You are now leaving our website and entering a third-party website over which we have no control.
Summer 2025
James H. Beam Jr.
Head of TD Wealth Planning, Retirement & Strategy (U.S.)
Mark D. Hasenauer
TD Wealth – Planning & Goals Based Advice Leader
Ashley W. Weeks
Editor-in-Chief TD Wealth – Wealth Strategist
Featured Articles
INVESTMENTS, SECURITIES AND ANNUITIES |
||||
NOT A DEPOSIT |
NOT FDIC-INSURED |
NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY |
NOT GUARANTEED BY THE BANK |
MAY GO DOWN IN VALUE |
The most critical time for an investor's portfolio is the five years before and the five years after retiring.
During working years investors often construct their retirement savings plan and portfolio considering long-term average returns. While short-term investment performance can be volatile, average returns compounded over time are the key ingredient to building long-term wealth for retirement. Early and mid-career savers have time to recover from market corrections since their portfolio can remain fully invested through the rebound and retirement contributions are likely still ongoing.
The calculus changes drastically as the retirement date approaches and time becomes less of an ally. Suffering a major portfolio decline early in retirement might require a retiree to liquidate positions and lock in losses to support retirement living expenses. The fact that a portfolio has exceptional returns when averaged over a 30-year period is less consequential if that portfolio suddenly loses 30% right before the owner needs to begin withdrawing funds for retirement.
Having poor returns early in retirement can increase the risk of prematurely exhausting funds, this is called "Sequence of Returns Risk."
Example of Sequence of Risk Returns
Remarkably, two retirees with the same retirement savings, identical spending habits, and the same 7% average annual return over a 30-year retirement can have starkly different outcomes based on the timing of an otherwise similar two-year correction.
Both "Retiree A" and "Retiree B" start with a $1 million portfolio, and they each spend $60,000 annually (indexed for inflation). The average annual investment return over 30 years is 7% for both individuals. However, Retiree A suffers a 12% loss in year two and a 6% loss in year three. Retiree B suffers the same 12% and 6% losses but in years fifteen and sixteen, respectively.
Assumptions: "Retiree A" starts with a $1 million Roth portfolio, spends $60,000/yr indexed for inflation at 2.4%. Retiree A suffers portfolio losses of -12% in year two and -6% in year three. For all other years Retiree A has portfolio gains of 8.15% resulting in a 30 year annual return average of 7%. Hypothetical results are for illustrative purposes only and not indicative of any client account.
Example of Sequence of Returns Risk
Assumptions: "Retiree B" starts with a $1 million Roth portfolio, spends $60,000/yr indexed for inflation at 2.4%. Retiree B suffers portfolio losses of -12% in year fifteen and -6% in year sixteen. For all other years Retiree B has portfolio gains of 8.15% resulting in a 30 year annual return average of 7%. Hypothetical results are for illustrative purposes only and not indicative of any client account.
In these hypothetical scenarios Retiree A would run out of money in year 23, but Retiree B would remain solvent throughout retirement with nearly $350,000 remaining as a cushion at the end of year 30.
Remember, both retirees enjoyed the same average rate of return throughout their retirement, and they both encountered a two-year period of identical percentage losses. However, because Retiree A encounters these losses early in retirement while drawing down on the assets, less principal remains to participate in the rebound and Retiree A runs out of funds.
On a whole dollar basis, Retiree B's losses (years fifteen and sixteen) exceed Retiree A's losses (years two and three) by about $50,000. Yet, Retiree B benefits from positive compounding returns until mid-retirement which more than compensates for those later losses. By enjoying a more favorable sequence of investment returns, Retiree B makes it through retirement with resources to spare.
