In this video I am sharing a sample case which is based on a couple that I have been working with recently. He is 65 and she is 67, and they have $500,000 saved in their retirement accounts. They would like to retire now.
We'll take a look at their current situation and the strength of their current retirement plan. Then we will take a look at the potential impact of incorporating various strategies to help improve the strength of their plan. We will talk about when they should take their Social Security, their investments, and more.
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Full Transcript:
(00:00):
In this video I'm going to share with you a sample case study. Now this is based upon a couple that I've been working with recently, but of course I've changed their names and I've also changed up some of the facts a little bit for the sake of simplicity. So what we're going to do is I'm going to share with you what their current financial situation looks like and the current strength of their retirement plan, and then we'll take a look at what the impact could be if they were to incorporate some of the different strategies and things that we had talked about. And I'll share with you kind of what we talked about at a high level anyways, certainly this was over the course of a few different meetings. So I'm going to kind of condense all this. We'll get into the weeds a little bit I think on some areas and we'll kind of gloss over things a little bit on some others.
(00:47):
So with that, let me go ahead and dive in here. I'll introduce you to Doug and Diana Sample I'm calling them. He's 65. She's 67, they have 400,000 in IRA or he does and she has a hundred thousand dollars in her IRA and then they have $30,000 that is in a joint checking account. Now these salaries right here, you can ignore this because what we're assuming in this is that they are going to be able to retire right now. So they're no longer going to be working. His Social Security if he were to take it at his full retirement age is 2,512. And hers, if she takes it at her full retirement age, is $1,456. Alright? Now their goal is again, they want to be able to retire right now. That's what we want to shoot for. And as far as their expenses, $5,000 is what we came up with.
(01:48):
Now this was a longer conversation. I'm not going to get into all that. Just know that they live in California. They are very much thinking about moving out of state. They have family in another state, which is a lower cost of living. So that was also factored in. But just for the sake of this, I'm just going to leave this here at this $5,000 a month, which is an after tax figure. Now this does not include healthcare costs, so those are approached separately. I always approach healthcare costs as a separate animal because historically healthcare has, or the cost for healthcare has risen at a faster rate than the overall inflation rate. So let's take a look at that right here. If you look right down here, you'll see that the Medicare part B and part D, the costs are going to be estimated based on their AGI.
(02:38):
And then on top of that, I'm also assuming that they'll need an additional $3,000 a year in out-of-pocket costs. Now, initially they're actually not going to meet that, but we decided to leave that number in there at that rate because just to err on the side of being maybe a little bit more conservative in case healthcare costs were to escalate a lot than even expected in the future. So that's what we started with. I'm not going to get into a whole lot of detail here on healthcare costs and retirement, but just know if you're not familiar, when you go on Medicare, you have the choice of either going with a supplement or going with an advantage and the particular type of plan that they chose and costs vary if you're on the advantage side, plans vary depending upon the part of the country and everything that you're in significantly.
(03:29):
But anyways, long story short, that's what we're assuming here in our assumptions. The other assumption here is that they are going to live to be 90. I usually like to plan up until age 95 or somewhere in that range. However, it's highly dependent of course on you the individual. So for instance with these folks, they felt that based upon their longevity in their family and also based upon their current health that they felt, hey, if we make it to 90, we're more than happy. So that's the age that this is based upon. Alright, so let's take a look at the current strength of their retirement plan. So right now they're at a 42%. This is a Monte Carlo analysis. If you're not familiar with this, what this is saying in a nutshell is that they will have, based on the analysis, they'll have a 42% chance of having all the money that they'll need and want all throughout their retirement years.
(04:31):
Now that number is too low in my opinion, to go into retirement with that sort of assumption. Now on the other hand, if that number were like 90% or a hundred percent, then I would say that number is too high actually, which might sound strange to some if you're not familiar with the Monte Carlo analysis. But if the number is too high, then most likely what that's going to do is lead to underspending in retirement. So personally, my opinion, I like to see this number somewhere around 75 to 80% and we'll get into that in a little bit more detail here. That said, though this is also highly dependent upon you, the individual because some people are more comfortable having to make changes in their spending along the road in retirement and are more risk tolerant and willing to make those adjustments. Others aren't others value more of that security and want to know that everything is exactly the way it is, right?
