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Importance of Liquidity in Retirement

Liquidity, liquidity, liquidity is as important to retirement planning as location, location, location is to buying real estate.  A retirement plan without adequate consideration for liquidity can become a scenario of frustrations and dashed dreams.

Liquidity in a retirement plan is the ability to write a large check to cover an unforeseen expense, without paying early withdrawal or surrender penalties, without having to sell an asset (real estate or stocks) in a down market and/or without having to liquidate an investment that is currently providing income.

Financial planning for retirement is a fairly simple process.  Start with the fixed income sources such as pensions and social security.  Subtract expected expenses, being careful to add inflation each year, from this income.  If the number is negative, the retiree will either have to cut expenses or increase withdrawals from investments.  Here is where it gets tricky.

Retirees with fewer resources needing investment income will generally elect to cut expenses in anticipation of trying to live off available income and/or a small investment portfolio.  There is no margin for error in this planning.  These retirees should be extremely careful that they do not “lock up” their available investment capital in non-liquid investments.

Here are several situations I frequently see in retirement planning. 

Investors chasing higher yields in order to squeeze out a little more income can find themselves paying a stiff price measured in lack of liquidity.  This is especially true in the case of some limited partnerships and higher bonds with severe credit risk (costly to sell if forced to sell in a down bond market).  Long term CDs that can carry substantial early withdrawal penalties are also costly to liquidate early.

Annuities can present a difficult problem.  Maximum income can be derived from a deferred annuity by annuitizing the contract.  To do so, the owner enters into an irrevocable decision with an insurance company calling for the company to pay a stream of income for a period of years or for the lifetime of the annuitant.  However, the owner gives up the right to withdraw additional cash to meet unexpected expenses.

If the annuity is left in a deferred state, the owner can withdraw from the contract but may pay surrender charges or unexpected taxes.

Retirees deriving income from rental real estate should be particularly careful in their planning.  If the property has a mortgage their plan should provide for unforeseen expenses or vacancies that may reduce income flow required to cover the mortgage.  If they are managing the property themselves, they need to consider how feasible it is to continue managing the property as they age or develop substantial travel interests. 

Even if the property does not have a mortgage, their plan should provide for a source of funds to take care of costly repairs, such as replacing the roof.  This is not usually the case when one is working, since lenders are much more willing to lend to a working individual than to an individual with only portfolio or rental income.

Finally, retirees should factor in the need to replace automobiles, household appliances and major household maintenance.  As life expectancies increase the probability of wearing out durable household devices and automobiles increases.

Even if it means reducing some income, keep an eye on the need to maintain liquidity in your plan.

Securities offered through Sigma Financial Corporation. A registered broker/dealer. Member FINRA & SIPC.

Planning Services offered through Sigma Planning Corporation, a registered investment advisor.

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Last modified: 05/11/10