because pensions and Social Security provide periodic payments, some people like to value them like the coupon payments of a bond. Here's the technical way to do that: Get any calculator with present value functions and enter the following:

• Your monthly payment is "PMT" (on the calculator)
• The number of months you expect to receive these payments is "N" (make sure you convert years to months).
• The growth rate you expect to apply to these payments is "I" (if you are using months for "N", then you'll need to convert your growth rate to months too).
• Then you hit the "PV" button to find the present value.

One word of caution: sometimes valuing streams of income like this can lead to the conclusion of placing much of the remaining investable portfolio in stocks. That may or may not be the "right" answer. If you can truly tolerate watching your nest egg go through quite volatile periods without selling at a low point, then perhaps this is the right answer for you.

On the other hand, there may be behavioral issues that cloud a strictly numeric exercise. If you think you'd be uncomfortable with that much of your portfolio at risk in the stock market, you might find a more balanced mix of stocks and bonds is better for you, even if the trade-off might mean lower overall returns.

There's also an argument for not taking more risk than you need to. Some retirees prefer to use their streams of income as a base and find the right mix of assets that will allow them to spend what they choose over their retirement lifetimes. Their preference is to take only as much risk as they need to and be content with more conservatively invested assets that they won't need to worry about.

Use of Required Minimum Distributions
Most of the retirees I work with use their required minimum distributions (RMDs) to fill up the cash pool in their taxable accounts periodically. Most take these distributions once a year. As long as you are still working, you could contribute up to $5,000 ($4,000 if under age 50) to a Roth IRA in 2007. (You can't contribute to a traditional IRA once you're over age 70 1/2.)

Retiree Health Insurance
Covering health-care costs is frequently a major sticking point in planning a happy, successful retirement. Health insurance (or the lack of it) should be incorporated into your overall cash-flow plan. As more companies drop retiree health-care benefits, I've seen people scramble to try to get something in place and figure out how to pay for it.

I usually figure private health insurance will cost about $10,000 to $12,000 a year per couple until you are eligible for Medicare. That number can go much higher depending on your health status. (I just ran one projection where the cost was $30,000 a year for a couple with significant health concerns.)

The key to managing your future health-care bills is planning ahead. If you don't know what health-care benefits your company provides to retirees, make a point of finding out. Even if your company will cover your health insurance until Medicare starts, you may want to think about a "backup" plan should your company decide to cancel that plan by the time you need it. Run your retirement projections with and without that expense to see what difference it may make as far as how long you'd need to work, how much more you'd need to save, etc.

A version of this article appeared on April 27, 2006.