Converting Your Nest Egg To Income - Part II
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By Mike Posey


1. Revisiting Retirement Income Options
2. Legacy Planning
3. Investing For Legacy Planning
4. Living On Investment Income
5. Retirement Tidbit


In my November 13 Retirement Focus E-Letter, I laid the groundwork for a discussion about the various ways to convert your savings and investments into retirement income. To recap, I discussed a number of factors you should consider before deciding how to take income, such as taxes, the need to use realistic assumptions when projecting income needs, and that continual monitoring is essential for the success of your plan.

I also listed the broad categories of alternatives available to retirees seeking a steady retirement income. This week, I'm going to discuss each of these alternatives in greater detail. Rather than linking back to the November 13 E-Letter, I'll list these alternatives again for you here:

  1. Continue to grow the money and take withdrawals only as needed or required by law - also sometimes called "legacy planning;"

  2. Take investment income without touching your original principal;

  3. Take a fixed dollar amount over a specified period of years or as long as your nest egg lasts;

  4. Systematically distribute both income and principal over your remaining lifetime, usually as a fixed percentage of assets each year, with an underlying goal of not outliving your money; and

  5. Give it away.

As we proceed, remember that none of these options are necessarily exclusive, and you can choose to combine just about any two or more of them into your retirement planning process. For example, you could take fixed dollar amounts from your personal savings, and supplement this with a constant percentage withdrawal from your IRA or other tax-qualified plan. Or, you could select one of the withdrawal methods for half of your money, and plan on leaving the other half to your heirs.

I only have space to discuss the first two of the above options this week, but we'll catch up with the rest in later installments of this series. Plus, remember that I am not a lawyer, CPA or tax or legal professional, so the information I provide should be considered as a guideline for further research. As always, feel free to print this E-Letter and give it to friends or loved ones, or forward it to anyone you feel may benefit from this information.

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Legacy Planning

The option to continue growing your retirement assets and not take any distributions (unless necessary) is often referred to as "legacy planning." In essence, this situation involves retirees who have sufficient income from a pension plan, Social Security and/or other income producing investments to cover living expenses, so they don't need to tap their 401(k) or IRA assets.

We often see individuals in this category who have investments in real estate, energy, etc. that, when combined with Social Security and any pension income, may produce enough money to handle their income needs in the future. Of course, there's no guarantee that the bottom won't fall out of the rental or energy markets, but you get the idea - there's no immediate need for income from retirement plan sources.

For these individuals, assets are managed in such a way so that they will be passed on to their heirs upon death. Thus, the important decisions in legacy planning are not how to arrange the best way for you to withdraw the money, but rather the most efficient way to transfer it to your heirs.

This is where the importance of estate planning becomes so apparent. There are many people that want to pass on even modest estates to heirs, but feel that it's not worth it to seek out an estate planning professional to help guide them. They think that since their estate is not large enough to be subject to the estate tax, such planning is unnecessary.

Nothing could be further from the truth. A qualified estate planning professional can help guide the legacy process so that your wishes are followed and none of your heirs gets a nasty "surprise" after you're gone. Through the use of wills, trusts, beneficiary designations and various other tools, an estate planner can produce a wealth transfer plan that should meet the test of time.

In fact, as Gary has discussed in past E-Letters, one of the most important services an estate planner provides is to simply require you to clarify exactly how you want your assets to be transferred. Some retirees wanting to leave assets to children and grandchildren have very general goals, but have not put much thought into exactly how the process would be handled upon their death. This clarification is especially important in regard to retirement assets, since most distributions from retirement plans are fully taxable (more about that below).

Your next question is probably how to find a qualified professional in your area. This is not always as easy as it sounds. While there are a number of financial planners, lawyers and CPAs that advertise estate planning services, not all of them are worth your time and money. Unfortunately, a professional's lack of knowledge is often not evident until after death occurs, and then it's too late. Since estate planning is not an inexpensive process, it's important that you get it done right the first time.

