I'm occasionally asked how I manage my retirement finances. I've touched on some aspects in previous posts, but I thought I'd share a little about my not-very-formal-or-complicated year-end regime.
I don't do this to suggest that I handle things in an exemplary way or that you should do what I do. Retired families can have very different personal and financial circumstances, so what I do or don't do may differ from what would be appropriate for others.
My goal is to highlight some of my basic retirement stewardship philosophies and how I apply the things I write about to my situation every day. If you subscribe to any of those philosophies, it may help you figure out how they can be applied to you.
Retirement portfolio review
A friend once told him that he thought he checked his retirement portfolio too often. (His remark intrigued me, so much so that I wrote an article about it.)
I'm not surprised that someone would check their portfolio balance fairly regularly, especially when the markets have been so volatile. Some do it weekly, daily, and during times of high volatility, several times a day (which just gives them something else to get stressed about).
I see my portfolio balance at least several times a month, anytime I do my banking. That's because I have my IRA and my banking and savings accounts all in the same place at Fidelity. When I log in to pay bills or transfer funds between accounts, there it is, staring me in the face. (Fidelity shows the current balance and the day's change in green or red.)
But the reality is that my portfolio doesn't change a lot. With an ~40% equity allocation (which is up a little from 35%), if the market is down 10%, my portfolio will lose about 4%, give or take (depending on how my more conservative investments perform).
That's not insignificant, but I don't see it as the end of the world either.
That said, other than our house, cars, and other possessions, most of our monetary wealth is in our retirement savings. So, it would be disingenuous for me to say that a total decline of 5 or 10% wouldn't be concerning. Still, I've been saving and investing long enough to know that what goes down almost always comes back up; it just takes time.
By the way, in terms of overall financial health and stewardship, your net worth (assets minus liabilities) may be a better barometer of your overall financial position than what you have in one brokerage or bank account or another. You could think of portfolio losses as a percentage of your net worth instead of as a percentage of your portfolio balance.
For example, let's say you have $800K in your IRA and own a mortgage-free home worth $450K at the start of 2021 and is now worth $545K. If you ended the year with a 10% loss in your IRA (balance is now $720K), your net worth still increased by $15,000 (due to real estate appreciation).
Granted, the money in your retirement portfolio is more liquid than the equity in your home, but I think you get the point. It helps to think about your financial situation holistically, beyond just your retirement savings account balance.
My portfolio would be considered "moderately conservative," so while I'm not unconcerned about day-to-day market volatility, it doesn't stress me out either.
I need to keep an eye out for a prolonged down-market event (which some say is inevitable, so it's just a matter of when). Even then, I may not be a seller without very compelling reasons to do so.
There are a couple of reasons why day-to-day market volatility doesn't bother me much:
1) My "moderately conservative" asset allocation. During the year or two before I retired and the three years since, I moved from a 60%/40% stock-to-bond allocation to a 35%/65% allocation (a "cash bucket" is part of the 65%), which significantly decreased the impact of stock market volatility on my portfolio. I use a "core and satellite" approach to portfolio construction, with the core consisting mostly of passively-managed indexed stock and bond funds.
My asset allocation has changed a little over the last year as I have added a few satellite holdings to juice up my income stream in this ultra-low interest rate environment. My current asset allocation is 32% stocks (mainly dividend and dividend growth funds—72% US and 28% Intl), 53% fixed income (bond funds), 10% alternatives (preferred stock and real estate funds), and 5% cash (my cash "bucket"). The preferred stock and real estate funds are closely correlated to stocks which have increased my overall stock allocation to ~40%, making my portfolio a little riskier in return for more income and some growth potential.
2) My simple investing strategy. I use a "strategic growth and income" approach, combined with a "bucket strategy" for managing cash flow. That means I'm seeking to optimize income through dividends and interest while also achieving some modest growth (to hopefully at least keep up with inflation) and maintaining a 2 to 3-year cash buffer in case of a prolonged down market.
As part of my bucket strategy, I have all dividends and interest deposited into a "cash bucket" (the cash holding inside my IRA). Then I transfer money from the IRA cash bucket to a checking account monthly and use that (minus taxes I request withheld) as income to supplement our monthly Social Security checks. Pretty simple.
