In this episode, James emphasizes the importance of having a well-thought-out financial plan for retirement, rather than relying solely on the size of your investment portfolio. Financial security doesn't come from a specific portfolio number but from having a comprehensive plan.
Using a listener's question, James walks through a step-by-step approach to assessing retirement readiness. He discusses aspects like income planning, investment strategies, tax optimization, and protection through insurance and estate planning.
Shifting your mindset from a saving mentality to a spending mentality in retirement allows you to fully enjoy your savings. Learn how to determine if you'll be financially secure in retirement and how to optimize your financial resources to enhance your overall retirement experience.
How do you assess your retirement readiness?
How can you optimize their retirement plan to enhance their overall retirement experience?
1:26 Listener question
4:03 The bills
6:03 Alternative strategy
10:36 The first thing we looked at
12:55 How to maximize
15:35 Your investments
18:58 Risk capacity
23:19 Big picture consideration
Create Your Custom Strategy ⬇️
It doesn't matter if you have 1 million, 5 million, 10 million or even more in your investment portfolio. You're not going to feel financially secure until you have a plan in place that shows you how to optimize that and not just optimize it, but optimize it in a way that allows you to fully fund everything that's most important to. You Think when the biggest hang-ups most people have is thinking that once they reach some net worth or some portfolio value, that's when they're going to feel more confident, that's when they're going to have more peace of mind. I'm here to tell you that's not the case. It does not matter how much money you have in your portfolio. Financial security doesn't come from a number. It comes from having a plan. So today I'm going to walk through a real-life scenario to show you how to think about your planning as you prepare for retirement. This is another episode of Ready for Retirement. I'm your host, james Cannell, and I'm here to teach you how to get the most out of life with your money. And now on to the episode A lot of education around retirement planning and investments. It's fairly abstract In general. Here's what you should do, or here's a principle that you should follow, which is helpful in many instances, but sometimes an actual example, something that's concrete and you can use to almost view yourself in, that's what's actually going to help you see what's important when it comes to your own planning. So we're going to go through an actual question today that a listener submitted and I'm going to walk through it and say what's the framework or what's the order of things that I want to make sure there's a plan for based upon real numbers. So this is from Peter. Peter is a listener and Peter submitted this question. He said I am 64 years old and my wife is 60 and she's retired. We have combined retirement accounts of $2.5 million. Mine is $2.1 million and my wife's is $400,000. Mine is in a 70-30 stock and bond mix and my wife's is in an 80-20 stock and bonds mix. We have $600,000 in cash and CDs which we plan on living off of and not touching our retirement accounts for six to seven years. We also have $50,000 in Roth IRA. My wife has a pension of $500 per month and our expenses are $80,000 to $90,000 per year. We have a primary home with $1.1 million, a second home worth $625,000 and my office condo worth about $225,000, and we have no mortgages on any of the properties. I will make a salary of about $170,000 in 2024 and I plan on retiring at the end of that year. I plan on taking my social security at $70,000 and then required minimum distributions. After that, the only income will be my wife's pension and rental income, which is a combined $29,000 per month. My question is does my wife take her social security early, at 62 or wait, and when should we start converting money from our retirement plans into our Roth IRA way? Also, do you feel we are on a good track for retirement? Thank you for your time. Your podcast keeps me informed and has helped me plan retirement, peter. Well, peter, thank you for that question. Like I said, let's take that, while I cannot provide specific advice so none of this is ever intended to be a recommendation or advice we can provide a framework and a way of thinking about this. That will hopefully shed a lot of light on what you could do in multiple different scenarios. When I'm looking at stuff like this for clients, there's a two-pronged approach. I'd like to take Number one first and foremost are you going to be okay? Then, number two how do we maximize this? How do we optimize every single thing that you're doing. We're not just doing okay, but we're doing the best we possibly can. When I start by saying are you going to be okay? Why do I say that? Well, for most people, their biggest concern in retirement is am I going to have enough money to pay my bills? My salary is going away. What income can I create to be okay and know that I'm not going to run out of money, which essentially means running out of income? When Peter's question he says, quote do you feel we are on a good track for retirement? There's two parts to this. If we're just starting, high level of answering the first part, which is are you going to be okay? The second part is now how do we optimize? When we're looking at that and again, are we going to be okay? It means, do we have enough income to pay our bills for the rest of our lives? What are the two parts of that equation? Are we going to be okay and what's the income going to be? So let's start with the bills. Well, in Peter's situation, he says they want to live on 80 to 90 thousand dollars per year. I'm assuming that Peter and his wife want to live on that after taxes, so I don't know what state they live in, I don't know what tax bracket