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Schulfer & Associates, LLC

Do you Understand Distribution Diversification?

Recently I was interviewed by Mark Henricks, a journalist from Austin, TX for an article that will be published on MainStreet.com, the personal finance website of TheStreet.com (if you watch CNBC you recognize “The Street”).  Mark has been writing about money and personal finance for over 20 years.  He said that he has understood and written about the importance of diversification of investments for years.  Recently though, he had a conversation with someone who told him about distribution diversification and how it is the next big thing for people to know about, how so many people do not understand it or have not even heard of it.  He and I had a great conversation and since the topic is rather profound, I thought it would be prudent for me to share his questions and my answers.

Q:  - What should readers know about your background on this topic?

A:  I am an Accredited Wealth Management Advisor (a designation earned through the College for Financial Planning) and an Accredited Investment Fiduciary (a designation through fi360).  Schulfer & Associates, LLC Financial Professionals is an independent firm.  Our Mission is to provide Financial Advice for Life.  Our core focus is helping people prepare for a successful retirement.

Q:  - What is distribution diversification?

A:  Most people understand how important it is to diversify with an asset allocation plan in their accumulation years.  In retirement income distribution, diversification should include more than your asset allocation.  It is prudent to diversify among different types of investments and understand how they correlate to each other in an income plan.  In our practice, we commonly use a few distinct “buckets” of money for income production.  One may include an annuity to pay monthly income over the course of a client and his/her spouse’s lifetime, while another may include alternative investments that are non-correlated to the stock market.  These investments generally are not appropriate for lump sum withdrawals, so we are certain to keep ample money in a third bucket, a liquid account, to draw from when additional money is needed for things like vacations or to purchase a new vehicle.  (Each investment must be carefully evaluated as to the appropriateness for each individual.)

Q:  - Why is it important?

A:  In retirement, consider that you are no longer adding to your investments, but rather taking money from your stockpile.  During the accumulation phase, dips in the market are opportunities to “buy low”.  In the distribution phase, however, if your investments lose value and you are taking money from them, this compounds the negative effect on your balance.   Furthermore, there is a stark difference in prudent management of an accumulated nest egg versus one that is still growing toward the goal of retirement.  For example, a 10% loss on $50,000 is a $5,000 net effect, while a 10% loss on $500,000 has a $50,000 net effect.  While accumulating money, you may have more time to make up that 10% loss, and may need to take on more “risk” for your money to grow to meet your end goal.  While in distribution, time is no longer on your side.  If your nest egg has already been built and your accumulation goal has been met, it is wise to manage your risk.

Q:  - How can retirement savers best plan for distribution from retirement accounts?

A:  By understanding their time horizons.  Use accumulation investments such as the investment options found inside of 401(k)’s during years you are actively saving and are a ways from retirement.  Within a couple of years before your retirement, it is prudent to sit down and re-evaluate your portfolio for income distribution during retirement. 

Q:  - How well do most retirement savers understand distribution planning?

Rarely do savers understand the importance of retirement income distribution planning.  After all, all they are accustom to is saving and building up their nest egg.  Retirement is a new chapter in life.  The greatest fear many people have is outliving their money.  Prior to retiring, I recommend formulating an income plan that includes social security, pensions, and of course, how you will position your own investments to produce income.  Be sure to keep sufficient reserves for emergencies and planned lump sum withdrawals.  For each person, these calculations will be different.  People who have a sufficient amount of guaranteed income through social security and pensions will have more flexibility with their own money, assuming they’ve done a good job saving.  People who do not have sufficient guaranteed income will have to be very careful in their planning and be more attentive, because it is likely that they will need to use more of their own savings to produce the income they need for retirement.
 
Q:  - Anything you’d like to add? Something I should have asked and didn’t?

A:  Yes.  TAXATION.  Taxation during accumulation is generally not a consideration because as a rule, retirement accounts are tax deferred.  Knowing your taxation during retirement income distribution, however, is very important.  From your traditional retirement accounts, there is income tax on distributions, penalties on early withdrawal if before 59 ½ (with little exception) and required minimum distributions (RMD) at 70 ½, as well as taxation rules on social security.  With that in mind, the surprise for many can be when wanting to take $40,000 out of their traditional IRA for a new car.  That $40,000 withdrawal is far from $40,000 after taxes.  What if you didn’t know you were supposed to take the RMD at 70 ½?  The penalty for that is 50% of what you should have taken.  If you should have taken a $10,000 RMD and failed to do so, you are subject to a $5,000 penalty from the IRS.  Understanding taxation is very important.  To make the most of your retirement income, start to plan years ahead of time.  As you are funding retirement savings, take into consideration whether you are funding ROTH accounts (which are funded with after-tax money and withdrawals from the account may be tax free, as long as they are considered qualified.  Limitations and restrictions may apply.) or traditional pre-tax accounts (which are funded with before-tax money, eventually to be received subject to ordinary income tax upon receipt).

Understanding retirement income distribution is profound.  My belief is that the reason many people have never heard of it is because a generation or so ago, people didn’t have to concern themselves with it.  Back in the day, it was far more common to retire with a gold watch when your hair turned grey and be taken care of by a great monthly pension check, social security, and continued company health insurance.  Today, not so much.  For most, the responsibility falls on the individual to have their own nest egg built AND to understand how to make it last.  It’s a complicated endeavor not to be taken casually.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.  Please consult your financial advisor regarding your specific situation.

 

(Author’s note:  Due to industry regulations, I am prohibited from responding to any online comments. I welcome you to contact me via e-mail or phone, including suggestions for article topics).

LouAnn Schulfer is co-owner of Schulfer & Associates, LLC Financial Professionals and can be reached at (715) 343-9600 or louann.schulfer@lpl.com.  Visit www.SchulferAndAssociates.com | blog.

Securities and advisory services offered through LPL Financial, a Registered Investment Advisor.  Member FINRA/SIPC.  Accredited Wealth Management Advisor SM and AWMA® are trademarks or registered service marks of the College for Financial Planning in the United States and/or other countries.  The Accredited Investment Fiduciary® designation is earned through the Center for Fiduciary Studies.