Ready For Retirement

Do We Have Enough for Retirement? [Plus Bonus Worksheet]

July 11, 2023 James Conole, CFP® Episode 171
Ready For Retirement
Do We Have Enough for Retirement? [Plus Bonus Worksheet]
Show Notes Transcript Chapter Markers

How much it will cost to meet your needs is one of the hardest parts to understand about retirement. Relying on conventional wisdom will only get you so far, and may even lead you astray.

In this episode, we explain how to get an accurate sense of your retirement expenses while walking you through a real example from a listener question.

As a bonus, we are including a free worksheet for you to use:
Retirement Cash Flow Planner

Questions answered:
How can you tell if you're financially on track for retirement?
What do you do before social security kicks in to supplement income?

Timestamps:
0:00 Intro
3:10 Listener question
3:57 A few things to consider
6:00 Here's where to start
10:23 Where does the rest go?
13:07 Steps 1 and 2
16:31 Their portfolio
18:31 Retirement expenses
21:50 Income strategy
23:40 Outro

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Speaker 1:

One of the hardest parts about retirement is understanding exactly how much it will cost to meet your needs, and if you just rely upon conventional wisdom that your expenses in retirement might be something like 70% of your current income, this is likely going to lead you astray. So today, i'm going to show you how you can get an accurate sense of retirement expenses, and I'm going to walk you through a real example to show you how that then leads to a full retirement income plan. I also have an added bonus, so I'll be giving you, so be sure to tune in and learn how you can use this to make the most of your retirement. This is another episode of Ready for Retirement. I'm your host, james Kanol, and I'm here to teach you how to get the most out of life with your money. And now on to the episode. What you'll see on today's episode is that dialing in your true retirement expenses is foundational to getting your retirement strategy right. This impacts everything from your cash flow to your investments, to your tax strategy. Even And although it doesn't have to be perfect, because we can never predict exactly what retirement will look like it is important to get as close as possible. So what I want to do today is go through an actual example to show you how I might do that or how I'd recommend you do it, so that every other aspect of your retirement plan can be addressed in the appropriate manner. Today's episode is based upon a listener question. This question comes from Gigi. Gigi says this. She says Hi, james, i recently discovered your YouTube channel and you've helped me think differently about retirement. Thank you for that. My husband is 58 and I'm 56 and we are planning to retire in the Philippines in four years. We presently have a combined income of $397,000 and we continue to contribute $39,000 per year to our TSP retirement investment. We also each max out our Roth IRA contribution with Vanguard with $6500 each. Our monthly expense is total around $12,400. We own a home in the Philippines with no mortgage. By the time we retire, we would still have a 19-year-old son who we're planning to send to college in Manila and we have some money saved for his college. So far we have over $800,000 invested for our retirement. That is mostly in TSP, so the Thrift Savings Plan, or both federal employees and a small percentage in Vanguard. We expect to have around $51,000 per year in pension income and, if we both get Social Security when we're 62, we will eventually have around $48,000 per year from that as well. We're projecting our total annual expenses in retirement to be at $74,000 per year, and that is already adjusted with a 3% inflation rate in the next four years. My worry is that we're miscalculating. But if we're not, do you think we have enough for retirement? We appreciate your valuable input. Thank you for what you do Sincerely, gigi. Well, gigi, i appreciate you as well, and I appreciate you submitting this question. I think this is a great question because what it shows is a couple of things. Number one is we have our life and our income and our expenses today, but that's going to change in retirement. And number two, we're planning and preparing for life and income and expenses today, but that is also going to change dramatically in retirement. So how on earth are we supposed to tell if we're on track for our retirement goals when both our expenses and our income will be different at that time? And that's exactly what we're going to go over today. As always, before we jump in, i'm going to highlight the review of the week. This is just a way of saying thank you to all of you who have left reviews, which helps me and it helps more people find the show. As I say every week, this review comes from a username, brandy and Coco. Brandy and Coco says five stars informative. James has a very informative topics. I look forward to his podcast when it comes out every Tuesday. Nice and short and sweet review. Brandy and Coco, thank you very much for that, and if this podcast has helped you at all, i would really appreciate knowing that. And the best way to do so is to leave a review so people can see what is this podcast all about. Is it helpful? Should I spend 20, 30 minutes of my time even bothering