As with seeking out any professional advisor, it's important to do your homework before making a selection. The first thing you can do is ask for references from friends or family who are in a similar situation and who have created an estate plan. Other trusted professionals may also be sources of referrals. For example, the CPA who does your taxes may know of a good estate planning attorney. Your Investment Advisor may know a good planner; the estate planning attorneys that Gary uses here in Austin help clients across the country. Insurance agents are also sometimes good sources of referrals for estate planners.

Absent a referral, hit the Yellow Pages or any of the various "find a lawyer" websites on the Internet and look for attorneys specializing in estate planning. I say look for attorneys rather than other professionals because there are a number of other professionals that will advertise estate planning services when they only have a cursory knowledge of the subject. I personally feel attorneys who advertise a specialty in estate planning are usually the best way to go.

Once you have names of a few estate planning attorneys, call them and ask about their services. Ask about fees, their process, and make sure they have experience with estate plans of your size. It makes no sense to pay the huge fees commanded by estate planning attorneys who regularly deal with very wealthy clients if your estate is only a few hundred thousand dollars, just as a wealthy individual would not want to deal with an attorney whose only experience is in smaller estates.

To the extent possible, see if you can talk to a satisfied client in a situation similar to yours. While attorneys must generally keep client information confidential, they often have clients who agree to serve as references.

Investing For Legacy Planning

From an investment standpoint, legacy planning doesn't always involve much change from the way your assets were invested prior to retirement. That's because the intention is to pass these assets on to heirs, and this goal might not be utilized until long after the retiree's death. Thus, the investment time horizon is usually long-term, and the goal is continued capital gains rather than income.

Gary has written extensively about how to invest to manage risks and produce "absolute returns," so I'm not going to repeat his advice here. Instead, I'll pick up another theme that Gary has written about less often, and that's making sure your heirs know about your investment philosophy.

With over a thousand clients, we have to deal with the issue of the death of a client far more often than we'd like. Because our clients are all over the country, we frequently do not get to meet with them face-to-face, but we have built close relationships with many of them over the phone through the years. It often surprises us to find that clients who may have spent thousands of dollars for estate planning have not spent any time communicating their investment philosophy to their heirs.

Very often, we get calls from spouses, children or trustees asking what kind of investment programs we offer and how they fit within a deceased client's overall portfolio. This means they not only were in the dark about their loved one's investment philosophy, but also about the individual investments making up the portfolio.

Unfortunately, some of these spouses and heirs fall victim to unscrupulous brokers or agents who recommend that they sell everything and start over (with all-new commissions, of course), but that's a subject for another E-letter. The main thing for you to take away from this discussion is that not only is it important for you to have a long-term outlook on assets invested for legacy planning, but also that you communicate your investment philosophy to those who will be taking the reins after your passing.

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Living On The Income

The second option for converting your nest egg into retirement income is to withdraw only the income produced by your investments and leave the principal untouched. For some retirees, taking only income produced by investments may produce enough money, when combined with Social Security and any other sources, to meet retirement income needs.

The method of taking income is relatively simple. You invest your nest egg and then withdraw whatever income it may produce either on a periodic basis or at the end of the year. Most banks, mutual funds and brokerage firms have ways for you to take automatic payments of income generated from CDs or investments, but you can also make a request each time you want to take income.

However, it is important to remember that this method of retirement distribution can produce varying results over time, depending upon the underlying investments. If you plan to live off of only investment income, then when investments earn less, your retirement income could go down significantly. Plus, the overall size of your portfolio will determine whether withdrawing only investment income will be sufficient for your post-retirement income needs.

As I noted in my last Retirement Focus issue, in any discussion of taking the income from investments, the real key is how much income you need and how to invest to generate this level of income. You should never take more risk than necessary to meet your current and projected future needs, so it may not always be feasible to just take the income from investments, as this may not produce as much retirement income as other methods I'll discuss later on that include taking income and a portion of the principal.