they're in, but let's assume that to get 80 to 90 thousand dollars per year after taxes, they really need 100 thousand dollars per year pre-tax. Nice round number and probably not too far off, depending on the specifics. So, going back to our equation, part one of the equation what are the bills? Well, for the sake of this podcast, I'm going to assume the bills are exactly 100 thousand dollars per year. Part two where's the income going to come from? Well, this is the scary part for people who are in Peter's position is it starts out as not much. So yes, peter has good amount of money in his portfolio. He's talking about collecting his social security at 70. But what about those years between retirement and social security? So if he's going to retire at 64 and social security kicks in at 70, that can be kind of scary. Where does that money actually come from? We're so used to collecting paycheck our whole lives. It just feels weird not to have that paycheck coming in. Well, let's go back to Peter's question, or his overview. He says we'll have pension and rental income of 29 thousand dollars per year. Well, if the pension is 500 dollars per month. That's his wife's pension. That's 6,000 per year. So by process of elimination, the rental income is 23 thousand. But when you look at the combined number they have 29 thousand dollars of income coming in. But if we compare that 200 thousand there's a shortfall, and so $71 thousand dollars of that is what the shortfall is. So where's that uncovered amount going to come from? What do you do in that situation? Do you live on cash? Do you invest in stocks that pay that amount in dividends? Do you invest in bonds that pay that amount in interest? Do you do some combination of these? Well, there's quite literally hundreds of different alternative options here. I want to explore just one, though for a second. I know Peter mentioned that he's probably going to collect Social Security at 70. For the sake of illustration, though, let's just quickly review or examine an alternative strategy. Let's assume that Peter collects his Social Security at 64. That's when he's going to retire. I'm going to assume he'll receive $2,500 per month. The reality is, I have no idea how much Peter will earn, but looking at his income, he probably has a decent benefit. And if he's collecting at 64, he's accepting a bit of a reduction from what he would get at full retirement age, but still probably a solid benefit. I have no idea what his wife's income is. If she collects hers at 62, though, which is the assumption I'm going to make, let's be really conservative and assume even just a spousal benefit that's reduced because of collecting early, and I'm just going to assume that her benefit is $1,000 per month. In reality, I would say there's a pretty good chance that both of their benefits are higher than what I'm assuming, but I want to be fairly conservative for this walkthrough as we illustrate this. So Peter's getting $2,500 per month. His wife is getting $1,000 per month. So combined that's another $3,500 per month. That's coming in on top of pension and rental income. Now Peter wanted guidance on when does it make sense to collect Social Security. This may not be the best strategy, but let's run the numbers at this rate, because my philosophy towards this is look if things work with this strategy. Well, if we can find a strategy that's better, it means things will work even more. So let's just use this as a starting point. So, combined Social Security of $42,000 per year. Now, when we look at their income sources of pension, plus rent, plus Social Security well, now that's $71,000 per year. So now, only $29,000 of their total bills or total expenses are uncovered, but there's still a gap. Well, that gap is what your portfolio is for. If your portfolio is growing and growing and growing and you never spend it, it's kind of going to waste. Think of your portfolio as deferred spending, deferred lifestyle income that you have today, but you're deferring it for a future date so that you can spend it down the road. So your portfolio is designed to be spent in between cash and retirement and Roth accounts. Peter and his wife have about $3.2 million in investments. So, with that information, what does $29,000 per year look like from a $3.2 million portfolio? Well, what it is is it represents a withdrawal rate of a little less than 1% per year. In other words, peter and his wife could retire at the end of 2024, both collect Social Security assuming the numbers I'm assuming are accurate collect pension, collect rent and if their expenses are $100,000 per year, pre-tax, they only need less than 1% of their portfolio to bridge the gap and fully allow them to do everything. So, going back to his question am I on track? Am I going to be okay? Well, assuming you don't make any major investment mistakes and assuming your expenses are accurate and assuming you plan for kind of one-off risk events long-term care, health events, death et cetera then yeah, the numbers here say you're in a really good position For some perspective. Depending upon your approach towards withdrawing money from your portfolio, you can take 4 to 5%, sometimes even a little bit more, out of your portfolio that first year of retirement and be reasonably assured that your portfolio is going to last 30 plus years into retirement. So the fact that Peter and his wife are taking out less than 1% means that's a very conservative withdrawal rate, which means there's a lot that would have to go wrong for them not to be okay with their position. Now that's where I start and I also cannot give advice. So, peter, I will not say I recommend you retire and you're absolutely in a good position. But, as we illustrate that, all I will say is, generally speaking, standard withdrawal rates are higher than what Peter and his wife could take out in this scenario and still be just fine. So today, peter's first question are we