to tune in? So if you could leave a review, would greatly appreciate that. And now let's get on to the show. So, with today's topics, there's a few things to consider as you finalize your retirement plans, or as you create your retirement plans, and, as I mentioned, one of the most crucial elements, maybe the most crucial element is understanding or getting a true sense of what will that actually cost to retire. What will your expenses be? So the first thing you need to do is make sure your retirement expenses are realistic. Here's what I see all too often People come in and they say, james, we want to retire And I say, great, how much do you want to spend? And they say, james, i don't know, 4,000, 5,000 per month. Obviously, this is a very abbreviated version of how those conversations actually go. We say, okay, 4,000, 5,000 per month. Let's start with this How much do you actually have today in income? And they might say you know what? we have 10,000 per month coming in. So they're still working, of course, they have their salary and say, okay, you have 10,000 per month coming in. You think you spend 5,000 per month? That tells me that you should be saving $5,000 per month because you have an extra 5,000 each month that's not accounted for. And they'll think about it for a second and they'll say, yeah, that sounds right. You know, if we say that we only spend 5,000 and we have 10,000 coming in, there should be another 5,000 left over somewhere. But what they'll find is, sometimes that's the case, but many times they'll say no, james, you know we actually spend all 10,000, or maybe we save one or 2,000. But we're certainly not saving 5,000 of that. And that's a great place to start, because what that tells us is there's more to the picture here. We're not truly only spending 5,000 per month. So let's really drill down and dial in what your expenses actually are, because all of your retirement projections, which flow into your investment projections, which flow into your tax projections and insurance needs and so much more everything is based upon this. This is kind of like that first domino that then sets off a chain of events that leads to a fully comprehensive plan. So let's apply this to Gigi's situation, her and her husband's situation. I'm going to round some of their numbers just to make this nice and simple for mental accounting and mental math as we go through this. So here's where we want to start. They have a combined income of, call it, $400,000. Now, does that mean for them to be able to retire, they need $400,000? Well, not really, because here's the first thing. Well, right off the bat, they're saving about 40,000 of that to their thrift savings plan. So this is like a 401k plan for federal employees. So, right off the bat, they're earning 400,000, but 40,000 is going to a TSP. Well, now, that's only 360,000 that's actually left, but there's still a lot more expenses or a lot more things we need to back out of that. So 360,000, we then need to back out taxes because we want to understand what's the after tax amount you need coming in each month to be able to retire. Well, i backed out the 40,000 first, because taxes aren't owed on that 40,000 to the TSP. They're owed on what's left, so down to 360,000 now. Now, of this amount, i have no idea what Gigi's deductions are. I don't know if she and her husband itemize deductions, take the standard deduction, but if they just take the standard deduction and their adjusted gross income is 360,000, their federal taxes would be about $67,000 per year. So now we back that out. So start at $400,000, back out $40,000 for TSP contributions to get to $360,000. Now back out $67,000 in federal taxes. Now they're down to $293,000 that we need to replace. Well, the next thing they said is they saved $13,000 per year to their Vanguard Roth IRAs. So let's back that out, because in retirement you're no longer contributing to Roth IRAs. You might be doing conversions, but you're not adding more dollars to that. So back out $13,000 from that $293,000. Now they're down to $280,000 per year after federal taxes and after investments. That covers everything else. Now here's what I haven't done yet. I don't know what their state taxes are, or even if they have state taxes, i don't know what their other deductions are. So do they have pension deductions? Do they have medical or their other insurances that come out of their paycheck? To use a nice simple, round example, let's assume that they do have state taxes and they do have contributions deducted for their pension or medical or other insurances, and let's just round all of those things to $40,000 per year. I'll show you where I'm going in a second with this. If you're saying James, you're jumping right into numbers and this is kind of confusing as to why, hang on for a second and I'm going to show you why I'm doing it. Let's assume, like I said, that all other state taxes or deductions come out to $40,000 per year. Well, so far we're down to 280. Once we start with our 400,000 of income, we back out TSP contributions, back out taxes, back out Roth contributions. Now let's back out that 40,000 per year. That's a catch-all for everything else. Again, gigi didn't give me these numbers, i'm just assuming them and I'm just using some nice round numbers. Well, now what we have is we have $240,000 per year after taxes and