(05:28):
Everyone's different. So enough said on that, let's go ahead and look at the first thing that we talked about. So the first thing we talked about was Social Security. And I had asked them, I said, when it comes to Social Security, if you did retire, do you have any thoughts on that as far as when you're going to take your benefits? And they said, well, we just kind of assumed that when we retire we'll go ahead and turn on Social Security. And I hear that a lot. And so I said, well, instead of doing that instead let's do that for Diana. But I said, let's have Doug instead take his Social Security when he gets to be 70. And by doing that it's going to improve our probability of success here quite a bit. I mean it goes from a 42% up to a 58% probability of success, and there's a number of different reasons why don't want to get into all of 'em.
(06:27):
One of them I will point out that's interesting is that on the tax front you will see that by adjusting the Social Security here, having him now file at 70, this now makes it so that they'll have to pay $62,000 less in taxes projected over the course of their lifetime. So Social Security is tax advantaged in the way that it's taxed with the provisional income formula. So certainly not going to get into all of that. But the other part about this is just you do earn those 8% delayed retirement credits during the time period between your full retirement age up until eight 70. And so for them you could see this truly makes a pretty big difference. Now, we could really get into the weeds here and take a look at, well, what if they did retire early, but maybe we changed their investment portfolio and they got more aggressive potentially that could work as well to help improve that probability of success.
(07:28):
Again, each person's situation's going to be different, but with these folks specifically, they were very conservative, they had more of a 35/65 split as far as allocation stocks to bonds. So their portfolio combined, their investments, the money in their IRAs, they had about 35%. In fact, I'll show you that here, about 35% in stocks and about 65% in bonds. And so these are the assumptions that we're utilizing here for that. Now of course there's no guarantee on what those rates of return would be and actually what standard deviation would actually make the most sense in the future. It depends upon the time periods we look at, but this is what we looked at based upon these particular assumptions here. Now, so again, these folks were conservative and this was another part of the conversation because being only 35% in stocks, it's so important. I truly believe that when you're developing a retirement income plan that it's not just about the objective and the math and the numbers and all of that.
(08:42):
In other words, even though objectively it might make sense when we look at the analysis for them to be a little bit more aggressive, if you're not comfortable with that from a risk tolerant standpoint and that's going to lead you to potentially make bad decisions when the market drops and now you're selling and you probably shouldn't have that sort of thing, then that can be the wrong answer. Also, if it causes more anxiety in retirement because you're just not as comfortable seeing the ups and downs within your portfolio. So there's a lot to it. I don't want to say too much on that other than to just share with you what we ultimately decided to look at here first anyways is just to make their portfolio a little bit more aggressive and I'll show you why we're able to do that in just a little bit.
(09:35):
But what we went with was more of a balance type approach, more 50/50 stocks to bonds. And let me share with you what that looks like. So you'll see we're now expecting a little higher rate of return. There's going to be a little bit more volatility. The higher that standard deviation is, the higher the volatility, the higher the ups and downs within the portfolio. But we went with a little bit more, and as you can see again, it did improve that probability of success there for them from 58 up to 64 by doing that. And part of the reason specifically with these folks why they were more comfortable being a little bit more aggressive is that we also decided to incorporate an annuity into the mix where they were going to get a guaranteed lifetime income. And so let me show you what that looks like.
