Retirement can be daunting to figure out, because the implications of your choices tend to get magnified. A market drop or negative health event could destroy your chances of the retirement you always worked and saved for. Making portfolio allocation decisions and choosing when to take Social Security can add to the complexity of retiring.
Rather than focusing on paralyzing minutia of retirement, let’s start with the big picture at 30,000 feet up. You are reading because you want to be guided on how to make prudent retirement decisions. “Nothing is more difficult, and therefore more precious, than to be able to decide.”1
The foundational principles discussed that can help you make decisions about your retirement are from Modern Retirement Theory (MRT).2 MRT views retirement expenses as current liabilities that must be matched with current income, derived from your assets, or as contingent liabilities that must be mitigated, or planned for by the assignment of available balance sheet assets (everything you own).
You will need a way forward and the best way to make your decisions is based on facts. The perfect retirement plan is one where the adviser knows all sorts of facts like when you will die and what will happen to the market, your health, and estate laws between now and then. Since no one knows the future in your individual situation, let’s admit what we do not know as material facts in helping guide you toward making decisions about retirement. Acknowledging the unknown allows us to prioritize the decisions you must make about your retirement.
MRT seeks to employ strategies that meet retirees’ goals in any market, mitigate and transfer longevity risk and conditions within longevity risk, are tax efficient, and maximize assets. This is accomplished by prioritizing and disbursing the retiree’s balance-sheet assets into four broad categories. Listed in order of priority, the four funds are:
- Base Fund
- Contingency Fund
- Discretionary Fund
-
Legacy Fund
Base Fund
Step 1: Evaluate your expenses. List all expenses you incur over a year and then categorize them as Base (mandatory) Expenses or Discretionary.
Step 2: Examine your possible retirement income sources like Social Security at various ages, pensions, Individual Retirement Account (IRA) distributions, interest or dividend income and part-time work. Retirement income should be secure, stable, and sustainable.3 If the income comes from a third party on a contractual basis, then classify it as Base Income. Base Income should be matched to satisfy Base Expenses. Only income that offers some kind of guarantee should be used in the Base Fund. The lower the mandatory expenses, the lower the on-going income needs, which can help overall tax efficiency.
Step 3: List all of your assets and debts. It is advisable to enter retirement debt free. To the extent that you have not covered your Base Expenses with Base Income, consider how you can convert some of your current assets into retirement income sources in tax efficient ways. If there are still assets remaining, build the next fund.
Contingency Fund
Step 4: Evaluate any highly improbably, yet highly consequential events. List all the possible items you want to protect against, like long-term care or a negative market cycle, then actively mitigate or transfer some of the risk to a third party like an insurance company or actively accept the possible risk through designating a balance sheet asset to this risk. For example, if you want to retain the long-term care risk, you may decide to use a paid off house as a way to cover all or a portion of a possible long-term care event.
Discretionary Fund
Step 5: Retirees can change gears with this fund, since we are focusing on wants vs. needs. List all of the things you would ‘like’ to do (travel, future car purchases, etc.) and designate balance sheet assets to pay for these items. If you are using a diversified portfolio to cover these, you would be accepting forgoing (the ‘wanted’ item) if the market turns negative or you cannot withdraw enough from your portfolio to cover the expense that year. Yet, your mandatory lifestyle would still be protected by your Base Fund and preserved through your Contingency Fund.
Legacy Fund
Step 6: List any legacy goals. If asset levels permit, designate assets for your legacy goals. These goals should be viewed as secondary to providing lifetime retirement income and protection against the financially devastating.
There are many complex and various assumptions, changing life factors, market fluctuations, and human emotions that get in the way of accurately predicting an individual’s future in a financial plan. A retirement plan that prioritizes needs and wants and segments them based on preserving and protecting all you have built is vital.
At best, a financial plan will offer a compass heading into retirement. Rather than constructing a plan that is primarily dependent on performance of a portfolio and a safe withdrawal rate, every retiree must face up to and plan for the unknowable questions of longevity and conditions within longevity. Seek the help of a qualified financial adviser to guide you through your retirement decisions.
Retirement can be daunting to figure out, because the implications of your choices tend to get magnified. A market drop or negative health event could destroy your chances of the retirement you always worked and saved for. Making portfolio allocation decisions and choosing when to take Social Security can add to the complexity of retiring.
