Where and When to Take Income From Your Retirement Portfolio

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. With yields still low, retirees may be grappling with where to go in their portfolio for income, and they may also be grappling with when to go into their portfolio for income. Joining me today to talk a little bit about that last topic specifically is Christine Benz. Christine is Morningstar's Director of Personal Finance. Hi, Christine.

Christine Benz: Hi, Susan. Great to be here.

Dziubinski: So, we want to talk a little bit today about the timing of taking income from your portfolio. But before we do, let's talk a little bit about where to go in your portfolio or where retirees can go for income these days. We've seen a little bit of an uptick in yields. What should retirees be looking at?

Benz: Well, it's tricky, Susan. As you indicated, that strategy of extracting income from income-producing securities is really, really tough today, where high-quality bond funds are yielding like 2%, even dividend-focused equity funds are maybe a little bit above that level but not too much. So, I'm a big believer in taking a total return approach to your portfolio, using income perhaps to fund a portion of your living expenses, but then, when your portfolio is up, not getting too worked up about having to take your withdrawals from those appreciated portions of your portfolio. Just use that total return mindset, because flexibility is really an important advantage to bring into retirement. If you can be a little bit flexible about where you go for those withdrawals, that can lead you to a more optimal portfolio over time, especially if trimming back appreciated areas reduces risk in your portfolio.

Dziubinski: So, let's pivot and talk a little bit about when you should be tapping into your portfolio during retirement for income. What should retirees be thinking about?

Benz: Well, it's a really good question. I like the idea of staying a little bit ahead of it. So, that's one of the ideas behind this bucket strategy where on an ongoing basis you're maintaining one to two years' worth of portfolio withdrawals in cash investments, and then you're periodically refilling that cash bucket as you go along. Or alternatively, you could--say, it's 2021. In 2021, you would begin setting aside the proceeds, either from income distributions or portfolio rebalancing, you'd want to begin building up the funds that you will spend in 2022. So, the name of the game is to stay ahead of it. And the key reason is that things can happen to your holdings that can change their income production. So, a really basic example would be a company that you had relied on or a fund that you had relied on for income distributions suddenly reduces its income. You'd want to be prepared and having the money filled up a little bit ahead of time helps you stay ahead of those periodic disruptions in income flows.

Dziubinski: Now, you're a big believer in retirees doing sort of a once per year portfolio review where they go in and try to figure out how they can source cash flows for the coming year. Is there a particular time of year that they do it at any point over the course of a year? Do you recommend a particular time of year to do this?

Benz: I think you could do it at any point in the year. From a practical standpoint, I think that year-end or toward year-end is an ideal time because you have some tax-planning considerations that come into play. So, if you're over age 72, you have those required minimum distributions to contend with. You may want to do some tax loss selling. You may want to do some charitable giving to tie in with the year end. So, I tend to gravitate toward that year-end period. But then, again, year-end gets busy for a lot of us, especially with the holiday season. And so, if doing it earlier in the year is a better time for you, that's fine too. But ideally, you would tie some of these threads together--required minimum distributions, tax planning, charitable giving.

Dziubinski: Now, what about regular income distributions that a retiree may be receiving over the course of a year? How should they be handling those?

Benz: One idea I like is, if you aren't reinvesting back into the positions, letting those funds build up in some sort of a cash account. And that way you sort of organically refill your spending bucket for the following year through those income distributions. So, if you have bonds and dividend-paying stocks in your portfolio and you're spending 4% from that portfolio, well, those organically generated dividends may take you half the way to your 4% today. They may give you 2%, and then you would only need to do rebalancing to supply the additional 2%. But I do like the idea of kind of building a fund that you can carry into the year ahead and use those distributions to supply a portion of your cash flow needs.

Dziubinski: So, let's say, it's later in the year in 2021 and a retiree is trying to source cashflows for 2022. What other things should be part of the process there?

Benz: Right. I love the idea of this being a holistic process. So, the starting point, in my opinion, would be to think about what sort of withdrawal you plan to take for the year ahead. Then take a look at your portfolio because the contents of your portfolio will have shifted around during the year. So, take a look at that portfolio, see how your asset allocation is positioned relative to your targets. If you need to do some repositioning, or repositioning may be your source of cash flow for the following year. So, think about repositioning with an eye toward improving and aligning your asset allocation with whatever blueprint you're using. You would also want to tie in required minimum distributions. So, if you determine that you need to rebalance out of a given area, well, that maybe--those are your required minimum distributions. So, tie in RMDs. Tie in tax loss selling. Some investors who find themselves in the lowest tax bracket may be able to do what's called tax gain harvesting, which is a topic that we've written about on Morningstar.com, and also tie in charitable giving. So, people who are subject to required minimum distributions have the opportunity to use what's called a qualified charitable distribution to steer a portion of their RMDs toward a charity. So, all of those things can be knitted together as part of a year-end portfolio overhaul tax management process. You don't need to be in there on a monthly or a quarterly basis overseeing your portfolio in retirement. Chances are you've got other fun things to do. I think a good holistic once annual review is plenty for most investors.

Dziubinski: Well, Christine, thank you for your time today. Retirement income is of course a critical topic of conversation among retirees. We appreciate it.

Benz: Thanks so much, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.