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What exactly will happen when we start living on our savings to support that eccentric personal lifestyle to which we all look forward?

When that day comes, we will typically have two types of money. First will be retirement plan money in IRA or 401(k) accounts. The rest will be so-called "after-tax" money that could have come from home equity available after downsizing. We might have inherited some money or sold a business.

A few of us may even have a conventional savings and investment account resulting from the practice of self-discipline and living like a monk.

Whatever. In deciding how to live on income from our assets, we start by identifying what we have and where it is located.

Retirement accounts (such as IRAs) allow earnings on investments to continue to accumulate without having to pay taxes on them, so this should be the last place we turn to for income. We should let this money compound in its tax-deferred nirvana as long as possible. The only exception is the so-called "minimum required distribution," which requires that we take at least some money out of our retirement plans each year after reaching age 701/2.

At the onset of retirement, assuming we're not on our death beds, we should have a 50/50 mix of stocks and bonds, because inflation could eat away at the value of our money if we don't have at least some of it in investments that rise with inflation.

We could be looking at a retirement period that will last for 30 years or more. The stocks, or mutual funds investing in stocks, should be in the taxable accounts and bond funds should be in retirement accounts.

This is because stocks gain in value and expose those gains to taxation only at the point at which they are sold. Bonds generate taxable interest each year, which is tax-sheltered by a retirement plan.

Capital gains taxes today are only 15 percent federal, plus California state income tax, so even as we start nibbling away at our after-tax money, we are receiving a tax break compared with the full marginal regular income tax we would pay (combined state and federal).

Considering that the base income will be coming from taxable Social Security, this investment income will be additional income taxed at our highest marginal bracket. That will be at least 35 percent for most of us if we're single making more than about $35,000 and married making more than about $60,000.

In the early years of retirement, we should access the nonretirement plan money first. However, we can't lose sight of the big picture.

We preserve our 50/50 mix of stocks and bonds by annual rebalancing. As we sell stock mutual funds in our after-tax account, we may have to move some bond money in the retirement account over to stocks to compensate.

Financial models illustrate that someone with $1 million in total assets during a period of poor stock market would be able to take out $35,000 per year for 30 years before exhausting everything and being flat broke.

Assuming normal stock market returns, the income level could be as high as about $50,000 per year before exhausting the principal in 30 years.

These represent 3.5 percent and 5 percent returns on the $1 million. We can earn that easily, so why does the principal disappear? The answer is inflation. If we have 3 percent annual inflation chewing into our asset value, the equivalent of today's $35,000 will be $85,000 in 30 years.

To put it another way, $1 million in today's dollars will be equivalent only to $410,000 in 30 years. This inflation factor illustrates why the 50 percent in stocks is so important.

Even then, we can have some bad periods such as the late 1970s and early '80s, when stagflation kept the stock market down and annual inflation ran at 18 percent -- a "tsunami" at the time for retirees, unless they moved everything into a new invention at the time known as "money market funds."

Banks back then lobbied furiously to outlaw this new investment opportunity so that they could continue paying 5 percent on savings accounts and investing the money in 18 percent risk-free investments themselves.

In a similar vein, the so-called lifestyle and target funds that offer an automatic shifting allocation of stocks and bonds to solve this problem are not the answer.

They are too simplistic and unsophisticated and will lead most investors toward a false sense of security. They ignore all of the careful analysis we considered above and offer a further demonstration of how the financial services industry thinks of itself first and us second.

When we're on our own, there is no substitute for sharpening a pencil and doing what are called "projected cash flows."

Nobody can predict investment returns beyond just a historical average rate of return for stocks and bonds in general. However, the extent to which you work around the tax code successfully can add hard-dollar guaranteed increases to your asset base.

It is time better spent than chasing mutual fund performance.

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