When I first started in the retirement planning business, CD rates were high. As a result, clients would dream of drawing high interest on a principal-protected asset for retirement income purposes. While the interest rates paid have definitely changed, CDs do still provide an excellent example of one way to live off of the income from investments.

Some retirees and even Advisors use CDs for at least a portion of retirement income planning, especially where the retiree's tolerance for investment risk is low. One way to use CDs in a retirement income portfolio is to "ladder" them. In other words, invest substantially equal amounts in CDs with maturity dates one year apart (hence, the years are the rungs of the ladder).

As time goes by, you reinvest maturing CDs into a new five-year CD. Eventually, you will have a portfolio of five-year CDs with staggered maturity dates and likely different yields. This helps you avoid putting all of your money into a single five-year CD, and then having it all mature at a time when renewal interest rates may be low.

Below, I have listed a number of additional ways to invest for taking retirement income. This list is by no means exhaustive, as there are many variations on each of these, and new "income investments" are being developed by the financial services industry every day. Each of these methods has its pros and cons, which should be carefully considered before making a decision:

  1. Bond Laddering - Like the CD option discussed above, many of the following alternatives are known as "fixed income investments," and the concept of bond laddering is very similar to the CD laddering discussed above. The main difference is that you are investing in individual bonds with varying interest rates and maturities as opposed to CDs. Bond laddering is one of the oldest methods for converting retirement savings into income that there is, and has been successful for many investors.

    One of the benefits of bond laddering over CD laddering is that there is a much greater variety of bonds than there are CDs, with maturity dates, yields and even tax status of the interest payments (such as in municipal bonds) treated differently. You also have the option of using a combination of bonds issued not only by corporations, but also by local, state and federal government entities.

    However, bonds also have a dark side. When interest rates are rising, the price of the underlying bond can go down, sometimes substantially. While this generally won't affect the payment of the promised coupon rate of interest, it does sometimes cause retirees to sell out and realize the losses.

    As a general rule, it's often best to ignore short-term fluctuations in bond values, since they should pay the full promised value at maturity (assuming the issuer of the bond is in a position to pay or refinance the debt). You need to be careful when considering bonds with higher coupon interest payments, as they are often more risky. Even so, it may sometimes be possible to include both low-risk and higher-risk bonds when constructing a laddered bond portfolio.

    As I noted above, it may also be worthwhile to consider tax-exempt municipal bonds issued by state and local governments. These bonds usually carry a lower rate of interest, but interest payments are federal income tax free. Treatment for state tax purposes varies among the states, so see your local tax professional about this. Plus, some (but not all) tax-exempt bond proceeds are added back to your income for purposes of calculating the Alternative Minimum Tax (AMT), and interest proceeds from ALL tax-exempt municipal bonds are added back into your income for purposes of determining how much of your Social Security Benefit is taxable.

  2. Stock Dividends - Another tried-and-true method of producing income is from stock dividends. The idea is that there are a number of very strong corporations that pay out dividends to their stockholders. In some cases, these dividends can provide a sufficient retirement income, especially considering the favorable income tax rate currently applied to dividend income.

    However, the late 1990s saw many companies reduce or eliminate dividends in favor of capital gains. Fortunately, there has been a reversal of that trend in recent years. As the Baby Boomers continue to age and retire, this trend might accelerate as corporations see more demand for dividend-paying stocks.

    One benefit of a dividends strategy is that some studies show corporations with higher dividend payout ratios actually generate higher earnings growth rates than their peers with lower or no dividends. However, growth in the underlying stock price is never guaranteed, so anyone investing to live off of dividend income should be prepared for fluctuations in the value of their principal.

    Of course, the key to a successful dividend income strategy is the selection of the right stocks. It's probably not best to seek out stocks with the highest dividend yield, as these companies may have a hard time increasing yields in the future. Instead, a general rule is to diversify among a variety of market sectors and even geographical sectors to build a well rounded portfolio of dividend-paying stocks.