deductions. So on average, that's $20,000 per month. So the first place I would start, if I was just to do a quick litmus test of this. I'd want to examine the numbers from this standpoint and then compare it to what they think their expenses are. So they said in their questions their monthly expenses come out to $12,400 per month. But as we look at this and again this is a very basic, arbitrary example I'm seeing that maybe monthly income is closer to $20,000 per month, based upon the assumptions I'm making. So if this is true, then based upon $20,000 per month of income, i would expect that they would be saving $7,600 per month because they say they're only spending $12,400. So if you combine the $12,400, they say they're spending plus that $7,600 they should be saving. That's where I get the $20,000 per month. So if, gigi, if you and your husband look at that and say, yeah, that's exactly what's happening, $20,000 per month is coming in, we're saving that amount and we're spending $12,400, great, your numbers are probably right on track. If that's not happening, then it raises some warning flags or caution flags. Okay, is this $12,400 actually accurate? So people will often say, going back to the example I started with, $20,000 comes in and my expenses are only $12,000. Well, where does the rest go? It goes to those one-off expenses that aren't so one-off Travel, new car, family support. So because those aren't regular expenses, people tend not to account for them. But you need to, because if you're not accounting for those things, what you do is you end up underestimating your expenses and then your retirement plan is way off and the real risk is you run the chance of running out of money because you end up spending way more than you thought you would and maybe don't have the full portfolio or plan to support that. So I mentioned at the beginning that there's going to be a bonus in today's episode, and what that bonus is is we have a retirement cash flow planner that we like to use with clients to make sure we're really dialing in your expenses correctly. So I'm actually going to include a link to that, that same cash flow planner we use for clients. It's going to be in the show notes of today's episode, and the most accurate way to determine your real retirement expenses is to fill this out, because whether it's going to show and it's just a very simple spreadsheet, but what it accounts for that most people don't account for when they're doing their budgeting is those one-off expenses. It's easy enough to understand. Okay, what's my mortgage payment? what are my utilities? what's my cell phone bill? what does Netflix cost? Those are all things you're paying every single month, so it's hard to miss them when you do your budget. It's those one-off expenses. Oh, property taxes were due this month. Auto registration was due this month. We had to buy a new vehicle this month. We had to travel or vacation this month. So those types of things that don't happen consistently each month. They tend to throw our budget, our numbers off. So we have a separate area in this cash flow planner to account for that and then averages it to understand what does that look like on a monthly basis, to determine how much we actually need to spend. So make sure you get your copy of that. You can access that right from the show notes, super easy here. Hey everyone, it's me again for The Disclaimer. Please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner or anything else. Nothing in this podcast should be construed as investment tax, legal or other financial advice. This is for informational purposes only. I haven't gone through this with Gigi. All I know from Gigi is what she submitted in her question. So what I'm gonna do is I'm gonna trust the numbers Gigi provided are accurate. It sounds like she and her husband have spent some time thinking about this. So for Gigi and her husband, i'd recommend a couple of things. One, do a version of this now how expenses are today. But then, two, do a version of this for when you think you'll be, or what you think expenses will be when you're in the Philippines, understanding that there's probably a lower cost of living. Now I don't know exactly what will taxes look like, or healthcare, that's something I don't know. But, gigi, you and your husband probably have a better sense and you can start to factor this in. So let's now go to the next step. So step number one is determine accurate expenses, because that's the foundation of everything. Step number two is now you can start to understand if you're on track to be able to meet those. So I'm gonna use the numbers Gigi gave. She said you know what 12,400 per month is what we're spending. That's what they're spending today, not necessarily in retirement. That's the number I'm gonna start with. Essentially, could you maintain the same lifestyle, the same level of spending, based upon what's going out today? So if we're assuming 12,400 per month, that's approximately $150,000 per year. Now that's 150,000 per year after taxes. So you need that coming in after taxes to be able to meet all of your needs. So what you have to do next is add on taxes, and this isn't as simple as increasing everything by 15% or 20% or whatever it is, because different things are taxed differently Social security, brokerage accounts, pensions, et cetera. So