going to be okay? Can't give specific advice, but the numbers would say you're probably in a pretty good spot. But here's the thing there's a difference between the numbers looking good and you being okay and optimizing every single aspect of what you're doing. So I'll tell clients all the time. People aren't coming to us just to say am I going to be okay? You can save your way to just being okay, you can invest your way to just being okay. But to optimize everything takes some pretty serious planning and intentionality to make sure that everything you've worked so hard for everything you've sacrificed for how do we make sure that's working as hard for you as it possibly can? So there is a better way than just being okay, and that's one that looks at optimizing everything. So here's the general framework we look at at root when we go through this. So we call this system Sequoia system in terms of how do we look at every single core aspect, every single pillar of a good, strong foundation to your retirement. What would that look like as we go through Peter's situation? Well, the first thing we looked at is optimizing what I wouldn't even consider the financial plan, but the life plan. What I mean by that is are you really living? Are you really doing everything that you want to possibly do in retirement? And the hardest part for that for most people is, it's very difficult to move from the saving mindset. So it's mindset you've had for the last 40 years of your career putting money into retirement, putting money into a Roth's, putting money into property. It's really hard to shift from that mindset to a spending mindset, to actually being able to enjoy the fruits of your labor and do everything that you want to do. So, peter, the thing I would ask yourself, or anyone listening to this, the thing I would ask myself, is why do you want to live on 80 to $90,000 per year? Does that truly allow you to do everything you want to do, whether that's experiences, or living comfortably, or charity, or gifting to family or just all the things that you could do with money? Or is that simply because you feel that's a responsible number to live on? So I think, in looking at those draw rates, going back to what we talked about, if you're withdrawing less than 1% per year of your portfolio to fully meet your needs, what that means is there's potentially quite a bit of room for you to enhance lifestyle, enhance spending and still be okay for the duration of your lifetime. So what does that look like? Well, check out podcast episode number 182, just a couple of weeks back where I talk about this of how do you go from a savings mindset to a spending mindset, and not just spending flippantly, not just spending foolishly, just to spend money because you have it, but spending money in a way that aligns with what's most valuable to you. That's the crucial component here. So the first step in any planning process we go through is set the finances aside. What do you actually want to do in retirement? What would have to happen for this to be one of the best seasons of your life in terms of the things you're able to do, the things you're able to experience, the people you're able to be with, the sites you're able to see? Start there and then work backwards into saying is this truly enough income? Is this the right amount of income for us to fully support that and if not, what is that amount so we can optimize everything that we worked for? 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. Nothing in this podcast should be construed as investment, tax, legal or other financial advice. It is for informational purposes only. The next thing is how do we maximize income? Well, right now, if we go back to the example I generated, or I just assumed there's only $29,000 of income needed from this $3.2 million portfolio that Peter and his wife have. If you look at that, a portfolio of $3.2 million could generate somewhere between $125,000 and $160,000 or more per year of income before taxes. Those numbers come from simply applying standard withdrawal rates. They're assuming you're invested a certain way and they're assuming you follow certain rules as you take money out of your portfolio. But just use that as an anchor point or as a starting point. Peter and his wife are taking $29,000, at least based upon the way that I assumed they take Social Security but they could be taking five to six times as much from their portfolio and still be in a position where that portfolio could last for the rest of their lives. That's before we even consider any of the equity value they have in their primary home, their second home or the office building. How do you maximize income? Not just how do you maximize it, but how do you now coordinate that on top of pension income or rental income or Social Security income? That would be something that you want to dive deep on to see what's the right combination of all these different income sources to maximize the lifetime income you can create Within that is, when does it make sense to collect Social Security? Peter, you mentioned you're going to defer until 70. That may be the best option, but at the same time, there's many reasons. I can think that it might not be. The typical person thinks and I don't mean this in any disrespect, peter but the typical even advisor I would say thinks oh, the breakeven age for Social Security is age 80 or 81. If you're going to live past that, then wait to collect your benefit at age 70. What they're not taking into account is that you waiting until 70 to collect Social Security means you're drawing down your portfolio assets along the way. What they're not factoring is what's the opportunity cost on those extra dollars that you had to draw down? Not just extra dollars, but extra tens of thousands of dollars, maybe even hundreds of thousands of dollars that you drew out of your portfolio that are no longer going to continue compounding for you like they