The Income Timeline

How Much Energy is There in Your Retirement Plan?

Fueling your clients’ investments to get them all the way through… whatever the timeline

by Herbert K. Daroff, J.D., CFP®

Mr. Daroff is affiliated with Baystate Financial Planning, Boston. He is a contributing editor to Life & Health Advisor Magazine. Connect with him through e-mail: [email protected]

When I was asked to write this article, the publisher anticipated that my focus would be on how the decline in energy prices would adversely affect investment portfolios holding those assets, but would decrease the expenses of those utilizing those energy products.

The price of a barrel of oil has dropped from $145 in July 2008 to under $30 today. The lower price results in a LOWER need for income to cover the cost of gasoline for your car, home heating oil, and other petroleum based products (including many plastics).

The lower price also LOWERS the return you have on your investment portfolio depending on how it is weighted towards oil.

Energy: The Power Derived from Resources

However, I have chosen to use “energy” in a more encompassing manner.

Energy is the power derived from resources. In physics, chemistry, and biology, it is the ability to provide heat and light, to drive machinery. In finance, it is the ability to provide for the payment of living expenses.

There was a famous commercial where a man was holding a seven digit number over his head. “This is what I need for retirement,” he said. The reality is that what he really wants is sufficient cash flow to cover his lifetime expenses.

His “number” for the amount he thinks he needs at retirement is based on a number of assumptions. Individual retirement goals should be based on purchasing power, not a set amount of income, or a set dollar amount at retirement.

A sample goal would be, “I want to maintain my current standard of living after I stop receiving paychecks.” The amounts depend on a series of assumptions, including:

Individual retirement goals should be based on purchasing power, not a set amount of income, or a set dollar amount at retirement

  • How long will I live?
    – How long will by spouse live?
    – What do I want to leave for my children?
  • What will my tax rates be for the rest of my life?
    – Even if my income is lower, will I necessarily be in a lower tax bracket than I was while I was receiving regular paychecks
    – Over the first 100 years of the Internal Revenue Code, the average top bracket was over 60%. Today, that top bracket is ONLY 39.6% = 3.8% for ACA = 43.4%
  • What will my cost of living be for the rest of my life?
    – Given inflation, but cost of living also depends on where you live.
  • What expenses will I incur that I don’t incur now?
    – For example, the costs of healthcare, the costs of custodial care, etc.
    – Also, consider the expenses that may be incurred for other close family members (i.e., parents, grandparents, children, grandchildren, etc.)
  • What will my investments yield and what is the sequence of those ups and downs?
  • What will I generate from Social Security?

So, the financial ad with the seven digit number should have included the disclaimers that the pharma ads have. This may treat your ailment, but it could create all new ailments in the process. This number may provide your desired retirement income, provided:

  • you don’t outlive your mortality assumption,
  • all of your personal assumptions were accurate, and
  • the government doesn’t change all the rules,

So, does your retirement plan (not just your portfolio) have sufficient “energy” to provide for a moving target? What “fuels” such a plan? The answer is Asset Allocation only when it is coordinated with Asset Location:

 

 

TAX RATES UPTAX RATES DOWN
MARKET UPRoth and Roth Look Alike portfolios

(life insurance cash value)

COORDINATED WITH

Traditional Taxable

Portfolios

Traditional Retirement

Accounts

COORDINATED WITH

Traditional Taxable

Portfolios

MARKET DOWN 

Roth and Roth Look Alike portfolios

(life insurance cash value)

COORDINATED WITH

Hedged Portfolios

(variable annuities with lifetime benefit riders

that lock in returns based on up markets)

Traditional Retirement

Accounts

COORDINATED WITH

Hedged Portfolios

(variable annuities with lifetime benefit riders

that lock in returns based on up markets)

 

Traditional Retirement Accounts

Not invested in things like large cap U.S. value stocks, which are purchased to take advantage of long term capital gains and dividends, but inside a traditional retirement account, all become ordinary taxable income, so, this may a good place to purchase fixed income assets.

Traditional Taxable Portfolios

Good place to hold large cap U.S. value stocks To take advantage of the lower tax rates for long term capital gains and dividends.

Hedged Portfolios

(Variable annuities with lifetime benefit riders that lock in returns based on up markets) Invested primarily in the most volatile and tax inefficient asset classes (e.g., small cap and international)

Roth and Roth Look Alike portfolios (life insurance cash value)

Good place to balance the rest of the asset allocation and, the death benefit from the life insurance can be used to fund a Roth Conversion at death of the Traditional Retirement Accounts.