every income source is gonna be taxed slightly differently. But what I'm gonna do here is assume an effective tax bracket of 15%, just to use a simple example. So their tax bracket is 15%, their effective tax bracket, so the average across everything. We need to divide $150,000 by 85%. So, in other words, $150,000 represents 85% of the gross number they need in income. So they can pay 15% in taxes and end up with 150,000 per year. So if I divide 150,000 per year by 85%, that tells me that Gigi and her husband need $176,000 per year of pre-tax income. Again, this is a very basic analysis. There's no way to apply a universal tax rate to all sources of income. So this is for illustrative and example purposes only. Gigi had strongly urged you to do an actual analysis or work with your financial advisor to go through this for your specific numbers. This is what I'm gonna use for the sake of today's episode. So $176,000, that becomes the goal. We're starting there. How do we generate this level of income in retirement? The second thing we do is we need to understand income sources. Well, i know from Gigi's question that she and her husband are expecting $51,000 per year combined in pension income. So we know what our expenses are. Again, those are $176,000. We now need to add up all of our sources of income And the first $51,000 comes from pension. We also know that once they both reach the age of 62, they'll be collecting $48,000 per year in social security benefits. Now that benefit won't actually start right away. So go back and listen to episode number 160. It's a lot of people's favorite episode. I think it helped to portray how do you account for differing withdrawal rates, knowing that social security won't start right away, so you need to pull more from your portfolio while you wait for that. So how do your withdrawal rates change as different levels of income stagger in? I'm not gonna go into all the details today for the sake of just brevity and getting through this on time, but go back and check out episode 160, where we talk about avoiding the pitfalls of standard withdrawal strategies. However, if we fast forward to the time that Gigi and her husband are 62,. They're at about $100,000 per year of combined outside income. So, before we talk about their portfolio, they have 100,000 per year from their pension and social security. Well, if they need $176,000 to meet their lifestyle needs, but they only have $100,000 between pension and social security, there's a $76,000 per year shortfall. So that $76,000, that's what we call the gap, and the gap is what comes from your portfolio. So we now need to work backwards to determine how much portfolio do we need to create? $76,000 per year, not just once, not just twice, but potentially for 30 plus years. So this is where you use some standard withdrawal rate. You could use 4%, you could use 5%. You can't just do so arbitrarily. You need to make sure your investments are allocated in the right way and you follow the right rules to support that. But let's take a 4% withdrawal rate. What we would do is we'd say $76,000 is what we need. Divide that by 4%, that tells us that our portfolio needs to be $1.9 million so that we can take 4% out per year which represents $76,000, and be able to support that for, call it, 30 plus years. Well, the first thing you look at is say, geez, we're way off here. $1.9 million is double what we currently have in our portfolio to support our needs. Does that mean we need to keep working in order to double our portfolio and then at that point we'd be ready to retire? Well, if this $176,000 before taxes is the actual amount you need to live on, then, yeah, you wouldn't quite be ready. You need to keep working until your portfolio balance had grown to an amount or your social security or pension had grown to an amount to fully cover this. However, if you recall from Gigi's question that $12,400 per month, which is $150,000 per year, which I'm estimating before taxes, is closer to about $176,000, that's today's expenses. What Gigi said is she says they think their retirement expenses will be $74,000 per year. Now I'm not sure if that's because when they move to the Philippines they won't have a mortgage here in the US. I'm not sure if it's because of lower cost of living, lower whatever it might be, but that's the number she provided. So that analysis we just did that was to maintain current lifestyle And I think it's important you do that analysis because sometimes people underestimate how much they'll actually spend in retirement. So it is healthy to understand what would it cost to maintain current expenses, but if current expenses today aren't what expenses will actually be in retirement, then you're over projecting the cost of retirement and you see what the implication of that is. The implication is you might get a report that says, hey, you need to keep working because you need to double your portfolio value before you can retire. So you end up working way longer, sacrificing way more, saving way more. Then you need to because you got your expenses wrong on the front end. So let's go back to Gigi's specific example. If you recall the analysis I just did, we started with $150,000 of after-tax dollars that they need. But Gigi says she thinks retirement expenses will actually be $74,000 per year for each of them. So that's about half