One year into the program, approximately half of the cushion will be left. At this point any combination of portfolio balancing, tax-loss harvesting or satisfying required minimum distributions can be used to add another year’s worth of discretionary expenses to the cushion income tier. Further, retirees that have been able to comfortably satisfy their first year’s income needs, consisting of both essential and discretionary expenses, should feel satisfied that their income plan is off to a successful start.
The third tier of our retirement income framework is yield. This category of investments will generally pay competitive interest or dividends; but remember, typically carry greater risks. For this reason, we believe in using anchor and cushion income to meet anticipated essential and discretionary expenses, while earmarking these higher-yielding investments for longer-term time horizons, similar to stock investments.
So, what does one do with the interest and dividends these investments generate, if essential and discretionary expenses are already satisfied? There are several options, depending upon the investor. In our framework, we try to set aside adequate sources of income for anticipated essential and discretionary expenses, but sometimes events occur that are unexpected. Interest and dividends can be used if and when these unexpected expenses arise. Alternatively, interest and dividends can be used to consistently replenish the cushion income tier throughout the year, rather than waiting until year-end. Finally, dividends and interest that are not immediately needed may be reinvested, thus offering the potential to generate additional income later on.
The most important takeaway from our framework is that investors are not using their dividends and interest to meet their immediate expenses. Instead, we are suggesting a systematic and reliable approach that matches income needs with all income sources, including Social Security and pensions. What’s more, we successfully shift the conversation away from those investments that offer the highest yield, to a more helpful discussion about generating sufficient cash flow depending upon each client’s unique set of circumstances.
Matt Sommer, CFP, CPWA, CFA, is director of retirement strategy at Janus Henderson and leads the Defined Contribution and Wealth Advisor Services team.