otherwise would have. You have to factor in the big picture when you're looking at this. So, peter, does it make sense for you to collect at 70 or 64? Should your wife collect at 62 or wait? Well, that's part of an integrated plan and looking at the big picture, that's something that you'd be able to determine. Then other things, like I mentioned will you keep your office building forever? What about the second home? Do you turn those into income properties? It sounds like one maybe already is. Do you sell and invest income-generating assets? All these types of things need to be considered as you're looking at maximizing your income. The next thing I'd want to look at, after determining your income strategy, is now look at your investments. How do your investments fit within your income strategy? Because the strategies that you had when you were accumulating and growing your assets are not the same strategies you should have on the back end or when you start retiring from it and you begin decimulating your assets. Here's what I mean by that. Peter mentioned he has a 70-30 portfolio, so 70% stocks, 30% bonds, and his wife has an 80-20 portfolio. I don't ask why. Where does that allocation come from? It could be a great allocation, it could be the right allocation or it could not be, but I'd like to know why that allocation? Specifically because what I see is all too often people start shifting their allocations based purely on their stage in life. I'm young. I need a more aggressive allocation. I'm getting close to retirement, I need a moderate growth allocation. I'm in retirement. I need a moderate or even a balanced allocation. That's the cookie cutter way of thinking about it, but it's the wrong way of thinking about it in my perspective. Here's what I would do instead. What I would start with is I'd start by looking at the overall portfolio to see how much of that portfolio is in cash or conservative investments. Well, what we know is 600,000 is in cash, in CDs. What we also know is that Peter is 30% of his $2.1 million in bonds and his wife has 20% of her $400,000 retirement account in bonds. So if you do the math on that, that's $710,000 in bonds. So, between cash and bonds inside of their portfolio, Peter and his wife have $1.31 million total in what I might consider the conservative bucket of their portfolio. Now keep this in mind the role of that portion of your portfolio, the conservative bucket, it's not to grow. Yes, ideally it grows a little bit, but that's not its primary objective. Its primary objective is to protect, provide stability and provide some income as well. Here's how I think about that. If Peter's living expenses are $100,000 per year, then he and his wife having $1.31 million total dollars in cash and bonds is the equivalent of having 13 years of safety. It's like a 13 year emergency fund in the event the stock market drops and doesn't recover for a very long time. That's a lot of years. Well, let's take that a step further. When you look at Peter and his wife's expenses, yes, it's $100,000, but only $29,000 of that is actually coming from their portfolio, assuming they collect Social Security early. So when you look at your portfolio, it's not up to the entire portfolio to generate all $100,000 per year. Your portfolio only needs to generate a portion of it because another amount is coming from Social Security, pension and rent. So if $29,000 is coming from their portfolio, then that $1.3 million actually represents about 45 years of living expenses. Meaning the stock market could drop and fall off a cliff and take 45 years to recover, and Peter and his wife would still have enough money and cash and bonds to fully fund everything without having to sell stocks. So is that excessive? Well, maybe it looks at one part of the equation. When you're looking at the right investment mix for you high level, there's two things you should look at. There's what's called your risk capacity and there's your risk tolerance. Risk capacity is what we just looked at. How much risk can you afford to take based upon your various income sources, based upon how much you want to spend, based upon your high level plan? That's more of a mathematical determination. Your risk capacity says what, financially speaking, can your plan afford? Risk tolerance is more of the emotional component. Theoretically, many people could have 100% stock portfolio in retirement, but they would be horrified to actually have that. They just wouldn't be able to stomach the ups and downs and the craziness of the market by having all their portfolio in stock. So even if their risk capacity says you could be all stocks, their risk tolerance might be in the opposite end of that spectrum. So when I'm looking at Peter's plan, this is why I would say why do you have 70, 30, and 80, 20 allocations for your portfolio? It could be a very good reason. I would just be curious what that is. His risk capacity, based on this preliminary analysis, would be higher in my opinion. But what I don't know is his risk tolerance, his comfort level with investing, his comfort level with any of the experiences that a wild market might have on you in retirement. But that's where I'd start with that. The next piece is in the tax strategy? So Roth conversions first and foremost do you have the ability to keep income very low those first few years of retirement while you simultaneously move money from pre-tax retirement accounts to Roth accounts? Peter's already alluding to the fact, I think, that they're going to do this. If they have that much money in cash, they're going to live on that cash Because that cash has already been taxed. It's not going to put them in a high income tax bracket. They will pay taxes on the interest that cash generates, but actually living on that cash will not put them into a higher tax bracket. So for 2023, just for some basic numbers here, if you make $117,150 of adjusted gross income these are 2023 