As part of my bucket strategy, I withdraw the equivalent of a starting Required Minimum Distribution (RMD), although I am under the age mandated by the IRS (which used to be age 70.5 but was changed to age 72 beginning in 2020 by the passage of the SECURE Act in 2019).
All that said, when I want to dig deeper into my portfolio and its performance, I mainly check my asset allocation, income, and asset class performance. However, I rarely do anything about it. I rebalanced once this year, mostly because stocks were hitting all-time highs, and I wanted to "take some profits" and use them to buy safer assets that were devalued, but I also shifted some money to "alternatives" (preferred stock and real estate funds).
I can't say I like paying taxes, especially on our Social Security benefits and withdrawals from our IRA. But taxes are a fact of life, so while I do what I can to minimize them, they remain a fact of life in retirement. (Of course, the Bible instructs us to pay our taxes with gratitude, pray for our leaders no matter who they are, etc., but you may not hear many sermons about that.)
Although I don't think about it much during the year, marginal tax rates are important. I was able to itemize deductions for the 2020 tax year (meaning my itemized deductions exceeded the standard deduction of $27,400 for a married couple age 65 or older filing jointly). It increases to $27,800 for 2021.
I have a fair amount of work to do to compile the records and compute my itemized deductions, but I won't start that until early next year. It's tedious because there are many things I could include: uninsured medical or dental expenses that are more than 7.5% of your adjusted gross income (AGI), and this includes medicare insurance and long term care policy premiums; real estate or personal property taxes; state and local income taxes or general sales taxes; and charitable expenses.
Because I am a published author and (believe it or not) receive a little income from book sales, I'm considered a self-employed sole proprietor for tax purposes. The income from books sales is taxable, of course, but I can deduct certain business expenses related to the books. For example, I "outsourced" the cover design for my Redeeming Retirement book I self-published earlier this year. That's considered a deductible business expense that I can use to reduce my taxable income.
I'm not sure what my effective tax rate will be for 2021, but I think it will be similar to 2020, which was about 10%. My marginal rate was 22% in 2020, and with a ceiling of $172,750 for that bracket, I'm very confident I won't exceed it for 2021 as I know my total income and deductions will be similar to last year. (Your marginal tax rate should guide most decisions related to tax optimization.)
As retirees, even if it looked like we were going to cross over to the next highest marginal tax rate, it would only be from 22% to 24%, which strikes me as "not a big deal." However, there wouldn't be much we could do about it apart from beefing up our itemized deductions, and the only way to do that would be more charitable giving.
As you can tell, my tax strategy isn't much of one at all; it's more tactical based on the basics of the current tax code. Things are pretty settled right now, but we never know when Congress might upset the apple cart. (Legislation currently pending in Congress could impact those in the highest income brackets.) Plus, the current tax rates are set to expire at the end of 2025, so who knows what it will look like a few years from now.
My biggest challenge is making sure I withhold a sufficient amount of taxes from the distributions from my IRA to ensure that:
1) I won't have to pay any IRS penalties. The IRS requires Fidelity to withhold 10% unless I specify otherwise. It also requires that my withholdings meet a percentage of my tax obligations, or I may be subject to IRS and state penalties.
2) I don't have to write a huge check in 2022 to pay my taxes. The irony of that is if I have to pay taxes and withdraw the money from my IRA to pay my taxes, I will have to pay taxes on it.
As retirees, we try to keep our expenses in check. Because we don't live an extravagant lifestyle and entered retirement debt-free (including our mortgage), we are in a fairly manageable situation.
Most of our expenses are relatively predictable, but like everyone else, we're starting to experience the impacts of much higher than usual inflation. We also have the occasional unplanned (though not totally unexpected) expense.
I review our overall expenses and compare them to the previous year's budget. I do this using the Fidelity website, and the budget tracking software I have on my Mac, Banktivity, which I also use to track the "sinking funds" in my savings account that I fund with part of my monthly withdrawals from my IRA cash bucket. (I want to make sure that my sinking fund "virtual" balances synch up with the total balance in my savings account.)
