Coming up with a plan to replace a weekly paycheck once retirement comes knocking is essential to making sure your money lasts as long as you do. The basics for designing this plan rest on the 'three legged stool of retirement??government pensions, personal savings and investments, and employer supplied retirement benefits.
An individual has little control over two of the three. But when it comes to managing the personal investments leg, a number of choices emerge.
Rules for investing retirement assets abound. A frequently quoted rule states that your portfolio should consist of bonds in proportion to your age minus 100. For example, a 60 year old would have his investment accounts invested in 60% bonds and 40% stocks.
The logic behind this rule is sound?as you age you need to reduce investment risk and increase certainty in your portfolio. Bonds held to maturity making predictable income payments are generally less risky than stocks held for price appreciation.
The problem with ?rules of thumb? is that they do not account for individual preferences and situations. For example, individual risk tolerances might allow some seniors to maintain a riskier portfolio than a person half their age.
A retiree with a proportionately larger portion of their retirement income coming from government and company pensions (or other
low or no risk income sources) may choose to be more aggressive in their investment strategy since the risk of investment loss is not as catastrophic to their plan.
Taxes play a part in determining an investment plan. For example, interest payments on corporate bonds are taxed as ordinary income while dividends and long-term capital gains are taxed at 15% (5% for taxpayers whose top marginal tax bracket is 15% or less).
Since all payments from a traditional IRA are taxable at ordinary income rates, a retiree with two portfolios?an IRA and a non-qualified investment account?would hold bonds paying interest in the IRA and dividend paying stocks or stocks held for appreciation in the non-qualified account.
This does not hold true for tax-free municipal bonds, which should always be held in the non-qualified account.
With the appreciation in real estate, many see their homes as a piece of the retirement income puzzle. I am commonly asked about the wisdom of paying off a home mortgage in lieu of holding the equivalent in an investment account.
A paid for home should be viewed as a bond in the portfolio. It provides a tax-free, risk free economic benefit?rent'to the owner. The cost to carry the mortgage is the after tax cost of the interest paid (equal to [1- your marginal tax rate x the mortgage interest rate]).
If a mortgage is carried, and the money to pay off the mortgage is invested, the investor should reasonably expect to earn the taxable interest on the mortgage plus 3% to 5% more to compensate for risk and taxes on investment returns.
Again, this decision to invest or pay off the mortgage should be based upon an individual's risk tolerance, and investment time horizon (length of time before the investments have to be spent).
Finally, a paid for home represents a financial safety net if a reverse mortgage is applied to the home later in the retiree's life. Reverse mortgages provide a potential lifetime income that is offset by a mortgage on the property that the senior does not have to pay back until he or she leaves the house. At that time the property is sold and all mortgage advances plus interest belong to the mortgage company. The income that can be realized depends on age (older equals more income), the value of the property, and location.