    Another thing to remember is that not all dividends are created equal from an income tax standpoint. Dividends from certain types of investments such as real estate investment trusts (REITs) are often very attractive, but are generally not considered "qualifying dividends" for purposes of the special 15% dividend income tax rate. While the special dividend tax rate is not important if the income is coming from a qualified retirement plan or traditional IRA (where all taxable withdrawals are ordinary income), it could make a big difference in planning for income from personal stock holdings.

    As you might imagine, collecting a portfolio of quality dividend-paying stocks is an exercise that requires a lot of research and knowledge. Therefore, it's also an area where I would recommend seeking out a qualified professional that specializes in dividend income portfolios.

  3. Income Mutual Funds - Mutual funds that specialize in bonds and/or dividend-paying companies may be the best way to use the services of a qualified investment professional. As in most mutual funds, the Fund Managers of income mutual funds select a group of stocks and bonds that fit their selection criteria.

    When evaluating dividend income mutual funds for a non-qualified (non-IRA or employer plan) account, the focus is on the type of dividends paid as much as on the yield. As a general rule, the goal is to produce a high level of qualified dividend income for the shareholders, so that the special income taxation rates will apply.

    For bond funds, there is less focus on the tax issues, and more on the absolute levels of yield and stability of the issuers. Important in both stock and bond funds is low turnover, so that capital gains will be minimized. The best bond funds are often those that buy and hold bonds to maturity, and then reinvest rather than trading frequently.

    As with other income options listed above, the underlying value of the income mutual fund shares may fluctuate significantly with market action. However, if a sufficient level of dividend income is maintained, these short-term fluctuations are probably best to be taken in stride.

  4. Rental Income - One source of income that we encounter frequently with our clients is that from income-producing properties. We have a number of clients who get a significant amount of income from rental property, and there's no good reason why this can't continue well on into retirement.

    On its face, rental property is a natural for producing income. You invest your money in the property, and renters pay you a return on your investment. All the while, the property value is hopefully increasing as well, so that you can later sell it at a profit.

    From my discussions with some of our clients, the biggest issue tends to be management of the properties, including leasing, maintenance and repairs, etc., etc. While many retirees have more time for such activities, some don't have the skills to do so, and others would like to spend their time doing other things. However, there are property management companies that can take over most (if not all) of these chores for a cut of the lease income.

    As a practical matter, I have seen this income source work best for those who already have a number of years of experience in handling rental property. I do not know that it's the best thing for a new retiree with no real estate experience, especially now with housing values slumping. Despite what the TV infomercials would have you believe, investing in real estate is not a slam-dunk way to riches - or sufficient retirement income.

  5. Investment Gains - Another way to produce retirement income can be to live off of the gains in your investment accounts, without regard to any specific income such as dividends or bond interest. In such a scenario, you would take as income all or part of the increase in your overall investments over the previous year. Theoretically, you'd have some level of income and never touch your principal.

    The only trouble with this plan is that you are not guaranteed that there will be any investment gains, and in fact, you could have losses. Do you just not take any income in those years when you have losses? Also, after such a loss, do you allow gains to remain invested until you reach your original principal amount? If so, it could be a long time between income distributions in certain market environments.

    I have less confidence in this method, as the probability of income is uncertain, at best. For those wanting to follow this type of strategy, it would probably be best to withdraw a certain percentage of the overall portfolio each year, which is another option that I will discuss in more detail in a later Retirement Focus issue.

  6. Other Alternatives - As I stated above, this list is not exhaustive. There are many other alternatives for taking income from investments after retirement, including certain types of fixed annuities, money market accounts, and so on. As with any alternative, the key to success is making sure the investment not only meets your income goals, but is also compatible with your risk tolerance.

    I have read a number of recent articles from Investment Advisors complaining about how the retirement of the Baby Boomers is being met with ever more complex "income" investments. Thus, the old adage "caveat emptor" is still very applicable.

Realistically, it takes quite a large portfolio to be able to pull off just living off of the income of your nest egg, unless you have a significant amount of other retirement income from an employer pension, etc. Many retirees using this option do so as a supplement to other sources of income, rather than as a primary income planning tool.

