G Pessotti cracking_the_nest_egg_reprint

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G Pessotti cracking_the_nest_egg_reprint

  1. 1. ADVISOR/CLIENT EDUCATION BRIEFCracking the Nest Egg: When Accumulation Becomes Distribution!"#$%&()#*%+",-#.*/0It’s a big transition when clients leave the workforce to live off their savings. Movingfrom an accumulation to a distribution strategy requires an attitude adjustment inboth you and your clients. Here are the issues to consider when time, compounding,and other conventional investment principles no longer work in your favor.Retirement planning is easy during theaccumulation phase. Just stash as much savings as George Pessottipossible into retirement and investment accounts, Owner / Presidentand maximize total returns. All that really mattersis what the client ends up with at retirement. If Pessotti and Associatesinvestment returns vary from year to year, or if 508-612-8101returns are made up of interest, dividends, or capitalgains, none of it much matters. It’s all a race to grow george@pessotti.comthe nest egg as large as possible. Success is measured www.pessotti.comby account values, pure and simple.Then comes the day when the client can finallycrack the nest egg and start withdrawing funds. Nowthe goal is no longer simply to grow the accountbalance, but rather to provide clients with enoughcurrent income to meet their spending needs and toallow the nest egg to diminish, as it naturally must,without letting it disappear. Success is measuredby client happiness and the careful monitoring ofwithdrawal rates and account values to ensure thatthe clients’ money is not in danger of running out.Attitude adjustmentSome of the fundamental truths that apply to anaccumulation strategy fall apart under a distributionstrategy. This means that certain basic conceptsthat have been drilled into clients’ heads at 401(k)meetings and advisor consultations must berelearned. Consider these shifts:Dollar-cost averaging works in reverse. Clientshave learned that investing a fixed dollar amount!"#$%&()*+*,-..*/00123456"%4147"3)(8*99!:**/;;*<&()4*<141%=1>:9&?1041*@A*6B/CD,-../ |1
  2. 2. during volatile markets allows them to buy more Income planningshares when prices are down. This is a good thing. Planning for income requires careful numberBut when clients are withdrawing fixed dollar crunching and a strategy for actually gettingamounts from a volatile portfolio, temporary dips cash into client hands. Here are some popularcan do serious damage because more shares must retirement-income strategiesbe liquidated to provide the same amount of cash. Live off the interest (or dividends). The classicCompounding also works in reverse. In the retirement-income strategy is to shift fromclassic “Why save now?” pitch, clients learn a growth-oriented portfolio at retirement tothat the early build-up of an investment account investments that generate income. These mightprovides a larger base for future compounding. include bonds and dividend-paying stocks. TheThe rule comes into play a little di erently when client’s income consists of the actual paymentsdetermining withdrawal rates: taking out too much thrown o by the investments. Any assets nottoo soon will diminish the impact of compounding needed for current income generation may beon the remaining assets. invested in equities for inflation protection and long-term growth.The sequence of investment returns matters.Under an accumulation strategy, dips in asset Set up a withdrawal plan. Another approach isvalues can be made up by a bull market or to invest for total return and set up a withdrawalincreased savings. What matters is the average plan starting at, say, 4% of the account balance.annual total return. During the distribution phase, Each subsequent withdrawal would be increasedpoor returns in the early years can cripple a by the annual inflation rate. Under the so-calledportfolio and cause money to run out early. “4% rule,” the assets are invested in a diversified portfolio of stocks and bonds.Time is the enemy. Under an accumulationstrategy, the longer the money stays invested, Draw from a cash bucket. Another strategy is tothe more it will grow. When funds are being keep enough cash in a money-market fund to fundwithdrawn, the opposite is true. two years worth of expenses and invest the bulk of the portfolio for total return. As the cash bucketMistakes can be fatal. During the accumulation empties, enough long-term assets are liquidated tophase, mistakes in planning, saving, or investing fill it back up.can always be fixed by adding more money,revising the portfolio, working longer, and so on. In Transition planningretirement, when money is coming out and no new Once you’ve