5 Steps to Prepare Your Retirement Plan Distribution Strategy

Bridget Handke, CFP®, CAP®
Dec 9, 2021 11:45:00 AM


As a financial advisor for nearly 20 years, it’s been gratifying to help people strategize, plan for, and pull the trigger on retirement. For some people, it’s a lifelong dream to retire. For others, retirement is just another chapter in their life. It can be challenging to decide when to retire. But once the decision is made and the client gives notice at work, invariably, they turn to us and say, “Now what?”

Clients want to know what the actual process is of financing their retirement. For example, how do they calculate how much they need to live? Do they live off bond income or sell some stocks? What account do they use first? How do they get money in their account? In this article, I’ll discuss the process of funding retirement.

Homework to Be Completed Before Setting a Retirement Date

Before calling it and giving your notice, hopefully, you have done two things: 

  1. Determined how much you spend on a regular basis.
  2. Run that spending number through financial planning software to determine your probability of success for retiring.

How Much Do You Spend?

The last thing you want to do is retire thinking you spend $7,000 per month only to realize you spend $9,000 per month. Look at your household bank statement to calculate your average monthly expenses.

Then, add the extras that occasionally occur throughout the year. Examples include property tax, insurance bills, vacations, medical bills, eyeglasses, and car and home maintenance and repairs.

In the case of maintenance and repairs, account for potential bigger ticket items that may arise, such as roof replacement or home residing.

Will your lifestyle change? Now that you have more time on your hands, could you spend more money in retirement than you had during your working years? Will you travel more? Will you take up a hobby, such as golf?

Run the Spending Estimate Through Financial Planning Software

Once you have your spending number, you can work with a Financial Advisor to run it through financial planning software. We generally separate basic monthly needs from health insurance to use a different inflation rate. Additionally, we split some of the retirement extras, such as travel since most people don’t travel well into their 80s. But they will continue to spend money on food. That way, we can put different term lengths on different expense items. For example, basic monthly needs last until the end of the plan, where travel might only last 20 years. Once you enter the various expense items into the plan, you can see what your probability of success is estimated to be. Hopefully, you haven’t given notice until your likelihood of success is in an acceptable zone of about 75% or above.

Can You Live off Bond Income?

Back in the days of our grandparents, there was a saying, “Never touch the principal.” This meant you can spend the income from your investments but don’t sell any of your stocks or bonds. When I graduated high school in 1979, my grandparents had been retired for a while. A quick Google search shows me the average 10-year Treasury in 1979 was paying 9.43%. So, if a person needed $8,000 per month in retirement over and above their Social Security and pension income, they could have a portfolio of $1,305,000 in bonds paying 9.43%, pay a blended tax rate of 22% and live on $8,000 per month. In reality, they would have wanted a larger portfolio so they could keep up with inflation.

Currently, the 10-year Treasury is paying 1.53% (this number fluctuates daily). So, using the above example, a person who spends $8,000 per month and relies on bond income to pay for their lifestyle would need a portfolio of over $8,000,000. And that doesn’t allow for spending to keep up with inflation.

Most people utilize a total return strategy these days. This strategy involves selecting an asset allocation, such as 60% stocks and 40% bonds and then following the market cycle and the asset allocation drift to sell the stocks or bonds to utilize those funds for your spending. For example, if you have a 60% stock and 40% bond portfolio and the stock market gains 15% in one year, your portfolio may have drifted to a 66% stock and 34% bond portfolio. In that case, your stock portion grew and made your portfolio bigger, but also outside of the target allocation. As a result, the stocks can then be sold to provide monthly income and rebalance the account to the target allocation.

On the other hand, if stocks declined 15%, then the opposite is true. This is because the bonds would represent a more significant percentage of the allocation than the target, and the bonds would be sold to provide you with monthly income.

What Account Do You Withdraw From First?

Let's say you have a nice diversification of accounts. You have a joint account, a couple of Roth IRAs, and a couple of Individual Retirement Accounts (IRA). What account do you use first?

It depends on your situation. Did you retire at 65 and will wait until age 70 to start your Social Security? If so, and you have significant savings and a joint savings or investment account, you might use the assets from those accounts first. This strategy can result in very little income since using savings creates no income.

Selling assets from a joint account only creates income if there is gain in a security that is sold. If this is the case, we might suggest you convert some dollars from your IRA to your Roth. Doing so will cause you to pay tax on the amount converted. But if you have very little other income, you might be able to do the conversion and only pay 10% or 12% of federal tax. Doing so will reduce your overall IRA and future Required Minimum Distributions (RMD), which you might otherwise have to withdraw and pay tax in the 22% or 24% range after you turn age 72. Doing a conversion in this circumstance could lower your overall 10-year tax bill.

What if you don’t have a joint account but only an IRA and a Roth? In that case, we would look at having you take distributions out of your IRA up to a particular tax bracket, and before you cross over to a higher bracket, we might suggest the rest of your funds come from your Roth.

Deciding what account to withdraw from depends on your unique situation. Considerations include the amount of resources in each account and your current and future tax brackets. Financial advisors can help develop a plan and then run tax illustrations every year to dial in which account to use each year.

How Do You Get Money Into Your Account to Pay Bills?

Some of our clients take a distribution once a year and manage their monthly payments manually each month. This approach can take a lot of effort on your part and constant account monitoring. This is stressful for some clients.

Most of our clients request that we send them money every month to create a retirement paycheck. Once you’ve decided how much you need each month, and after we’ve determined from what account the funds should come, our investment team determines which investments to sell to get you the funds. We set up an automatic distribution to land in your account the same day every month. If funds come from an IRA account, taxes can be withheld so you don’t have to worry about paying tax quarterly. We’ve learned this method is the most familiar since people have received monthly income since they started their careers. It’s predictable and also provides some visual guidance and boundaries on what is a sustainable spending level.

It can be exciting as well as nerve-racking to retire. Having a game plan for your retirement paycheck and understanding how you will receive money to continue paying bills can help alleviate the stress of the unknown—knowing the “how” of things can make it a lot easier to manage after you’ve determined “when” to retire.

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Topics: Retirement

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