Retirement Tidbit

Well, this isn't so much a retirement planning tidbit as it is a year-end planning reminder. Last year, Gary wrote a very good article about the value of gifting assets to children and grandchildren. If you didn't get the opportunity to read it, I would urge you to do so. Just click on the link to go to his November 21, 2006 Forecasts & Trends E-Letter.

Just to briefly summarize, Gary said:

"Since we're entering the season of giving, I want to talk about the issue of "gifting" and how you can give up to $12,000 per year to your kids or grandkids (or anyone for that matter) with no tax consequences. A husband and wife can give $12,000 each, or a total of $24,000 a year, with no tax consequences for the donor(s) or recipient(s)."

"Gifting is one good and legal way to minimize estate taxes. You can transfer large sums of money to your kids or grandkids (or whomever) by taking advantage of gifting."

While I'll not go further into all of the requirements for gifting and suggestions that Gary made, I do want to remind you that gifting must occur prior to the end of the tax year (December 31st) in order to count for this year, assuming you have not gifted any amounts earlier in 2007.

Therefore, if you began a regular program of gifting assets to your heirs and have not yet made your gifts this year, be sure to do so before year-end. If you took Gary's advice and invested in one of our Absolute Return Portfolios in order to gift to adult children, be sure to send us your 2007 gift contribution made payable to "TD Ameritrade" no later than December 20, so we'll have time to turn it around to TD Ameritrade and it can be applied by the end of the month.

If you have any questions about an existing account, or about using one of our Absolute Return Portfolios as a medium for gifting to adult children, just call one of our Investment Consultants at 800-348-3601 and they will be happy to assist you. If you would like more information about how to use gifting as part of your estate planning process, see IRS Publication 950 at the following Internet address:

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Conclusions & Happy Holidays!

That's two down and three to go on the list of ways to convert your nest egg into retirement income. Next time, I hope to be able to finish off the list. In the meantime, if you have any questions about any of the above material, please feel free to send me a message at [email protected]. Also, I welcome all of your comments and suggestions!

Since starting in January, I have enjoyed my year of providing information on retirement topics, and I have just barely scratched the surface. I very much appreciate all of the comments and suggestions I have received from readers, and I welcome you to continue providing them.

Since Gary will be writing next week's E-Letter, I won't have another opportunity to wish all of you a very Merry Christmas, Happy Holidays and a Happy New Year!

Best regards,

Mike Posey


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Gary Halbert is the president and CEO of ProFutures, Inc. which produces this E-Letter. Mr. Halbert is also president and CEO of Halbert Wealth Management, Inc., an affiliate of ProFutures, Inc. Both firms are located in Austin, Texas. Halbert Wealth Management is a Registered Investment Advisor that offers professional investment management services to a nationwide base of clients, and specializes in risk-managed investments and its recommended programs include mutual funds, managed accounts with professional Investment Advisors and alternative investments. For more information about the programs offered, call 800-348-3601.


"Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc. are not affiliated with nor do they endorse, sponsor or recommend any product or service advertised herein, unless otherwise specifically noted."

Forecasts & Trends is published by ProFutures, Inc., and Gary D. Halbert is the editor of this publication. Information contained herein is taken from sources believed to be reliable, but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgment of Gary D. Halbert and may change at any time without written notice, and ProFutures assumes no duty to update you regarding any changes. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Any references to products offered by Halbert Wealth Management are not a solicitation for any investment. Such offer or solicitation can only be made by way of Halbert Wealth Management’s Form ADV Part II, complete disclosures regarding the product and otherwise in accordance with applicable securities laws. Readers are urged to check with their investment counselors and review all disclosures before making a decision to invest. This electronic newsletter does not constitute an offer of sales of any securities. Gary D. Halbert, ProFutures, Inc. and all affiliated companies, InvestorsInsight, their officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Securities trading is speculative and involves the potential loss of investment. Past results are not necessarily indicative of future results.

Posted 12-12-2007 5:45 AM by Gary D. Halbert