run the numbers and determinedmoney is going in, there is far less room for error. how you are going to get income to your client, the next step is to determine exactly howPart of transitioning clients into retirement is you will position the portfolio and make thehelping them learn some fundamental concepts transition. Because major portfolio shake-upsrelating to the management of their nest egg. can have serious tax and investment implications,In particular, warn them of the dangers of transitioning to a distribution-phase portfoliovolatility, excessive withdrawals in the early years, could take several years of planning. Here areand a longer-than-expected withdrawal period. some things to think about.These potential dangers can undo a lifetimeof diligent saving. The worst part is that these Where are the assets?mistakes may not show up until it is too late to The retirement-income strategies you use forreverse their impact. taxable accounts won’t necessarily be appropriate Copyright  ©  2011  Annexus/Horsesmouth,  LLC.    All  Rights  Reserved. License  #:  HMANX2011A2|
  3. 3. for nontaxable accounts. For example, if the client large required minimum distributions that thewants tax-free income from a taxable account, client ends up in a higher tax bracket.you can buy municipal bonds. If he wants tax-freeincome from an IRA, you’ll have to convert it to a Also, consider the income and estate taxRoth, which means paying taxes on the account at consequences of a large IRA that is allowedthe time of the conversion. to grow out of control. Long-term income projections need to be part of your transitionBy the time clients reach retirement they may planning so you can set up accounts and planhave lots of di erent accounts. When arranging distributions from the outset.for distributions you’ll need to look at them as awhole for overall investment planning, and also What future transitions are in store?individually to determine which accounts will Many clients don’t plan to retire all at once. Theygenerate which distributions. plan to ease into retirement by working part- time for a while and then seeing how they feel.When should you sell? Distribution planning for these clients involves aThe liquidation of assets is often an important series of transitions. You may set up the accountspart of the transition to the distribution phase. and the portfolio to generate a relatively smallIf you will be doing a major portfolio overhaul, income now with the idea of increasing theyou’ll need to consider the tax and investment income later. This may require another transitionimplications of asset sales. or two, with all the same attention given to asset positioning, the timing of liquidations, and theFor taxable accounts you should know the tax basis tax impact of IRA withdrawals--not to mentionof each and every holding. You’ll also need to know all the handholding and warnings about drawingthe client’s overall tax situation in any year you down their nest egg too quickly.propose a sale of assets, including previous losscarry-forwards, AMT status, the receipt of taxable Perhaps one of the biggest di erences betweenretirement distributions, and so on. accumulation planning and distribution planning, at least from the advisor’s standpoint, is that onceIf you think a major reorganization of the client’s clients begin drawing income from their investmentinvestment portfolio is in order to meet the client’s portfolio, their accounts require much closernew objectives of income, liquidity, and capital attention. Not only must you invest the assets in apreservation, meet with the client’s tax advisor and prudent manner, you also must watch the amountmap out a plan for the orderly liquidation of assets. and timing of distributions to ensure that the nestThis could take years. Periodic asset sales will also egg lasts. Advisors who are used to investing onlybe necessary during the client’s retirement years, for growth may need to go through an importantespecially if you are using the cash bucket strategy. transition themselves to fully understand theEach time a liquidation becomes necessary you’ll nuances of retirement-income planning.need to balance tax and investment considerationsand time these asset sales for optimal benefit.What will be the impact of IRA withdrawals?If part of the client’s income will come fromregular IRA withdrawals, you’ll need to considerthe current--and future--tax impact of thesewithdrawals. It may not make sense to deferdistributions from traditional IRAs until the lastpossible moment if doing so might create such!"#$%&()*+*,-..*/00123456"%4147"3)(8*99!:**/;;*<&()4*<141%=1>:9&?1041*@A*6B/CD,-../ |3

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