Anum
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Hello, I'd like financial advice on managing my retirement funds. When I retire, I will be receiving a pension equivalent to what I earn today (100 percent). What I would like to do is cash out 33.33 percent of my retirement as a lump sum payment and use these funds to pay off my mortgage. With the mortgage paid off, I'd still be receiving 66.67 percent of my pension for the rest of my retirement years. Does this approach make good financial sense. Thank you. Muna Salim

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Answers (1)

Answers (1)

Anum –

 

Thank you for a great question. In retirement, it makes sense to try and have your money go as far as possible, and certainly reducing debt can improve your overall cash flow, however, when it comes to using retirement dollars to do it, you need to pause and consider the potential trade offs. Bottom line up front, this may be best answered by going through a financial plan with one of our advisors. However, I want to give you some high-level direction and items to review.

We believe a successful retirement cash flow plan has three key components:

  • First, your fixed living expenses should be paid for with guaranteed income sources like a pension, social security or from an immediate annuity. This creates a “floor” for you and no matter what happens with the market, you should know that your fixed expenses are taken care of.
  • Second, your investment portfolio’s asset allocation should be aligned to your risk tolerance. This portion of your “pie” should be used to pay for discretionary expenses like travel or entertainment. It’s easier to tighten the belt on non-essential costs during difficult times than trying to figure out how the lights are going to be kept on.
  • Lastly, protecting your cash flow plan means to have adequate insurance in place. Health care costs and the risk of needing long term care can be significant obstacles. Having a plan in place to mitigate these costs is necessary.

So with this approach in mind, consider the impact of reducing your pension amount by taking a partial lump sum:

 

Guaranteed Income and Cash Flow Planning – Your lump sum will reduce the income that you will receive. This lowers your “floor” so you need to figure out exactly what you need to have paid for each month and determine if your adjusted income amount is going to be sufficient. Plan for future changes in health costs, insurance and taxes.

 

Taxes – Depending on your pension plan, taking a large lump sum could significantly increase your income tax liabilities. In most cases your lump sum from your pension will be treated as ordinary income and could push you into a higher tax bracket overall. Additionally, if you don’t have non-retirement cash to use to pay the taxes, then you will need to distribute more from your pension to get the after-tax amount of cash needed to pay off the mortgage. This could affect your fixed income plan as well.

 

Potential changes to cash flow – As I have mentioned, health costs are a big obstacle. A recent study from Kaiser Family Foundation, a retired couple age 65 in 2018 may face approximately $280,000 in costs over their lifetime. These numbers don’t factor in long term care costs which can be significant as well. Again, my concern would be that your “floor” could be reduced by the mortgage payoff and may not be enough to factor in insurance policies or budgeting that could help to offset these risks.

 

Withdrawal rate on retirement assets – A good rule of thumb is to limit the amount you pull from savings in retirement to 4% of your portfolio’s value. If you are forced to withdrawal more than this to meet your fixed and discretionary costs, you could run the risk of running out of money during your lifetime.

 

Your home – Do you plan to live in it the rest of your life and it is reasonable to plan on it? Fast forward and consider if you need health care support, can you receive it in your home; are you near family members or other loved ones for support? The home is an asset but if you need to sell in a pinch, do you have enough cash on hand to relocate without having to take a reduced price?

 

As I stated at the beginning, this may be a great question to have answered by working through a financial plan with one of USAA’s financial advisors. Give us a call at 1-800-531-USAA and let us help determine what the best approach is for your situation.

 

I hope that this has at least helped in identifying some of the things that your question should consider. Thank you for your membership!

 

Sean Scaturro, MBA, CFP®

Director of Advice