Retirement planning is more than just a target savings number.

AuthorWatkins, Andrew J.

Today, the hot concept around retirement planning is that each person should "know his/her number." If you had $XX, you could retire and live the life you want today.

While there is utility in having a target number, it's not so much the number that matters but where and how those assets are invested that truly counts. Don't get me wrong, there is value in having a target. It helps to create a goal, which can lead to being a more disciplined saver. However, this train of thought fails to consider two important aspects of retirement planning: impact of tax-efficiency and need for diversification.

First, not all assets are treated the same. For example, 401(k)s, Roth IRAs, brokerage accounts, and bonds are all taxed differently. Once you hit age 59 1/2, withdrawals from your Roth 401(k) or IRA are tax-free. Traditional IRAs and 401(k)s, along with CDs and bonds are taxed as ordinary income. Meanwhile, gains from brokerage accounts will be taxed at capital gains rates, which vary depending on your income and filing status. Based on this general concept, you can see that if you have the same amount of money in a tax-free account as opposed to a taxable one, your assets are much more valuable.

The retirement picture is further complicated by the fact that federal income tax-brackets and many state tax systems are tiered. This means that the more taxable income you receive in a year, the bigger the cut to Uncle Sam. Today, these tiers start at 10% and extend up to 37%. Your tax-filing status and income are huge factors in determining the amount of money you keep. Therefore, if a majority of the income generated from your retirement savings is taxable, your after-tax spendable income might be much lower than expected. Focusing on your withdrawal strategy may significantly reduce taxation, thereby increasing the amount you can safely spend and helping ensure your money lasts longer. Tax brackets change most years and therefore it's important to regularly revisit your income plans.

In addition to tax-diversification, it is important to have asset diversification. In a given month, it is unlikely that all assets are positive or negative. For example, your bond positions might be up when your stock positions are down. Market volatility is to be expected and can create a challenge to the "know your number" retirement strategy. For example, let's assume that you've reached your target asset number and then the market experiences a fairly typical 15%...

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