(10:26):
Let's put this over here to the adjusted investments and then we'll compare based on incorporating the annuity. And so what we did specifically is we took 200,000 and right here from Doug's IRA, we took $200,000 and then we're going to turn on an income stream not this year but next year. And then by doing that, they only have $300,000 now remaining in the investment portion of their IRAs. So interestingly enough, once we took that $200,000 into the annuity to provide that guaranteed income from the insurance company, then of course now the conversation was they actually were more comfortable now with the balanced approach. But then we even looked at more of what I consider more moderate approach, more of 60/40 stocks to bonds. And that's actually what we ended up doing. If they would've kept that there at the balanced approach, what you'll see is the probability of success is not a ton different, but by having that guaranteed income from the annuity, they were then comfortable getting a little bit more aggressive with their investments. Still not a lot we're 60/40 only on the investment portion, which is $300,000 of that initial $500,000 portfolio. So if you follow what I'm saying there, if there's 60% invested in stocks and they've got now $300,000
(11:53):
In the investment portfolio, they only have $180,000 that's invested in stocks of that initial $500,000. So that's what 36% of the retirement portfolio, that's right about where they were before at 35% allocation. Now just to take a look at where what it looks like right now on what we've looked at, we can see here this is all their income sources. So initially the first year is a little bit funky because what's happening is they're retiring midyear. And so we're seeing a lot of income coming in from their salaries. But then after that next year what we're seeing is we've got her Social Security starting up and then we've got this money that $200,000, by the way, this is what that's from the annuity, that's what this is buying is $15,700 of lifetime income. It'll continue on for as long as both of them live. And then they have to withdraw about $38,000 from their remaining investment retirement portfolio, the IRAs, and also even the checking savings.
(13:04):
So that's incorporated into this as well. So that was $30,000 that was there. Now what you're going to see here is that there's a lot of money that they're going to have to withdraw initially from the remaining investment portfolio, but once he gets to be 70, and this is actually at age 71, which is his first full year when he'll receive Social Security, his birthday I believe was in August. And so we're now seeing this that the total amount of their income is from Social Security is about $64,000, the annuity is $15,000, and then they only have to take about $4,000 here from the rest of their portfolio in order to meet their living expenses and healthcare expenses and all of that. So for them being more conservative, they like that idea of saying, Hey, okay, we'll delay that Social Security, we'll turn on the annuity, get that guaranteed income.
(14:02):
We're going to rely more on this investment portfolio. And by the way, because we do need to rely so much on that portion of the portfolio and we're more in a 60 40 type of split beyond the scope, what I really want to get into here is that we segmented off a portion of that portfolio more in that 40% that fixed income range in order to help provide that income over the course of these next few years before Social Security will kick in. And the reason that that's important that we allocated that money that we're going to need for the next few years to a more conservative bucket is to minimize the risk of sequence of returns risk, which is the risk that you're going to have a big market pullback, especially if you have a big market pullback, especially early in retirement. And then you need to withdraw a significant amount from your portfolio and now you run the risk of potentially running out of money.
(14:56):
And so that can be a big problem, certainly for sure. So let's go back and let's now compare and let's look at the next thing that we talked about. So now they're at 68% probability of success. So again, they're looking pretty good. And actually before I do that, let's look at their confidence tab here. Again, I typically like to see this, that 68% of this right now, I like to see it somewhere in 75 to a 80, but some people are comfortable here. It's 68. I mean that means about two out of every three times you have all the money you'll need and want for the rest of your life. But what this shows here is that based on the simulation, they may not even potentially run out of money until they're 82 years old now. And even having said that, it's much greater of a likelihood that they'll have money at that time.
(15:49):
In fact, they could have a lot more money at that time. It all depends upon how the investment portfolio ends up performing over the course of that time. And even if that happened, kind of a worst case scenario based upon the analysis here at age 82, let's just take a look again at the retirement details. At age 82, even if their portfolio went down to zero, we can see here they've got 85,000 from Social Security, they got 15,000 from the annuity, and then that 19,000 that they would've taken from the portfolio, that's the amount that they would not have received. Okay? So almost, I don't want to say almost all of it, but a large majority of their income that they're needing is still going to be coming in no matter what. It's only this portion right here, even if kind of that worst case scenario played out and they did run out of money.
(16:44):
Alright, so let's take a look at the next thing. And again, that's why sometimes 68% or even a lower probability of success might be comfortable for some people, it might not be for others. Alright, so the next thing we looked at is kind of adjusting their spending. Most of the time I find that people do not spend in a linear fashion in retirement when it comes to their living expenses. Now again, healthcare different animal, typically those continue to rise and rise and rise and those end up becoming a much larger percentage of your overall expenses the older you get. But what I typically find is that in the early years of retirement is when people want to spend more money and then as people get older, they want to spend less. So what we're taking a look at here is incorporating what's called the spending stages type strategy of spending where we're going to reduce spending by 10% in today's dollars at age 75, and then we'll reduce it again by 10% at age 85.
