The Ideal Retirement Portfolio

The Ideal Retirement Portfolio

April 15, 2019

Many pre-retirees are constantly searching for the “ideal” portfolio as they head into this new season of life. As you tweak your portfolio in the last few years of your career, it can be challenging to know exactly how to diversify your investments in a way that balances tax minimization and wealth growth. 

Your Three Tax Buckets

As you enter retirement, your assets should be across three tax “buckets”:

  1. Deferred
  2. Taxable
  3. Roth

You’ve likely heard of asset allocation – or the process of balancing risk by allocating your assets across several different types of investments. However, focusing on the different tax buckets you’re going to tap for income during retirement, and which assets belong in those buckets, is called asset location

Asset location is focused less on diversifying risk, and more on diversifying how your assets will be taxed during retirement. This can help you to maximize the amount of take-home cash flow you and your partner or spouse have access to in retirement. Let’s go over what type of accounts fall into each tax bucket category.

Your deferred accounts typically include your employer sponsored retirement plan (401k, 403b), a traditional IRA, or a tax-deferred annuity. Taxable accounts are individual or joint investment accounts, cash-savings, or money market funds. Finally, your Roth tax “bucket” is exactly what it sounds like – a Roth 401(k) or IRA that you either fund outright, or through a Backdoor Roth IRA strategy.

How Do You Divide Assets?

When you start thinking about your asset location strategy, you need to accomplish two separate goals:

  1. Implementing a tax-efficient withdrawal strategy to create a retirement income.
  2. Allow for continued growth of your assets throughout retirement to extend the life of your savings – and create wealth to pass on and leave a legacy after you pass away.

How an individual holding is taxed can help to determine to which tax bucket they belong. The strategy here is to reduce the drain of taxes on each individual investment type in your portfolio by locating it in an account that matches it’s tax make-up. Then, you build a withdrawal strategy that further maximizes tax minimization. 

A few examples of dividing your assets among various tax buckets might be:

  • Tax-friendly stocks that are taxed as long-term capital gains can be held in taxable accounts
  • Other tax-efficient investments (like ETFs, or “riskier” assets that can capture tax losses) can also be held in taxable accounts
  • Tax-deferred accounts often house taxable bonds or high-yield mutual funds that generate distributions taxed at ordinary income tax rates
  • Investments that are geared toward aggressive growth may make sense in a Roth account, as they can grow tax-exempt for long periods of time, and are available whenever you need them during retirement

Which Tax Bucket Do You Tap First?

Every financial situation is unique, and the beauty of this tax-bucket strategy is that it offers you a multitude of cash flow options during retirement. Developing a unique portfolio that addresses your tax obligations and your lifestyle goals is your ultimate goal. 

Let’s take a look at how the “tax buckets” might work, and how you might use them to create a tax-efficient retirement income:

You have a portion of your assets invested in taxable investments that provide qualified dividends. These could be housed in a brokerage account or individual/joint investment account. You also have some of your assets in a tax-deferred 401(k), and another portion of your savings in a Roth IRA. 

In this case, it may make sense to hold your stocks (or taxable assets) for a longer period of time. This helps you to reduce your taxes by qualifying your stocks for long-term capital gains tax, instead of ordinary income tax. 

Your tax-deferred accounts have required minimum distributions that provide some consistent retirement income, and are taxed as regular income throughout retirement. 

Finally, your Roth accounts (which don’t have RMDs associated with them) can be leveraged to continue growing your nest egg for years to come, with all withdrawals being tax-exempt if taken during retirement.

Your goal is to strike a balance between tax-efficient income creation and wealth preservation, and there’s rarely a “perfect” solution. Mixing and matching withdrawals from various accounts in a well-diversified and balanced portfolio can help you to offset your tax obligations while meeting your RMD requirements.

A Strategy That Meets Your Goals

Every person is different, and everyone has a unique view of what they want their retirement to look like. Some want to stay close to home and enjoy a leisurely life being highly involved with their community. Others (myself included!) want to relocate to somewhere that doesn’t have Chicago’s icy winters, or to have a second home to live the snow bird lifestyle. 

Whether extravagant travel or laid-back days tending your garden are part of your ideal retirement picture – having investments that are taxed in a diverse way can help you build an income plan that supports those goals. 

Working With a Professional

Many pre-retirees are under the impression that their investments during retirement should be smooth-sailing. After all, you’ve done all the hard work leading up to retirement, right? 

This couldn’t be further from the truth. Creating a retirement savings strategy and investment plan that carries you to and through retirement is key. This is where working with a fee-only, fiduciary financial planner can be helpful. 

As a financial planner who specializes in working with retirees in the greater Chicago area, I help my clients create an ideal investment portfolio that guides them toward their goals in retirement. A big part of that is determining where their assets are located, how they’re allocated, and how we withdraw them to minimize taxes. 

Are you interested in creating your tax-efficient, growth-minded retirement portfolio? Let’s have a conversation. I’d love to talk with you about your goals, and how your plan can support them.