How To Transition Your Client’s Portfolio From Growth To Income

One of the biggest challenges investors face as they near retirement is transitioning their portfolio from a focus on accumulation and asset allocation to a new, but just as critical, emphasis on distribution and income allocation.

The aim is the same -- to create a retirement paycheck that will provide the lifestyle they want and will last as long as they live. But the mindset and the strategies involved can take some getting used to.

This can be a tricky time for pre-retirees, especially those who need to fill a shortfall in their income plan. If their Social Security benefits and employer pension (assuming there is one) won't cover their bills, they'll have to turn to their savings for the rest. Deciding how much to take out, and which assets can provide that retirement income reliably, requires careful planning.

Here are some things you can do to prepare:

Calculate the cost of the lifestyle you expect to have in retirement

Setting a budget for a lifestyle you aren't yet living is difficult, but you can get a basic idea of what you'll need. Start with the costs you have now, and think about which bills might go away and which expenses might go up as your needs change over the years. Will your mortgage be paid off when you retire? If you retire before you're eligible for Medicare, will your health care costs increase? Will you spend more, less or the same on car payments, utilities and things like travel, clothes, hobbies and entertainment? And don't forget taxes and inflation, which can take small but consistent bites out of your nest egg if you don't have a plan to deal with them.

Maximize your Social Security and pension benefits

Taking the time to get your Social Security and pension strategies right can make a huge difference in how much income you can expect to collect during your lifetime. Consider all your options -- and what works for both you and your spouse -- before you claim these benefits.

With Social Security, the longer you wait, the larger the payments from this guaranteed income stream will be, at least until you reach age 70. Keep in mind that when one spouse dies the lower of the couple's two Social Security payments goes away, so you may want to grow the higher earner's benefit to the largest amount possible.

Providing for a surviving spouse also should be a factor in any pension decisions. (You'll get a larger payment if you choose the single-life option, but your surviving spouse will be left without that income if you die first.)

Reassess your risk tolerance

As you move toward retirement, it's a good time to reassess the amount of risk you can tolerate personally -- and not just in terms of how much loss you can handle emotionally (although that's still important). It's also about looking at your "risk capacity," or how much you can afford to lose if you'll be depending on your investments for income.

Advisers often call the five years before and after retirement the "Retirement Red Zone" because it's when your nest egg is most vulnerable. If the market drops in this critical time, and you have to make withdrawals for income, you could deplete your portfolio before the market goes up again. In addition, market returns are not consistent but rather are volatile. This is known as "sequence of returns risk," and it's a significant worry for retirees. If you haven't already, you may want to ask a financial professional to analyze your portfolio to determine if it matches up with your retirement needs and goals.

Adjust your assets to protect what you'll need

Once you determine how much income you'll need in retirement, and how much guaranteed income you'll receive from Social Security and your pension, you can start to transition your portfolio to fill any shortfall.

Some retirees plan to withdraw a predetermined percentage of their portfolio every month. You may have heard of the 4% rule, which suggests you withdraw 4% of your nest egg in your first year of retirement, and then, using that number as a baseline, adjust for inflation each year. The theory is that if you follow this plan while maintaining a moderate 60/40 stock-bond mix in your portfolio, there's a good chance your assets will last through 25 years of retirement.

But that number has been questioned in recent years, based on a long period of low interest rates and increased market volatility. Critics include Wade Pfau, a respected retirement specialist and co-director of The New York Life Center for Retirement Income at The American College of Financial Services. Pfau says his post-coronavirus calculation puts a safe withdrawal rate closer to 2.4% for retirees who are taking a moderate amount of risk with their investments.

A more reliable strategy might be to allocate a percentage of your portfolio to income sources that are predictable, measurable and sustainable so you can be sure your needs are covered no matter what happens in the stock market.

Annuities, for example, work much like Social Security and employer pensions, except you're creating this steady, pension-like income for yourself. Yes, annuities get a bad rap because of the fees and confusing contracts -- and you have to be careful about what you're signing on for. But the right kind of annuity can offer retirees the guaranteed income stream they need, and, depending on the type, they can be adjusted upward with the cost of living (fixed annuities) or adjusted upward based on a market index (variable annuities with income riders).

Obviously, there's no way to predict what the future has in store for any of us. We've gotten a good reminder of that over the past few months. And the same holds for any income stream or strategy you might put in place. You may have to make some adjustments to your plan as you go. But a well-thought-out income plan can help you make the transition from your work paycheck to your retirement paycheck with fewer questions about where the money will come from month to month and year to year.

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Kim Franke-Folstad contributed to this article.

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