Retirement » Retirement Income

A secret tax efficient monthly cash flow system

Larry from Qualicum dropped by to ask me how he could start taking income from his mutual funds. I said, How would you like to have a majority of it paid to you tax-free? Of course but how can I do that Larry answered? I replied, Larry, if you’re looking for tax-efficient income solutions, here is an idea to think about.

Set up a systematic withdrawal program (SWP). The concept is simple. You withdraw a specific monthly amount from your mutual fund.

Consider it the opposite of dollar-cost averaging. A majority of the initial income is a return of your own money or capital, which is tax-free. You set up a monthly withdrawal from the fund. You can state the withdrawal either as a percentage of the fund’s value or as a specific monthly amount say $500 per month. The fund will direct the deposit to your bank account each month, so you don’t have to worry about lost mail.

We recommend that you set up a specific dollar amount rather than a percentage because your monthly income is a fixed amount and will not fluctuate.

To help protect your money, you should consider withdrawing less than what the fund earns. It will help you keep pace with inflation and possibly increase the income in the future. In my experience, most investors set up withdrawals of 4% to 6%, although you can set up withdrawals of as much as 10% (In such cases, we warn clients that they are increasing the risk of eroding the principal)

In an ideal world, Larry would withdraw 6% from a fund that is producing 8%. That way, the fund will continue to grow over time. Larry and I have chosen balanced funds for SWPs, although you can also do it with other kinds of funds. We choose balanced funds because they are highly diversified, with stocks, bonds, government securities, cash, and sometimes even international securities.

A bond fund is unlikely to earn 8% consistently, and a stock fund is too risky for clients who depend on investment income. Balanced funds strike a nice, well-balanced plan for Larry’s retirement income needs.

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