Paul Samuelson was one of the great American economists. He transformed the MIT Economics Department, was the first American to win the Nobel Prize in Economics and advised various presidents. Recently his son published and interesting summary of his talks with his father about how to prepare financially for retirement.
Samuelson’s investment strategy was direct and simple: buy and hold low cost index funds and stocks with limited distributions. That was it. They did everything possible to avoid realizing gains, including making gifts of appreciated stock. The primary drag on long-term investing success is taxes. This point was one of his investing “tips.”
The next major concern was determining the best way to make withdrawals from multiple account registrations. This matter is complex and challenging, enough so that Bill Sharpe, another Nobel Laureate, has called retirement income the trickiest problem in all of finance.
The analysis necessary for planning retirement income requires complex mathematical methods. Simple ideas, like “take 4%, are woefully inadequate. To add to the difficulties, the details change every year during retirement. The challenge is how to reduce risk and taxes in a household portfolio to increase what a retiree can spend and also leave as a bequest.
Years of research by those in academia and in financial planning has clearly shown that a multitude of factors apply, and with different significance to different families. It is not what you make, but what you keep, or can spend. So consider these factors:
You want to have an overall sound portfolio allocation. But different accounts have different tax treatments, so assigning particular investments to specific accounts can be beneficial by leading to improved after-tax accumulation.
A recent catchy phrase is tax-loss harvesting, but this short term technique only delays tax consequences with the hope that tax rates could be lower in the future. The bill comes due eventually.
For those already in retirement and living off their savings, the strategy of drawing from accounts with different tax treatments can be used dynamically to manage taxes while maintaining the desired lifestyle spending.
Rebalancing and readjusting the portfolio should be done with the intent to manage the overall risk and to use the accounts with different tax treatments to stay on track while improving after-tax returns.
Social Security has become anything but simple. The answer to when to start and how to file is complex and often surprisingly different depending on the circumstances of the family.
An important note is that the government provides a risk-free 8% guaranteed increase in Social Security benefits between the ages of 62 and 70. Some pundits endorse delaying Social Security payments to receive the larger amounts. The other consideration is that the retiree receives nothing until the payments start. So which will deliver the best long-term result? Again, this depends on the specific circumstances.
A coordinated sequence of withdrawals with tax efficiency on top of Social Security across all accounts and income sources, including pension, annuities and investments, is fundamentally important. Strategic withdrawals from investment accounts help meet necessary spending, fund discretionary spending, and pay taxes on non-investment income.
The accounting firm, Ernst & Young, conducted an independent analysis of this methodology and determined that careful selection of withdrawals, somewhat different each year, could improve after-tax returns and income by up to 33% over an investment lifetime.
Clearly maximizing retirement income is complex. It is not one simple decision at the start without any changes. Be thoughtful, do your homework, get advice, avoid financial products which allege to solve everything.