As financial planning evolves from asset accumulation to portfolio drawdowns, the key role for advisers becomes helping clients who are retiring replace their paychecks.
“Many clients want to start withdrawing from their taxable accounts to hold taxes down,” says Paul Gydosh, a CFP and managing director at Kensington Wealth Partners in Columbus, Ohio. “I give them two reasons to take money from their [individual retirement account], too.”
First, Gydosh explains that depleting taxable accounts will leave only their IRAs.
Then he asks whether the government will need more or less money in the future.
“They usually answer more,” Gydosh says. “The trillions of dollars in IRAs could be a target for tax increases.”
Second, Gydosh points out that if clients die holding only IRA money, the next generation will have to take taxable distributions, reducing the legacy.
If retirees withdraw from taxable and tax-deferred accounts, they can retain some highly appreciated portfolio assets on the taxable side.
“Those assets will get a basis step-up to market value, under current law, reducing or eliminating the tax when the heirs sell,” Gydosh says.
Gydosh adds that few retired clients are willing to deplete their IRAs first.
“The tax bite would be too painful,” he says.
Advising clients to go halfway might find receptive listeners, Gydosh says.
Other drawdown decisions involve asset liquidation, converting portfolio securities to spendable cash.
“The answer on where to pull assets from is not the same for everyone,” says Jessica Hovis Smith, a CFP and the vice president and director of financial planning at Longview Financial Advisors in Huntsville, Ala. “We want to make sure that tax planning and portfolio liquidation are annual decisions that are in keeping with the client’s plan.”
Smith’s firm makes those annual decisions by reviewing the portfolio, including all taxable and tax-favored accounts, at the time.
“We adjust across multiple asset classes to ensure the portfolio stays in balance with the client’s risk tolerance, risk capacity and risk need,” she says. “Depending on the current market conditions, this could mean cutting back on equities or cutting back on fixed income.”
Gydosh prepares for portfolio drawdown by estimating cash needs, in addition to Social Security and other sources.
“We want clients to retire with a cash bucket of five years’ withdrawals,” he says.
“If the need will be, say, $5,000 a month -- $60,000 a year -- we’ll plan to have $300,000 in bank accounts and money market funds and short-term bonds. Then the clients will sleep well and I’ll sleep well, without worrying where the money will come from, regardless of market performance,” Gydosh says.
Interest and dividends from other portfolio assets generally don’t flow into the cash bucket.
“That reinforces the concept, making it clear to clients how the cash is going down,” Gydosh says.
“Among the other portfolio assets, bonds typically won’t fluctuate very much,” he says. “If stocks have run up, we may cream off some profits to put money into the cash bucket.”
Such a plan can keep clients confident that they can ride out any market turmoil.
This story is part of a 30-30 series on ways to build a better portfolio.