numbers then what you've done is you've filled up the 0%, 10% and 12% tax bracket. After that it jumps to 22%. Now there's not technically a 0% tax bracket, but what that is is that's the amount of your standard deduction or your itemized deduction, if you itemize. So if your itemized deduction, for example, in 2023, is $27,700, which is what it is if you're married finally and jointly, then what that means is you could earn up to $27,700 and pay $0 in federal taxes, because your standard deduction and this is married, finally jointly completely wipes it out. The standard deduction for single is $13,850, so exactly one half of that. So that's an important number for many retirees to keep in mind, because there's a big jump from the 12% bracket to the 22% bracket. So if you can prioritize filling out the 10% and the 12% bracket not for everybody, but for many people that becomes a priority early in retirement. So what I would want to look at for Peter is what's the adjusted gross income that they have? Well, his wife has a pension, so that's going to contribute. They have rental income, but it's not the gross income from rent that you're going to include in your adjusted gross income. It's the net income. So you have rental income, but then there's some property taxes, then there's some maintenance and there's some depreciation, then there's some other expenses. So once you deduct all of those, the remaining amount is what's actually taxable income and that's included in your adjusted gross income. So look at all that and then any gaps. Let's assume, for example, peter and his wife want to convert up to the 12% bracket. Well then, any gaps between where their adjusted gross income is in $117,150, they might want to consider shifting that amount from IRAs or retirement accounts into Roth IRAs to fully fill up the 10% and 12% bracket. Once again, that's not a specific recommendation to Peter or to anyone, that's just a common tactic. Most people take is to say look, the 10% to 12% bracket, that's relatively low. The next bracket jumps to 22% and that's a fairly big jump. So what can we do to stay beneath that? I don't want to know from Peter are you charitable inclined at all? Do you give to charity? Do you have specific donations you give? If so, do qualified charitable distributions make sense? I also want to take a look at do you use cash to do large Roth conversions, like we just mentioned, or do you do more of a balance strategy where you take some from cash each year and some from pre-tax retirement accounts each year to maintain your living expenses, all while staying under certain thresholds? So various tax things I want to consider. And then the final consideration, at least the final big picture consideration is just protection. Okay, so you have the life plan in place, you have the income strategy in place, you have the investment strategy in place, you have the tax strategy in place. Now how do we protect it? Protection falls in two main categories. The first is insurance. So do we have the right insurances? This is health insurance or Medicare. This could also be long-term care insurance. It's going to be property and casualty insurance. So liability protection on your automobile, your home? What about umbrella coverage? So what are all the types of insurances you may need, and do you have the appropriate coverage to protect what you have? The second form of protection is your estate plan. So do you have the right estate documents in order? This is a trust, this is a will, this is your advance directives. This is making sure that you have all the right things in place, and it's oftentimes not incredibly complicated, but a lot of people never get around to doing it or they never get around to updating it. So how do we make sure that assets are properly titled? How do we make sure the beneficiaries are properly registered? How do we make sure that you have all of your necessary documents so that you have control both over what happens while you're living as well as once you've passed? So making things easy on you and your family, and that's one way in which you protect the plan. Now, after that, there's all kinds of details and little questions and ongoing review of this that comes into play, but the general strategy. Going back to Peter's question, it's number one are we going to be okay? It's nice to have a back of the napkin assessment of are we going to be okay or not, and generally you can get to a good answer pretty quickly. But how do you not just do okay, but make the best of everything? That's a more thorough process. How do we identify your purpose and what you want life to look like in retirement? How do we then filter every single thing that you're doing from a financial standpoint through that lens so you can optimize income, investments, taxes and security to make sure that you're living a well-aligned and optimized life in using your financial resources as a tool to support that, as opposed to viewing your finances something separate but not fully integrated with the rest of your life? So that is it for today's episode. Peter, thank you very much for that question. Thank you to all of you who have left questions and thank you especially to those of you who have left reviews. It really helps more people find this podcast. If you haven't left a review, please go ahead and do so. If you have someone that you think could benefit from this episode or any of the content we've put out there. Please share it with them. It's fun to hear feedback from all of you of how much this has helped as you've explored your own retirement plans and, ultimately, the goals to help you get the most out of life with your money. So thank you, as always, for listening 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 in this podcast, then go to rootfinancialpartnerscom and 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 in 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.