Asset dislocation—liquidating or selling the assets in your retirement accounts—involves tax planning and budgeting, among other things. Are you ready?
Many investors are familiar with “asset location,” or how retirement savings can be distributed across various long-term investment vehicles (not to be confused with “asset allocation,” which involves more specifically what assets to own and in what proportions). Now, let’s flip the term: “asset dislocation.”
Asset dislocation—do you know what it means? Maybe, maybe not—but it’s equally important for an individual investor to understand, because at some point, you’ll probably have to do it. Do you know how?
Here are a few basics of asset dislocation, as explained by Christine Russell, senior manager, retirement, at TD Ameritrade.
Simply put, asset dislocation refers to liquidating or selling the investments in the “account types" you have saved for retirement, Russell says. Thus asset dislocation applies once you are in retirement and living off your assets. These assets typically fall into three primary categories:
If you want or need to spend some, or all, of your retirement savings, having a firm grasp on asset dislocation is critical, in part because it can help you optimize when to sell from different types of accounts, Russell says. She notes that it’s not about what investments to sell in those account categories; rather it refers to whether it makes sense, for example, to pay taxes from 401(k) distributions or whether to avoid paying income taxes by selling investments in your Roth IRA.
Furthermore, asset dislocation affects your actual spendable income in retirement. For example, one dollar of tax-free retirement income means you can spend all of that dollar, whereas cashing in a dollar of tax-deferred assets (like Traditional IRA or most 401(k) assets) might leave you with only 75 or 80 cents to spend (or less) after you pay taxes.
Additionally, Russell notes investors should understand how increasing their taxable income might also boost other items, such as Medicare premiums, as this also impacts spendable income in retirement.
In general, before you reach retirement, do some “what-if” planning on the potential tax impact of withdrawals to determine if you might need, for example, more Roth money in retirement, Russell says.
It may be worth paying taxes now to convert some tax-deferred assets to a Roth IRA. “You would have alternatives in retirement to keep your taxable income below a certain level, thus keeping other items like Medicare premiums lower,” Russell says. “Yet, the Roth withdrawals in retirement would be fully spendable.”
As with most anything else in investing, seeking out professional guidance and conducting a thorough analysis of your alternatives can make a tremendous difference in determining the most tax-efficient asset dislocation strategy.
Such an analysis, Russell says, should incorporate several additional questions and considerations, such as “other” household income if you or your spouse plan on continuing to work, even part-time, in retirement.
You can also include legacy planning as part of your asset dislocation strategy, according to Russell. For example, you could preserve some of your Roth IRA assets for your beneficiaries so that they likely won’t have to pay taxes on this inherited amount. In contrast, most inherited 401(k) assets would be taxable to your beneficiaries. This may or may not matter to you, but it’s helpful to understand your alternatives. And of course, no matter what you decide, Russell says to make sure your beneficiary forms for all your accounts are up-to-date as these forms (not your will) are what determine who will receive your assets upon death.
Asset dislocation, and by extension, your income in retirement, is only one side of the financial equation. The other side is expenses.
How do you plan to live in retirement? Are you picturing days and years of cruise ships and golf courses, or might you instead be taking care of the grandkids, focusing on a favorite hobby, or perhaps doing volunteer work?
How you spend your time in retirement will affect when and at what rate your assets may be “dislocated.” So your pre-retirement planning should include a hard look at the retirement budget.
By comparing your retirement income to your retirement spending on both mandatory and discretionary items (aka “needs, wants, and wishes”), you may get a better idea of how to approach asset dislocation. And if your tax bill matters to you, so should dislocation once you get to retirement.