of what I projected where I went through that analysis with you just now. So if you think about this, does this mean that if expenses are half, then they need half of the $1.9 million portfolio value we just projected that they would need? Well, no, because, remember, the first thing we do before we even look at their portfolio is understand how much of these expenses will be covered by non-portfolio income sources, and that number is $100,000. So if they need $74,000 per year And they have 100,000 coming in from non-portfolio income sources. They actually have a surplus of $26,000 per year. I mean they have $26,000 more per year than she thinks they'll even need before they even tap into their portfolio. Now I have not accounted for taxes yet. I don't know if GG included taxes in that 74,000, but even with taxes and granted, i don't know what taxes in the Philippines would be but if you just applied US tax brackets and even the most expensive state tax brackets to this, even with taxes, they'd be under that $100,000 of fixed income that they have coming in from Social Security and Pension. So really we'd want to do some inflation adjustments between now and retirement. Gg said they'd already done that, which is good. So that 74,000, she said that's after accounting for a few years of inflation. If you're not GG and you're doing this on your own, make sure you're factoring in taxes and inflation going forward. But if I go back to GG's question and again I cannot give specific advice this is just for illustrative purposes only and we only have a very limited amount of information that we're basing this analysis on. But when I look at it, i see income from pension and Social Security fully covering all expenses of $74,000 per year, which means the several hundred thousand dollars that GG and her husband have in TSP accounts and Roth IRAs. That's, in a way, just extra. Now, just because you have extra, just because you're going to be okay, doesn't mean you're all set and you should just sit on your hands going forward. You still want to ensure you're doing the best you possibly can. So you still need an income strategy that answers the question of what do you do before Social Security kicks in to supplement income. Do you collect at 62, or is it better for one or both of you to push benefits back to a later time? If you can get by on just the two pensions and one of your Social Security benefits and I'd suggest at least seriously considering have one spouse delay benefits to lock in a higher Social Security benefit and provide some longevity risk insurance in a way of making sure that if both of you live a real long time, will you now have one of your benefits at least that's much higher. So you still need an income strategy, even if you're projected to be okay. You also still need an investment strategy. So how do you allocate your investments, given their role in your portfolio And their role is a little unique here. In Gigi's case, they don't necessarily quote unquote need their investment portfolio to be okay through retirement. So you could justify being more conservative than ordinary if you don't want the ups and downs of the market because you don't fully need those investments. You could also justify being much more aggressive than what you might call an ordinary retirement portfolio because you're not dependent upon withdrawals from that. So how do you allocate your investments in the right way to supplement everything else that you have in a way that's consistent with your values and what you want to accomplish in retirement? And then taxes and security. So your estate plan, insurance coverages how do you make sure that everything's optimized? I think this is the important point. Going through a plan, going through a strategy it's nice to see do we have the cash flow plan mapped out? Just because the answer is yes doesn't mean there's not a whole lot. You can still do with your income strategy, your tax strategy, your investment strategy, your insurance, your estate strategy to really get the most out of everything and ensure everything's properly protected going forward. So, gigi, thank you for that question. I think that's very helpful to walk through an example of how would you approach this, even at a high level? Thank you everyone for tuning in and listening. I always appreciate you taking the time to spend a few minutes with me each week, or however often you're tuning in. And a quick reminder that if you're enjoying the podcast, please let me know by leaving a five star review. And if you want more great content, be sure to check out our YouTube page. If you're just listening to this on Spotify or Apple Podcasts or Google Podcasts or wherever it is, we have this and other great content on YouTube to supplement this, all to make sure you get the most life out of your money. So that's it for this week and I'll see you all next time. Thank you for listening to another episode of the Ready for Retirement podcast. If you want to see how Root Financial can help you implement the techniques I discussed with this podcast, then go to rootfinancialpartnerscom Click Start Here, where you can schedule a call to one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember nothing we discuss on this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.

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