Strategies to Minimize Sequence of Returns Risk
- Reduce Overall Portfolio Volatility
The key to mitigating sequence of returns risk is to create a portfolio that is adequately defensive given the time horizon involved. Starting about ten years prior to retirement investors should consider reducing risk by shifting a portion of the portfolio from more volatile equities to defensive stocks, investment grade fixed income and cash equivalents. As the retirement date approaches, principal protection becomes increasingly important. - Maximize Income
Having a reliable stream of income can reduce the burden placed on an investment portfolio in retirement. Retirees may be able to maximize income by delaying Social Security benefits. In some cases, individuals who are eligible for a pension can delay receiving benefits in favor of a higher payment later. Finally, certain annuity contracts may provide a reliable stream of income that is impervious to market performance. - Adjust Spending Based on Performance
In lieu of abiding by a set annual spending rate in retirement, consider adjusting spending to account for investment performance. If spending can be reduced in the wake of portfolio losses, more funds will be left to benefit from a market rebound. Spending can then be increased in periods where the portfolio outperforms expectations. - Maintain a Cash Reserve
The greatest damage with sequence of returns risk is inflicted when a retiree is forced to sell into a loss due to liquidity needs. This risk can be limited by maintaining a cash equivalent buffer throughout retirement that will cover essential expenses for the next three to five years.
Not all investments are equally tax efficient, and it can be kind of a drag!
- A popular adage is the only free lunch in investing is diversification. However, a well-diversified portfolio can introduce an additional variable in the form of disparate tax treatment for different types of holdings.
- A successful retirement plan is predicated on years of compounding investment growth. It is important to consider that annual taxes on portfolio yield can chip away at the earnings available for reinvestment and compounding. The rather fitting term for this impact is "Tax Drag."
- Younger investors may focus solely on maximizing contributions to retirement accounts where tax drag is not a key factor because taxes will only be assessed on future withdrawals (or never in the case of a Roth account). Ultimately, many investors will also begin funding taxable investment accounts where taxes on annual yields can have a material long-term impact on wealth accumulation.
- The strategy to mitigate tax drag by intentionally holding tax efficient assets in taxable accounts and tax inefficient assets in retirement accounts (tax deferred or Roth) has a name: "Asset Location."
Quantifying Tax Drag
It is important to note that yield, unlike total return, only considers portfolio income (interest and dividends) and ignores capital appreciation. An investor can typically choose when to sell a holding which provides greater control over taxes from realized gains due to capital appreciation.
The following charts compare tax drag based on a hypothetical investor's tax rates and recent approximate yields from indexes for major types of investments.
Assumptions: Equity yields are all qualified dividends subject to the long term capital gains rate (20% for high tax and 15% for low tax). Bond and Treasury yields are subject to ordinary income tax rates (37% for high tax and 22% for low tax). REIT yields are subject to ordinary income tax rates with a 20% deduction for qualified business income (29.6% for high tax and 17.6% for low tax). Additional 3.8% net investment income tax is applied to all yields in high tax scenario. State and local taxes are not considered. 1-yr trailing yield estimates are derived from major index tracking ETFs reporting in Q1-Q2 2025. Hypothetical results are for illustrative purposes only and not indicative of any client account.
Tax drag reduces the residual yield available for reinvestment in a taxable account each year. The impact is especially pronounced for investors in higher tax brackets and over decades the cumulative impact can be profound. For this reason, allocating less tax efficient (higher tax drag) investments to retirement accounts (tax deferred or Roth) and more tax efficient investments to taxable accounts may be a worthwhile strategy.
Putting it All Together: Asset Location
Understanding that certain investments are less tax efficient and quantifying this inefficiency allows investors to thoughtfully allocate holdings to maximize after tax yield. This is the foundation of an asset location strategy.
A Word of Caution: Creating an appropriate portfolio considering time horizon, liquidity needs, and long-term goals supersedes all other objectives. The tax "tail" should not wag the planning "dog." An asset location strategy builds around a thoughtfully constructed portfolio where an investor has different types of accounts within which to allocate portfolio holdings.
Considerations for Asset Location by Account Type
❖Taxable Accounts
Typically, the most tax efficient assets are allocated to taxable accounts as yields and realized gains will be subject to annual tax drag. These could include:
- Municipal Bonds – Interest is typically exempt from federal income tax.
- Growth Equities – Less annual dividends than defensive / value equities.
- Treasuries – Typically lower yields than corporate bonds and state tax exempt.
- Passive ETFs – Less ongoing taxable gain realization than actively managed funds.
