A couple of weeks back, I received a call from a client couple, (who I’ll call ‘Z’) who have been happily retired for a few years. During our conversation, they let me know they needed to take out some extra money for a one-time expense that their regular retirement income won’t quite cover. However, this isn’t the first time; in fact, it seems for client couple Z there’s a different one-time request more years than not.
As couple Z has heard me say many times, a withdrawal is a withdrawal whether it goes for regular monthly income, income tax withholding, or a one-time want. And repeated additional withdrawals, even if they don’t occur every year, put added risk to any retirement plan. What the one-time expenses that become more regular risk doing is turning what was a safe and sustainable retirement income plan initially, into one considerably less so.
For these particular clients, it was quite tempting for me to assume that their spending pattern of the previous few years was not permanent, especially since client couple Z are in their most active years of retirement. This pattern will stop eventually, right? Well not only might it not stop, but it also could just as easily increase in magnitude.
The challenge any financial planner has when managing a client’s investment portfolio during retirement is helping them stick to their retirement income plan. Using conservative assumptions on investment returns and conservative assumptions on annual safe withdrawal rates, a plan is put in motion and monitored regularly.
What’s not usually planned for when designing a long-term strategy are additional withdrawals (one-time or otherwise) from the core portfolio. The core portfolio being the total investment assets responsible for sustaining a client’s income and lifestyle for as long as they live.
Think of your core portfolio as the foundation of your overall retirement plan. It’s built to sustain the ups and downs of stock market returns and create enough income to last the rest of your life. Making additional withdrawals from your core portfolio creates a chink in the armor of your long-term financial security.
So what’s a financial planner to do when helping clients in retirement understand these risks?
The Power of Establishing a Discretionary Account
One option we’ve started implementing for clients in retirement is establishing a separate and distinct discretionary account that stands apart from their separate and distinct core account. The money in the discretionary account is expressly designated for any and all additional expenses (one-time or otherwise) that clients may wish to make.
Instead of me needing to play bad cop by advising clients of the risk they’re taking with these additional withdrawals, with a discretionary account established, clients are empowered to create clear boundaries and define for themselves the amount of extra expenses they can afford, at least for the foreseeable future. But even more importantly, clients get to determine which purposes are worthy of tapping this account.
For couples especially, this choice can spark significant conversation about what they truly value and which ‘wants’ matter most. It’s also putting more power in the hands of clients to make choices of how they want to spend the money they’ve accumulated during their working years. Clients can decide:
- How much to set aside in this discretionary account (2-5% of your core portfolio for example)
- How to create withdrawal rules and strategies
- How to set up the investments in their discretionary portfolio.
These operational questions and many more need to be considered individually and holistically when developing a comprehensive retirement plan.
Take-away: Even the most beautifully designed and well executed retirement income plan is challenging for clients to follow when retired, especially during the first few years of retirement. One way around this challenge is by establishing what many of my clients now lovingly refer to as their ‘slush fund’. They feel more empowered and that sense of empowerment brings them joy, much less conflict and perhaps most importantly, it brings them, as well as their holistic financial planner, a whole lot of peace of mind.
Photo credit http://www.flickr.com/photos/crobj/