You’ve spent years investing so you can retire on your terms. But as your employer paychecks stop, you’ll need a strategy to help ensure your portfolio lasts as long as you need it to.
Align your investments with your goal
Portfolio growth still matters since inflation doesn’t retire. But you’ll also need investments designed to help provide for your current income needs and provide more stability. It helps to understand the purpose of your investments in retirement.
Cash — You may be tempted to load up on cash, given its relative safety. But too much cash can cost you in terms of missed investment opportunities.
To calculate how much cash you may need:
- Add up a year’s worth of living expenses.
- Subtract outside sources of income, such as Social Security, a pension or an annuity payment.
The total gives you an estimate of the amount of cash to hold for retirement spending. This is in addition to any cash you’ve saved for emergencies, investment purposes or other goals.
Short-term fixed income — Consider creating a ladder of certificates of deposit (CDs) or other short-term investments that will mature annually over the next three to five years. This can provide the annual income you need your portfolio to generate.
Investors should evaluate whether a CD or bond ladder and the securities held within it are consistent with their investment objectives, risk tolerance and financial circumstances. Including callable bonds may increase the interest rate risk of a bond ladder. Bonds may be called prior to maturity, which could result in lower yields with new investments.
ADA description: This table illustrates how a CD ladder works. Over five years, you buy CDs of varying maturities and then reinvest the amount into a five-year CD each time one comes due.
Bonds and other fixed-income investments
These provide interest that can supplement your near-term income. They also can provide income over the intermediate term. We recommend considering a laddered bond portfolio of individual bonds or bond mutual funds to round out your fixed-income portfolio.
Stocks and other growth investments
These can provide growth and rising income potential to help outpace inflation and provide for your income needs years from now. You’ll want to diversify within your stock portfolio as well.
The equities you own may lean toward larger, higher-quality dividend-paying companies and those with the potential to increase their dividends over time.* This helps provide rising income. That said, we recommend investing in small and midsize companies as well — for diversification purposes and to provide growth potential for your needs down the road.
*Dividends can be increased, decreased or eliminated at any time without notice.
Make sure your withdrawals are efficient
Ideally, you should maintain a year’s worth of income needs in an account set up just for retirement spending. The money in this account can come from outside sources such as Social Security or a pension, annuity payments (if applicable) and the amount you’ll need from your portfolio. This account should be separate from your emergency savings.
When it’s time to refill your spending account, consider this sequence as a guide:
- Outside income sources — Start with your Social Security and pensions.
- Guaranteed income — Factor in withdrawals from annuities with lifetime income (if applicable).
- Required minimum distributions (RMDs) — Add RMDs from any IRAs (if applicable).
- Dividends and interest — Include dividends and interest from taxable accounts (including municipal bond interest).
- Sales from your investments — Add proceeds from maturing investments (such as the CD ladder mentioned above) or investment sales. You’ll want to remain sensitive to rebalancing and taxes, with the withdrawals taken in this order:
- Taxable accounts
- Traditional retirement accounts
- Roth retirement accounts
Putting guidelines into practice
When considering which account to use for distributions:
- Depending on your circumstances, it might make sense to take from your traditional IRA or 401(k) before (or in addition to) your taxable accounts to use space in the lower tax brackets. This could also potentially decrease your tax burden in the future by helping to reduce RMDs later in life.
- It may make sense to take distributions from a Roth IRA or Roth 401(k) in certain years to prevent you from moving into a higher tax bracket.
- If you have several accounts with the same tax treatment (such as multiple traditional IRAs), consider items such as cost differences between accounts, the purpose of the account and rebalancing opportunities.
While this framework is a good starting point, your portfolio or circumstances may change how you take distributions. Before deciding to sell an investment, talk with your financial advisor about the following:
- Are there opportunities for tax-loss harvesting?
- Are you overweight in certain investments and can rebalance?
- If you’re taking your RMD but don’t need the money, could you consider strategies such as taking the distribution in kind or making a qualified charitable distribution?
- Do any investments have a higher cost basis relative to current value (potentially providing a lower capital gain or higher capital loss)?
Your retirement income strategy
Keep in mind that your strategy can change depending on your circumstances. You’ll want to talk with your tax professional each year about your expected income and withdrawals.
Your financial advisor can help you position your portfolio to provide the income you need when you need it. This can help you better navigate the changing market environment during retirement and help provide you with the ongoing paycheck you need to help you live the retirement you deserve.