Retirees: Time to Check Cash Holdings

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. As we enter into the second half of 2018, it might be a good time for retirees to do a portfolio checkup. I'm here today with Christine Benz, she is our director of personal finance, to look at six tips of how to make that go smoothly.

Christine, thanks for joining me.

Christine Benz: Jeremy, it's great to be here.

Glaser: Christine, you've written a companion article to this video touching on these six steps. But if you are a retiree and you want to take a look at your portfolio, what do you think the first thing to is?

Benz: The first thing is to check your spending rate, because that's kind of the baseline number that will tell you how healthy your in-retirement plan is. If you have your spending totals for the year to date through the middle of the year you can just extrapolate out, annualize that number and then you divide that by your current portfolio balance to arrive at your withdrawal rate. If you are a new retiree, you probably want to come in close to that 4% withdrawal guideline that we often talk about. If you are an older retiree, you can probably take a more aggressive withdrawal rate than just that 4%.

Our colleague, David Blanchett, who is the head of retirement research for Morningstar Investment Management, has written about how retirees should revisit their withdrawal rates on an annual basis, and they might be able to use the required minimum distribution tables that the IRS publishes as kind of a guideline to determine, how much can I sensibly take out of this portfolio per year. That's a starting point that you can use. This is another place where if you work with a financial advisor, if you want some guidance on much you can spend per year, this is a place to get some advice.

Glaser: We saw some volatility in the first half of the year, but stocks did end up. Is this is a good time to revisit your asset allocation to make sure you are not too equity heavy?

Benz: I think it is. If you are conducting any sort of portfolio checkup, that's one of the key things to look at, is what your baseline asset allocation looks like. And Morningstar X-Ray is certainly a great tool for getting a very specific read on your current asset allocation. Many of us, retirees included, have gotten more equity heavy with our portfolios as we have seen stocks drift up. Even if we haven't been aggressively adding to equities, we have seen our equity portfolios enlarging. I do think it's a good time to take a look at that asset allocation, potentially scale back on equities if you are heavier there than your targets would call for.

Glaser: Speaking of that volatility, we don't know what the second half will bring, but there's certainly the possibility of even more, potentially a sell-off, given where valuations are. You think that means it's really important to look at how much cash you are holding today.

Benz: It does. You want to look at cash for a couple of reasons. One is simply--and as you know, I'm a proponent of the Bucket strategy where you set aside enough liquidity to cover your next six months' to two years' worth of living expenses--but I think having cash on hand can make sense, not just from the standpoint of making sure that you are not having to sell anything when it's down to meet your living expenses, but also if you are an opportunistic investor who wants to take advantage of bargains should they present themselves, holding a little bit of extra cash seems like a reasonable strategy to me. I often say, six months' to two years' worth of portfolio withdrawals in cash is a good benchmark. I don't think it's unreasonable for retirees to think about tipping their allocations to cash even higher than that, maybe up to three years, because the opportunity cost seems really quite low to me. Where we have seen cash yields coming online that are over 2% today, the trade-off between investing in cash and say, a short-term bond fund seems like a pretty good one right now.

Glaser: You think this is also a decent time to think about Roth IRA conversion?

Benz: Potentially. And this is something I would urge, especially early retirees to check into. Maria Bruno, who focuses on retirement planning for Vanguard, has talked about those post-retirement, pre-required minimum distributions years as being kind of a sweet spot for investigating conversions, the reason being that you have a lot of control over your income at that life stage where you are not earning a salary, but you are not subject to RMDs. Check into whether converting some traditional assets, IRA assets, to Roth makes sense, work with a tax advisor or a financial advisor. One thing people, I think, underrate is the idea of doing partial conversions versus converting a whole IRA balance. That's another idea. You may be able to work with a tax advisor to figure out specifically how much you can covert in a given year in order to avoid pushing yourself into the next highest tax bracket.

Glaser: Speaking of RMDs, they are not something you have to do at the end of year, but you should start thinking about them now.

Benz: I think so. I am a big fan of sourcing required minimum distributions from portfolio withdrawals. Look at your portfolio, size it up, see where you want to make adjustments and pull from those pieces of your portfolio that you want to trim back on from a portfolio perspective, from a risk reduction perspective. For a lot of investors today, their equity component of their portfolios is a logical place to look for trimming, specifically, the growth component of equities because they have performed so well.

Glaser: Another item that many retirees leave to the end of the year is charitable giving. It could make sense to look at that now though.

Benz: I do think so, because things are changing a bit in terms of charitable contributions for many households. Many people, retirees included, will probably not be itemizing their deductions on their tax returns. They won't get the bang for their charitable contributions in the same way that they did in the past. One strategy, I think, well worth exploring for people who are subject to required minimum distributions is what's called a qualified charitable distribution. The basic idea is that you take a portion of your RMD, up to $100,000, and send it directly to the charity of your choice. You are letting your brokerage firm or your mutual fund company work directly with the charity to execute this transaction. The benefit is that that RMD does not affect your adjusted gross income. You may be able to reduce your taxes by taking advantage of the QCD.

Another idea for all retirees or really anyone is the idea of using of a donor-advised fund. And the basic idea there is that if you aggregate all of your charitable contributions into a single year in which you plan to itemize, then you can get more of a bang for your charitable donations by doing that. That's another strategy to investigate if your charitably inclined.

Glaser: Christine, thank you.

Benz: Jeremy, thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.