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Strategies for Living

How should you use the assets you've accumulated to make your retirement as comfortable and rewarding as you want it to be? The answer depends, in part, on what your attitude toward spending money is.

Experts frequently comment on three categories of retirement spenders:

  • Those who live on their earnings only, trying never to use any of the principal, or amount they invested.
  • Those who plan to spend all their money, both principal and earnings, while they are alive, which is sometimes described as total liquidation.
  • Those who earmark portions of their retirement nest egg for certain expenses, which is described as selective allocation or creating mental accounts.

Specific retirement investments are better suited for one spending style than others. The smartest move, assuming that you've accumulated a diversified retirement account with a range of investments, is to match the way you use each type with the way it can serve you best.

Preserve the Principal

There's real logic in trying to preserve principal. It's principal, after all, that has the potential to produce earnings in your investment accounts year after year. When the principal disappears, there's nothing left to accumulate earnings.

On the other hand, assets left when you die are assets you didn't enjoy. Some of them can be passed to your heirs through your will or different types of trusts, or become their property as the result of your naming them as beneficiaries. Some of those assets may be taxed, either as part of your estate or for the income they provide, or both.

You have no choice about whether to preserve or spend in certain cases: Pensions are paid out on a fixed schedule and, in most cases, you're required by law to withdraw from your traditional IRAs, SEPs, and similar plans once you've reached 70½. But with other investments, you can postpone withdrawing until age 85 or later, and in some cases never touch them at all.

Setting Priorities

The things you may consider important uses of your money in retirement are:

  • Meeting your own and your spouse's needs (food, medical care, lodging).
  • Having money to do the things you enjoy, such as travel, leisure activities, or whatever appeals to you.
  • Providing for your heirs.
  • Making charitable contributions.

Spend It All

Your attitude toward the assets you've accumulated may well be "I earned it, I'll spend it." Lots of people share that view, and with good reason. The point of accumulating retirement assets is, after all, your ability to live a satisfying and fulfilling life for 20, 30, or more years after you stop working.

Although the idea of spending all your retirement money may seem reckless, the truth is that most retirement plans are set up for precisely that reason. An annuitization plan, which you can choose for your pension or annuity payout, promises to pay out your accumulated assets over a set period of years, or for your lifetime, or your and your spouse's joint lifetimes.

In other cases, you can use up the assets as you please, turning them into cash at whatever pace you like. The danger, of course, is using up your assets while you're still around to need them.

Mental Accounts

If you analyze the way you think about money, you may find that you allocate your assets into distinct categories in your head. You may, for example, put the money you spend on living expenses in one category, what you've got set aside for retirement in another, and your investment assets in a third – and you don't mix and match.

A simple example is earmarking your bonus to pay for a special family vacation. Someone who practices the principle of mental accounting wouldn't sell off an investment or borrow the money from a retirement plan to take a vacation, but would be comfortable assigning extra income to that use.

If handling money that way makes sense to you, you'll be likely to use mental accounting in retirement as well. That can position you to identify which investments you should use for living expenses, which for special expenses, and which for preserving in your estate.

The Impact of Taxes

Most experts suggest you'll want to take taxes into account when you're deciding which assets to use for income in retirement, assuming you have a variety from which to choose. That's because what your heirs will owe varies with different types of inherited investments.

Stocks, for example, become the property of your heirs at their current market value. No tax is ever due on the gains that occurred prior to your death. Dividends from qualifying domestic stocks, some international stocks, and any long-term capital gains on stocks are taxed at a lower rate than regular income

Investments in IRAs, annuities, and other tax-deferred investments are taxed as they are withdrawn at your regular tax rate.1 The timing of those withdrawals, and taxes that are due, depends on the way your particular plan is set up. If you're married, your spouse can spread them over his or her lifetime, and the same may be true for other beneficiaries as well. That's one of the provisions to check as you choose among tax-deferred investments.

© 2004 by Lightbulb Press, Inc. All Rights Reserved.

This information is provided by Lightbulb Press, Inc. and does not express the views of Wells Fargo Funds Management, LLC, or any of its affiliates. Wells Fargo Funds Management, LLC, is not responsible for the accuracy, completeness, or correctness of the information provided by Lightbulb Press, Inc. or other third parties.

This information is provided with the understanding that the authors and publishers are not engaged in rendering financial, accounting or legal advice, and they assume no legal responsibility for the completeness or accuracy of the contents. Some charts and graphs have been edited for illustrative purposes. The text is based on information available at time of publication. Readers should consult a financial professional about their own situation before acting on any information. • Lightbulb Press, Inc., 112 Madison Avenue, New York, New York, 10016, Tel: 212-485-8800, www.lightbulbpress.com.

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