Preserving Your Income Stream Through Retirement – Part Two

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Preserving Your Income Stream Through Retirement – Part TwoSee Part 1 and Part 3 in this series.

Last week we began a discussion on how to build a retirement income strategy that would provide an increasing stream of income over life expectancy so you can maintain your lifestyle. The three fundamentals established in the first part of this series for the investment side of this strategy are:

  • Equities are needed to provide growth
  • Establish an asset allocation strategy to take advantage of market volatility
  • Set a sustainable withdrawal rate

The next step to building an effective retirement income strategy is optimizing the portfolio from a tax standpoint. Tax efficiency will come from three areas:

  • Using all three legs of the New Three-Legged Stool™ strategy
  • Properly diversifying your asset allocation over the three legs
  • Taking tax-smart distributions that will vary based on your circumstances and market conditions

A key challenge to building proper tax diversification into a retirement income strategy is the fact that many individuals hold a large percentage of their overall savings in tax-deferred retirement accounts. Traditional IRAs, 401(k) plans, and pensions are great to have when you’re working but withdrawals are fully taxable at ordinary income rates when distributed. According to a study from the Employee Benefit Research Institute, among families with assets in tax-deferred accounts, these resources accounted for a median of 62.5% of their total financial assets. Roth IRA accounts, which are funded with after-tax dollars and can produce tax-free distributions in retirement, comprised just 5% of all tax-deferred assets.

Tax Treatment of Various Types of Retirement Income

Type of Income/Account Tax Treatment
Tax-Deferred accounts – 401(k), 403(b), 457 plans, Thrift Savings, Traditional IRA, Annuities Taxable at ordinary income rates upon distribution. 10% to 35% in 2012.
Pensions Taxed at ordinary income rates.
Roth IRAs and Roth 401(k)s Distributions are non-taxable if owner is age 59 1/2 and the account at least 5-years old.
After-tax investment accounts Long-term capital gains and qualified dividends: taxed at a maximum of 15% in 2012. Other income: taxed at ordinary income rates.
Social Security May be partially taxable at ordinary income rates.

From The New-Three Legged Stool: A Tax-Efficient Approach to Retirement Planning

Unfortunately, retirement savings have been building up in tax-deferred accounts at a time when personal income tax rates have declined to historically low levels. Historically, tax brackets have been at current levels only 14% of the time. Congress is currently trying to reduce budget deficits that have been in the trillions of dollars. The $15.6 trillion of pre-tax assets currently sitting in retirement accounts has to look very appealing to a cash-starved Congress. Retirees who have the majority of their assets in traditional accounts anticipating lower tax rates in retirement could be in for an unpleasant surprise.

A historical analysis of different tax scenarios showed the survivability over various time periods of a diver­sified portfolio of equities, fixed income, and cash when the portfolio is taxed at different rates. Not surprisingly, the portfolio with the highest tax bracket had the shortest survivability.

Historical Success Rate1

20 Years

30 Years

40 Years

No Taxes




25% tax rate




35% tax rate




Following the New Three-Legged Stool™ retirement strategy offers several benefits:

  • Provides flexibility – the ability to draw income from the three different account sources depending on your tax situation from year-to-year.
  • Sustainability – Research shows that a lower tax rate may help your portfolio last longer.
  • Hedge against higher tax rates – We don’t know what will happen with the tax code in the future or who will be affected. Diversifying your savings can help minimize tax changes that affect you.

The final week of this series will look at specific techniques used to achieve tax-efficiency.

See Part 1 and Part 3 in this series.

1This hypothetical illustration is based on rolling historical time period analysis and does not represent the performance of any specific mutual fund, which will fluctuate. This illustration uses the historical rolling periods from 1926 to 2011 and a portfolio composed of 60% equities (as represented by an S&P 500 composite), 30% fixed income (as represented by a 20-year long-term government bond (50%) and a 20-year corporate bond (50%)), and 10% cash (as represented by U.S. 30-day T-bills) to determine how long a portfolio would have lasted given a 5% initial withdrawal rate adjusted each year for inflation. A one-year rolling average is used to calculate performance of the 20-year bonds. Past performance is not a guarantee of future results. The S&P 500 Index is an unmanaged index of common stock performance. You cannot invest directly in an index.

Rick’s Insights

  • Holding all your retirement savings in a tax-deferred account provides few opportunities to minimize taxes during retirement.
  • Research shows that lower tax rates can increase the survivability of your portfolio over life expectancy.
  • If Congress could figure a way to tax just 1/5 of retirement assets it could eliminate the current budget deficit.

Will Your Money Last Through Retirement?

No one wants to run out of money. But without goals and a solid plan,
how can you know for sure whether you’re on the right track?

Will I be able to maintain my current lifestyle?

What will my monthly income be in retirement?

Can I protect my hard-earned savings and still
have the income I want?

Rodgers & Associates answers questions like these every day.

Get Personalized Answers
2025 Lititz Pike, Lancaster, PA 17601
Phone: 717-560-3800, Toll-Free: 888-876-3437