Herbert K. Daroff, J.D., CFP®
Baystate Financial Planning
hdaroff@baystatefinancialplanning.com
www.baystatefinancialplanning.com
Retirement planning involves much more than asset ALLOCATION.
First, the study that resulted in asset allocation did not take into consideration tax consequences. All of their data points were qualified retirement plan portfolios. If you think economic markets experience turmoil, take a look at the last nearly 100 years of income taxes.
Second, there is market turmoil. However, that must be examined by not losing track of our history. In addition to practicing as a financial planning, I also teach at Bentley University in Waltham, MA. My students are finance majors in their senior year, average age 21. They were born in 1987. So, in the Fall of 2008, I asked them to describe for me the poverty and famine that they have experienced since the market crashed October 19, 1987. They, of course, looked at meet quite quizzically. Devastation, what devastation? I don't know about you, but I did reasonably well in the decade of the 1990s that followed 1987.
The newspapers and magazines were full of bleak economic forecasts in 1987 that virtually mirror today's news.
Third, asset allocation addresses the contribution and accumulation phases of retirement planning, not the distribution phase. Tools like dollar cost averaging, which may be very helpful during accumulation, can be devastating during distribution. During accumulation, high returns first, followed by lows, or vice versa, produce the same average return as a flat return. During distribution, lows at the beginning will cause the portfolio to go to zero before the retiree's blood pressure goes to zero.
So, I propose that we focus on asset LOCATION. Many advisors have embraced the "bucket" theory based on changing the asset allocation for varying time periods. Overly simplified, take the money you need for the next 5-7-10 years and invest it 20/80 (i.e., 20% equities and 80% fixed income), the next 5-7-10 years 40/60, then the next 60/40, then 80/20).
I propose that along with asset LOCATION whose focus is on tax consequences, as follows:
Most people have only the top two of these four quadrants, and their investment asset allocation is the same for both. For example, 30% large cap growth, 30% large cap value, 15% small cap and international, and 25% bonds:
Asset LOCATION theory asks, "Why are you allowing 15% taxable items to be taxed at 35%?" Large cap value is a very tax EFFICIENT asset class. It produces dividends, which are currently taxed at 15% and you typically buy and hold this asset class, resulting in long-term capital gains, which are taxed currently at 15%. Put them in your qualified retirement account (i.e., profit sharing or 401(k)) or IRA and your have successfully converted 15% income into 35% income since all of the money coming out of the plan is taxed at ordinary income rates.
When I see municipal bonds in the taxable accounts quadrant I ask if they are needed for income. Most of the time the answer is that they are not, but that the client wanted some bonds to balance their portfolio and didn't want to pay income taxes. So, why not put them in their qualified plan or IRA account?
An asset LOCATION portfolio will add up to the same 30/30/15/25, but let's place the right assets in the right quadrants, for example:
During retirement, first, look to draw on the taxable accounts. You want to hold onto the qualified plan or IRA accounts at least until 70½ when you have to take them, and then only take the required minimum distribution (RMD) to take advantage of the continued tax deferral. The exit strategy for a qualified plan or IRA is "stretch IRA".
So, what are "hedged income base" accounts? In addition to other financial hedges (i.e., options, collars, etc.), they are variable annuities with lifetime income guarantees (e.g., guaranteed minimum income benefits (GMIB) and guaranteed withdrawal benefits (GWB), etc.). We had anticipated that this quadrant would be used for a later retirement timeframe. However, given current market conditions, it may be advantageous to turn on the income faucet from these accounts for now (not making it an annuity, just taking the 5-6-7% income from the income base) rather than dip into under-performing assets in the other boxes.
What are Roths? Most of my clients don't qualify for Roth IRAs. They do, however, qualify for Roth 401(k)s. As with most bell shaped curves, Roths work best for the youngest/lowest paid (who will likely retire into a higher tax bracket that they are in now while they are making contributions) and the oldest/highest paid (who will likely always be in the highest income tax brackets, which are more likely to go up and not down),
What are Roth Look Alike accounts? That's life insurance cash value. Not only can the cash value be used for retirement income, the death benefit can be used to fund the income taxes on a Roth Conversion for a surviving spouse or children, or simply replace principal for the surviving spouse and children. What's better than a "stretch IRA"? A "stretch-ROTH"!