Rather than focusing on paralyzing minutia of retirement, let’s start with the big picture at 30,000 feet up. You are reading because you want to be guided on how to make prudent retirement decisions. “Nothing is more difficult, and therefore more precious, than to be able to decide.”1
The foundational principles discussed that can help you make decisions about your retirement are from Modern Retirement Theory (MRT).2 MRT views retirement expenses as current liabilities that must be matched with current income, derived from your assets, or as contingent liabilities that must be mitigated, or planned for by the assignment of available balance sheet assets (everything you own).
You will need a way forward and the best way to make your decisions is based on facts. The perfect retirement plan is one where the adviser knows all sorts of facts like when you will die and what will happen to the market, your health, and estate laws between now and then. Since no one knows the future in your individual situation, let’s admit what we do not know as material facts in helping guide you toward making decisions about retirement. Acknowledging the unknown allows us to prioritize the decisions you must make about your retirement.
MRT seeks to employ strategies that meet retirees’ goals in any market, mitigate and transfer longevity risk and conditions within longevity risk, are tax efficient, and maximize assets. This is accomplished by prioritizing and disbursing the retiree’s balance-sheet assets into four broad categories. Listed in order of priority, the four funds are:
- Base Fund
- Contingency Fund
- Discretionary Fund
-
Legacy Fund
Base Fund
Step 1: Evaluate your expenses. List all expenses you incur over a year and then categorize them as Base (mandatory) Expenses or Discretionary.
Step 2: Examine your possible retirement income sources like Social Security at various ages, pensions, Individual Retirement Account (IRA) distributions, interest or dividend income and part-time work. Retirement income should be secure, stable, and sustainable.3 If the income comes from a third party on a contractual basis, then classify it as Base Income. Base Income should be matched to satisfy Base Expenses. Only income that offers some kind of guarantee should be used in the Base Fund. The lower the mandatory expenses, the lower the on-going income needs, which can help overall tax efficiency.
Step 3: List all of your assets and debts. It is advisable to enter retirement debt free. To the extent that you have not covered your Base Expenses with Base Income, consider how you can convert some of your current assets into retirement income sources in tax efficient ways. If there are still assets remaining, build the next fund.
Contingency Fund
Step 4: Evaluate any highly improbably, yet highly consequential events. List all the possible items you want to protect against, like long-term care or a negative market cycle, then actively mitigate or transfer some of the risk to a third party like an insurance company or actively accept the possible risk through designating a balance sheet asset to this risk. For example, if you want to retain the long-term care risk, you may decide to use a paid off house as a way to cover all or a portion of a possible long-term care event.
Discretionary Fund
Step 5: Retirees can change gears with this fund, since we are focusing on wants vs. needs. List all of the things you would ‘like’ to do (travel, future car purchases, etc.) and designate balance sheet assets to pay for these items. If you are using a diversified portfolio to cover these, you would be accepting forgoing (the ‘wanted’ item) if the market turns negative or you cannot withdraw enough from your portfolio to cover the expense that year. Yet, your mandatory lifestyle would still be protected by your Base Fund and preserved through your Contingency Fund.
Legacy Fund
Step 6: List any legacy goals. If asset levels permit, designate assets for your legacy goals. These goals should be viewed as secondary to providing lifetime retirement income and protection against the financially devastating.
There are many complex and various assumptions, changing life factors, market fluctuations, and human emotions that get in the way of accurately predicting an individual’s future in a financial plan. A retirement plan that prioritizes needs and wants and segments them based on preserving and protecting all you have built is vital.
At best, a financial plan will offer a compass heading into retirement. Rather than constructing a plan that is primarily dependent on performance of a portfolio and a safe withdrawal rate, every retiree must face up to and plan for the unknowable questions of longevity and conditions within longevity. Seek the help of a qualified financial adviser to guide you through your retirement decisions.
References:
1 Napoleon Bonaparte
2 “Modern Retirement Theory”, Journal of Financial Planning’s Retirement Distribution Supplement, December 2009. Copyright Jason K. Branning, CFP® and M. Ray Grubbs, Ph.D.
3 Base Income covers an expense with an income stream using the 3-S Model, which is secure, stable, and sustainable.
FPA member Jason Branning, CFP®, is a fee-based investment adviser and financial planner with CS Planning Corp. an SEC Registered Investment Advisory firm in Ridgeland, Miss. He owns Branning Wealth Management LLC.
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