❖Tax Deferred Accounts (e.g., Traditional IRA)
The most tax inefficient assets can be allocated to tax deferred accounts since yields and gains are not subject to annual taxes prior to withdrawal. These could include:
- Corporate Bonds – Higher interest rates that are taxed as ordinary income.
- REITs – Dividends are not "qualified" and are taxed as ordinary income.
- Value Equities – Often provide higher taxable dividends than growth-oriented stocks.
- Actively Managed Funds – Frequent taxable gain realization.
❖Tax Free Accounts (e.g., Roth IRA)
Roth accounts shelter tax inefficient assets from tax drag too. However, the benefit of tax-free compounding justifies also placing high growth assets in Roth accounts.
Every situation is different, and investors should evaluate all options considering their investing objectives and applicable tax rates after consulting with their independent tax advisor.
Adding an adult child (or another caregiver) as a co-owner may seem like a convenient solution. However, unintended consequences can abound.
As retirees age it is fairly common for an adult child, or another loved one, to assist with some of the day-to-day financial tasks. Older individuals might seek help with managing their investment portfolio or bill payments, even when there are no issues with diminished capacity. An additional consideration involves legacy planning and the frequent desire to efficiently pass assets and avoid probate.
Reflecting on these goals, some retirees come to an "obvious" solution, by simply adding an adult child as a co-owner for all assets, that child will be able to manage the assets and will automatically inherit the property outright at death. Piece of cake!
If only it were that simple. This easy solution is rife with unintended pitfalls including tax consequences and creditor issues. But there is a better way, with a bit of planning the same goals can be accomplished without the risks of joint ownership.
Potential Risks with Joint Ownership
❖Taxes
Gratuitously adding a non-spouse as a joint owner of an asset is typically viewed as a reportable gift and could require filing a gift tax return. When an additional owner is added to an income generating asset, like a brokerage account or even a high interest savings account, the annual tax reporting process can become more complex as well.
❖Co-Owner Liability
One of the greatest risks with adding a child as a co-owner simply for convenience is that in some cases the assets could become subject to the child's legal liabilities. If the child were to go through a lawsuit, divorce, or bankruptcy, any asset over which the child has an ownership interest could be targeted to satisfy a judgement or creditor.
❖Reduced Control
Adding a co-owner usually grants that person full access to the subject account or asset which reduces the primary owner's control.
Alternative Solutions
❖Transfer/Payable on Death Registration (TOD or POD)
If the primary goal is simply to avoid probate, financial assets and even real estate in some states can be registered or titled with a TOD or POD endorsement and at the owner's death the asset will automatically pass to the named TOD/POD recipient(s).
❖Durable Financial Power of Attorney (Financial POA)
A financial POA is a legal document that authorizes another individual to manage your financial assets without transferring an ownership interest to them. Financial POAs are quite flexible and avoid the tax and creditor issues of adding a co-owner.
❖Revocable Trust
A Revocable Trust can be established to own assets, avoid probate, and even appoint another individual to serve as trustee and manage trust owned property within the guidelines outlined in the trust document.
Speaking to a knowledgeable attorney is a critical part of the process with any of these solutions as the legal implications can be significant.
Your Credit Score
Keeping tabs on one's credit report may not be top of mind during retirement, especially if access to credit is no longer an important part of the financial plan. However, a credit report impacts more than just borrowing ability. A good credit score can provide the following:
- Reduced car insurance rates
- Preferential payment options for utilities
- More favorable terms for a car lease
- Preferential cell phone plans and payment options
Additionally, a retiree who is considering renting a home or seeking a part time job may find that a credit check is part of the rental or employment application.
It is a good idea to review your credit report at least annually to see the factors influencing your score and to identify any unauthorized activity. Credit monitoring can be a useful tool for quickly detecting identity theft.
Consider obtaining a copy of your credit report today.
By law you are entitled to a free copy of your credit report annually from each credit bureau and the federal government has authorized the following website to issue these free credit reports online: AnnualCreditReport.com
Connect with a TD Wealth Advisor
Our TD Wealth Advisors are available for a consultation to start planning for your future.