Baystate Financial Planning
hdaroff@baystatefinancialplanning.com
www.baystatefinancialplanning.com
Retirement planning involves much more than asset ALLOCATION.
First, the study that resulted in asset allocation did not take into consideration tax consequences. All of their data points were qualified retirement plan portfolios. If you think economic markets experience turmoil, take a look at the last nearly 100 years of income taxes.
Second, there is market turmoil. However, that must be examined by not losing track of our history. In addition to practicing as a financial planning, I also teach at Bentley University in Waltham, MA. My students are finance majors in their senior year, average age 21. They were born in 1987. So, in the Fall of 2008, I asked them to describe for me the poverty and famine that they have experienced since the market crashed October 19, 1987. They, of course, looked at meet quite quizzically. Devastation, what devastation? I don't know about you, but I did reasonably well in the decade of the 1990s that followed 1987.
The newspapers and magazines were full of bleak economic forecasts in 1987 that virtually mirror today's news.
Third, asset allocation addresses the contribution and accumulation phases of retirement planning, not the distribution phase. Tools like dollar cost averaging, which may be very helpful during accumulation, can be devastating during distribution. During accumulation, high returns first, followed by lows, or vice versa, produce the same average return as a flat return. During distribution, lows at the beginning will cause the portfolio to go to zero before the retiree's blood pressure goes to zero.
So, I propose that we focus on asset LOCATION. Many advisors have embraced the "bucket" theory based on changing the asset allocation for varying time periods. Overly simplified, take the money you need for the next 5-7-10 years and invest it 20/80 (i.e., 20% equities and 80% fixed income), the next 5-7-10 years 40/60, then the next 60/40, then 80/20).
I propose that along with asset LOCATION whose focus is on tax consequences, as follows:
Most people have only the top two of these four quadrants, and their investment asset allocation is the same for both. For example, 30% large cap growth, 30% large cap value, 15% small cap and international, and 25% bonds:Asset LOCATION theory asks, "Why are you allowing 15% taxable items to be taxed at 35%?" Large cap value is a very tax EFFICIENT asset class. It produces dividends, which are currently taxed at 15% and you typically buy and hold this asset class, resulting in long-term capital gains, which are taxed currently at 15%. Put them in your qualified retirement account (i.e., profit sharing or 401(k)) or IRA and your have successfully converted 15% income into 35% income since all of the money coming out of the plan is taxed at ordinary income rates.When I see municipal bonds in the taxable accounts quadrant I ask if they are needed for income. Most of the time the answer is that they are not, but that the client wanted some bonds to balance their portfolio and didn't want to pay income taxes. So, why not put them in their qualified plan or IRA account?
An asset LOCATION portfolio will add up to the same 30/30/15/25, but let's place the right assets in the right quadrants, for example:
During retirement, first, look to draw on the taxable accounts. You want to hold onto the qualified plan or IRA accounts at least until 70½ when you have to take them, and then only take the required minimum distribution (RMD) to take advantage of the continued tax deferral. The exit strategy for a qualified plan or IRA is "stretch IRA".Then, look to the other two.* NOTE: For 2009, Congress has passed a delay on taking RMDs.
So, what are "hedged income base" accounts? In addition to other financial hedges (i.e., options, collars, etc.), they are variable annuities with lifetime income guarantees (e.g., guaranteed minimum income benefits (GMIB) and guaranteed withdrawal benefits (GWB), etc.). We had anticipated that this quadrant would be used for a later retirement timeframe. However, given current market conditions, it may be advantageous to turn on the income faucet from these accounts for now (not making it an annuity, just taking the 5-6-7% income from the income base) rather than dip into under-performing assets in the other boxes.
What are Roths? Most of my clients don't qualify for Roth IRAs. They do, however, qualify for Roth 401(k)s. As with most bell shaped curves, Roths work best for the youngest/lowest paid (who will likely retire into a higher tax bracket that they are in now while they are making contributions) and the oldest/highest paid (who will likely always be in the highest income tax brackets, which are more likely to go up and not down),
What are Roth Look Alike accounts? That's life insurance cash value. Not only can the cash value be used for retirement income, the death benefit can be used to fund the income taxes on a Roth Conversion for a surviving spouse or children, or simply replace principal for the surviving spouse and children. What's better than a "stretch IRA"? A "stretch-ROTH"!
Leave a comment