Making Sense of Retirement Planning - 2

Retirement planning online calculators typically help with two distinct phases: accumulation and distribution.

Accumulation takes place before you retire. You figure out what you'll need to support yourself in the style to which you aspire and the calculator tells you how much you need to save and invest to accumulate an amount that might satisfy that aspiration.

Distribution begins after you quit working (or ease up). Instead of investing your savings to build up your investments, your investments now need to produce income. Since you're not working, and therefore not earning anything (earned income), you need some other source of income. For most people, this consists of social security, what they build up in retirement accounts (e.g., 401ks, IRAs, etc.) and other personal savings and investments (e.g. brokerage accounts). Some lucky folks still get pensions from their companies, but those numbers have dwindled over time.

Calculators crunch numbers. As such, they rely on assumptions about how much you'll save, over what period of time, how your investments will perform, etc. The more assumptions you use, the less accurate the calculations will likely be, so be careful with these calculators. Nevertheless, you will likely use some sort of calculations to get some "ballpark" numbers that you need to save to support your lifestyle when you retire.

But there are other aspects of retirement planning that also play an important role in how you live when you stop working, or stop working full time. These rely less on the assumptions that go into figuring out your social security and/or pension payout, as well as expected investment returns you think you need in retirement. A study by the American College tries to quantify the importance and impact of these items on your retirement planning. Here's a list of the items they considered along with their estimated impact:

Social Security claiming decision: 

• You can claim reduced benefits at age 62 (earliest available age), full retirement benefits at age 66 or later (depending on when you were born - see SSA.gov), or wait until you're age 70 1/2 for increased annual payouts. There's more variation than this, especially if you're married, but you get the point.

Dynamic withdrawal strategy

• An example of this is withdrawing 4% of your investment assets each year, with an adjustment of inflation, or perhaps a reduction or increase based on investment returns in a given year. 

Tax efficiency

• The interest from bonds is taxed as ordinary income rates; the dividends from stocks typically are taxed at a lower rate, as are long-term capital gains from stocks held more than a year. Should you hold tax-free bonds? Should you place taxable bonds in a qualified (e.g. IRA) account so the interest isn't taxed unless you receive it? Question abound, but just know that portfolios can be constructed to more efficiently utilize these different sources of income.  

Total wealth asset allocation

• Look at all your accounts, including social security or any fixed income source like a pension. Decide how much to hold in fixed income, vs. stocks, vs. other asset classes, based on the amount of income you need and the timing of the distribution of that income (monthly, quarterly, annually, less now, more in later years or vice-versa, etc.)

Annuity allocation

• The use of an annuity is frequently overlooked, especially in our era of low interest rates, since low rates reduce relative payouts from annuities. But there are certain tax advantages of annuity payouts, in addition to the attractive feature (for some) that you can count on the income no matter what the markets are doing (assuming the insurance company that issues the annuity remains solvent of course!).

Liability relative optimization

• This item's a bit more technical and has to do with evaluating your portfolio based on a framework using what's called "mean-variance optimization." Unless you're schooled in this, you might want to consult a professional. Then again, as you'll see below, it's got the least % impact overall.

The study claims that making good decision in these areas results in the following improvement (in descending order) to your overall plan:

• Social Security claiming decision: 9%
• Dynamic withdrawal strategy: 8.5%
• Tax efficiency: 8.2%
• Total wealth asset allocation: 6.1%
• Annuity allocation: 3.8%
• Liability relative optimization: 2.2%

I don't know how they arrived at these percentages, but the American College is a reputable institution and the factors discussed are relevant. They will impact your plan, so give them serious consideration.

We'll discuss more about retirement planning in the future.

Meanwhile, it's already June and in a month 2017 will be half over. Time flies - which is one simple reason why you need to plan for your retirement if you haven't already started.