I don't do a detailed analysis—I mainly look for trends or anomalies that I may need to address, but I have learned that our expenses aren't as predictable as I thought.
Since I retired, we have had to replace a refrigerator and a washer and repair some rotten wood on our porch. (We also made some discretionary expenditures on our house to improve livability and maintainability instead of moving to a newer place.)
None of these things were inexpensive, especially during the pandemic. Yes, our everyday recurring expenses are somewhat predictable. But I've learned that total annual expenses aren't nearly as predictable as I thought due to spending shocks.
It's one thing to plan and save to paint the trim on my house, but I wasn't prepared to learn that I had some extensive wood rot in my porch. What I have learned is to expect significant unplanned expenses. The challenge, then, becomes how to plan for them. For most, that means creating some kind of contingency fund.
Once I complete my review of the year's spending and give some thought to planning for expenditures in the coming year and my portfolio allocation, I decide whether I need to make any significant changes. I am trying to stick to an RMD-based withdrawal rate of about 3.5% from our savings, but I know that if I have to repair my roof, or make more wood rot repairs, or replace another major appliance, I will have to pay them whether I budgeted them or not because I don't want to put them on a credit card.
I may need to beef up my emergency fund to handle high ticket repairs or replacements around the house. I would have to increase my withdrawal rate from 3.5% to 4 or 5% to do so. But I know my "safe" withdrawal rate may need to change from year to year, often significantly, especially during a time of prolonged down-market conditions, making that higher withdrawal rate problematic.
I'm sticking with my RMD approach, but I know there is no reasonable fixed amount that I can safely spend for the rest of our lifetimes from a retirement portfolio, even if it's moderately conservative as mine is. Retirement stewardship has no cruise control.
Having a giving plan is very important, whether in retirement or not. Some would say, and I'm inclined to agree, that it should be prioritized above everything else. Not because we are under compulsion to give, but because it is a form of worship (Matt. 6:21). The Bible encourages us to give willingly and with the right motives (2 Cor. 9:7), which makes it a joy and a privilege (Prov. 11:25, Luke 6:38, Acts 20:35).
Like most people, I give online to my church (using the Easy Tithe app, but sometimes I do it through our church website, which uses Easy Tithe in the background). I have factored that kind of regular giving into our budget. So as part of my year-end activities, I check my records against those kept by our church office (mainly for tax purposes, but also to make sure I haven't missed making a gift I intended to make).
Occasionally an opportunity arises to do something beyond our regular tithes and offerings, especially during the holiday season. When that happens, I withdraw the money from my savings just like any other "unplanned" (but not necessarily unanticipated) expense.
At the end of the year, I also decide if there are any additional special gifts I want to make to ensure they are included in my current year giving for tax purposes.
I think we'd all agree that tax benefits are not the reason we give; it's for the reasons I cited above—we do so as an expression of our love and gratitude toward God, who has given us so much to help further his Kingdom on the earth (2 Cor. 9:15).
The current tax code has reduced the number of taxpayers who benefit from itemizing charitable contributions due to higher standard deductions unless they have lots of other deductions and make large contributions. Still, there's nothing wrong with getting a lawful tax benefit if you can.
By the way, you may not know that even if you take the standard deduction in 2021, according to the IRS, you can still claim a deduction due to the 2020 Cares Act. That amounts to up to $600 for married people filing jointly and $300 for those of other filing statuses. This is an "above the line" tax deduction, which reduces both your adjusted gross income and taxable income. That, in turn, reduces the amount of federal income tax you owe.
When I do my taxes, I include my charitable giving with my other itemized deductions and then determine my deductions exceed the standard deduction for a married couple age 65 or older who are filing jointly (which for 2021 is $27,800).
There are, however, more tax-wise (for some) and deliberate ways to plan your giving. I plan to do an article about this in early 2022, but the two main ways are as follows:
1) Donor Advised Funds (DAF). Fidelity Investments defines a DAF this way:
A DAF is a dedicated charitable fund maintained by a public charity (a "sponsored organization") exclusively dedicated to charitable giving. When you contribute to a donor-advised fund during your lifetime, you are eligible for an immediate income tax deduction. When your estate makes a contribution to a DAF at your death, there may be estate or inheritance tax benefits, in addition to income tax benefits.
DAFs are most beneficial to those with a sizeable taxable windfall or many appreciated assets outside of tax-advantaged accounts who would like to reduce taxes as much as possible in the current year while having the flexibility to make disbursements to charities according to some schedule in the future.
I have been corresponding with a reader about his experience setting up and using a DAF, and with his permission, I may share some of that in a future article.
2) Qualified Charitable Distributions (QCD). This one is on my radar and will probably appeal to more readers than a DAF. It's not complex, nor does it only apply to a small percentage of more wealthy taxpayers. Fidelity also provides a helpful definition:
A QCD is a direct transfer of funds from your IRA custodian, payable to a qualified charity. QCDs can be counted toward satisfying your required minimum distributions (RMDs) for the year, as long as certain rules are met. In addition to the benefits of giving to charity, a QCD excludes the amount donated from taxable income, unlike regular withdrawals from an IRA. Keeping your taxable income lower may reduce the impact to certain tax credits and deductions, including Social Security and Medicare. Also, QCDs don't require that you itemize, which due to the recent tax law changes, means you may decide to take advantage of the higher standard deduction but still use a QCD for charitable giving.
With a QCD, almost all taxpayers with a Traditional IRA will reduce their overall tax liability by funding charitable gifts via the QCD rather than by other methods such as giving cash or appreciated securities.
Due to the dramatic increase in the standard deduction (which, for 2021 is $27,800), some have found that their charitable giving no longer reduces their federal income taxes. That's because the total of all itemized deductions is no longer more than their standard deduction, making the standard deduction more advantageous.
I will be able to make QCDs when I turn age 70.5 in early 2023, even though Congress increased the RMD age to 72 as part of the SECURE Act in 2019. Since I am effectively taking an 'RMD' from my IRA, pushing it out to age 72 was inconsequential to me.
Assuming most other things remain constant, using a QCD could enable me to take the standard deduction while further reducing my taxable income by my charitable distributions. But since I have been itemizing up to now, and I include charitable contributions as part of my itemized deductions, I'll have to see which approach is most tax-advantageous for me.
I'll keep you posted on this one!
Planning for next year
This mainly involves looking at my "sinking funds" (e.g., car maintenance) to see if I have been adequately funding them based on my budget and thinking about how I want to handle any major expenses that I anticipate but haven't made provision for.
For example, next year is a big one for my wife and me. We will, Lord willing, both turn 70 (okay, not that big a deal, but it is a significant milestone). But here's the biggie: Sept. 1, 2022, will be our 50th WEDDING ANNIVERSARY! That's a big deal, and I need to start planning for it as we would like to take a special trip together to celebrate.
Like most people, I am concerned about inflation and will monitor how it is affecting our expenses. As a retiree, it's showing up mostly in the cost of groceries, utilities, and healthcare, none of which are minor categories.
I don't foresee anything too significant other than that, but as I mentioned earlier, unexpected "shocks" to our budget have been more common than I would have thought. I should've known better.
That's basically it, and I admit, it's not very complicated and certainly not glamorous or exciting. One big reason is that I try to keep our financial affairs as simple as possible.
It doesn't take me hours and hours to do this either. Instead of getting bogged down in the minutia, I focus on the "big" areas discussed above. Still, there are so many unknowns—how long my wife and I will live, our health care and long term care costs, inflation, market returns, and unexpected expenses— so any "plan" I come up with may need to change many times.
Also, given my asset allocation and focus on income, I don't lose sleep over market declines or check my portfolio balance excessively. My portfolio reflects my risk tolerance and capacity, both of which are relatively low as I approach age 70, which I think is prudent at this time.
With my finances, as with so many other important concerns in life, my philosophy is to manage them as wisely as I can based on Scripture's teachings and trust God with the ultimate outcome. There are many uncertainties and unknowns from year to year, and next year will be no exception. But God holds the future and his hands, and we can rest in his love and care for us (Matt. 6:25–34).