(17:45):
And so what we did was we actually increased the amount of our monthly expenses. And as you can see here, just going from $5,000 initially up to $5,300 right here, that's extra 300 bucks if they do that and then they're going to reduce again by 10% it at 75 and 10%, again at age 85 in today's dollars, this puts 'em at a 78% probability of success. And so this can be nice for some people, especially if, well a lot, like I said, a lot of people do want to scale back those living expenses there over time. So that's kind of the first thing that we looked at. And they liked that because even they figured, look at age 75, if we cut this $5,300 by 10%, that's $530 less. So that's around 4,800 bucks that they would be able to spend, which is almost that $5,000 number right there.
(18:53):
Now they're at a 78% probability of success. If we look at that confidence scale, it doesn't even show them now potentially running out of money until 79 again. So they're looking good. Alright, next thing that we looked at was if he were to work part-time in retirement. So this was just kind of an idea that he had that he was thinking about his, I guess his brother had something where he could work with him and so he was thinking about doing that or maybe something else. So we just kind of wanted to play with the numbers to see what that would look like if he were to work. And I had him throw out a number to me and he said, well, what if I could make 1500 bucks a month? And I said, well, how long might you work until? And so we just assumed age 70, he goes, well, maybe not past 70.
(19:51):
So that's what we did. So what you're seeing here is if he were to make $1,500 a month and which is $18,000 for the year and only up until age 70 and then at age 70, this income would stop. And so if he were to do that, I said, well, we could increase these monthly expenses here from $5,300 up to $5,600 and now by the time you're 75 and you cut back by 10%, you'll actually be, what is that? A little bit above $5,000, right? If we cut this by 10% at age 75. So you'll be right about where you want it to be initially right now today, now at age 85, you'll cut back by 10%. And they said, we're not too concerned about that and we know we're planning till 90, but maybe we don't make it to 85. So that's not really a big concern. So this wasn't something he was necessarily going to do, but it was something he was considering. So let's look at the next thing that we took a look at here.
(20:55):
So the next thing that we talked about, and this is always so important, and you're going to see this number drop tremendously here. This is if Doug were to die next year, one of the holes or one of the problems that I see a lot of times when people are having retirement plans put together or whatever the case is, is that too often if you're a couple, what I'm seeing is that the plan is only considering what would happen if both spouses were to live a long life. Unfortunately though that doesn't always happen. Sometimes one spouse does pass away early. So we always want to plan for these contingencies and understand what the impact could be if that were to happen. And so what we're taking a look at here is we're assuming that Doug passes away next year. Now the reason that this number is dropping so significantly, and by the way, this is also assuming that she reduces her living expenses by 15%.
(22:02):
So that's already factored into here. And the reason that we do that, by the way, is now you have one less car, of course, one less mouth to feed, those sort of things. So we've already factored in that she would spend 15% less, but it still drops so much. And so some of the reasons why this is dropping so much is remember what was part of the plan anyways was of course for this additional amount of money was that he was going to be continuing to work part-time making that other 1500 bucks a month until 70. So this, of course, he would not be able to do that. Second thing is his plan or their plan, but for him to take his Social Security when he turns 70. So if he dies next year, then he would not have had the opportunity to have earned those delayed retirement credits.
(22:59):
And so here's the issue. So if he passes away next year, she'll end up getting his Social Security benefit as her now survivor benefit. But the amount she's going to get is the amount that he would have received had he filed on the date that he passed away. So what that means is that he would not have had the opportunity to earn those delayed retirement credits. And so that benefit is going to be smaller. And so that's another reason why we're seeing this as well. Now, not to mention, of course there's only one Social Security check she's living on. She also has to file as a single person. Taxes weren't as big of a concern here, but still it is a factor in anybody's situation almost. So what we talked about is a few different things I said, one, I said if you want to keep these same expenses minus the 15% that we've already factored in when one spouse passes away, one thing that we could do is just look into getting some inexpensive term life insurance.
(24:08):
And so you could buy, let's say a 10 year term in their case for $150,000 and you'll see that the impact here would be tremendous. So if he were to pass next year, she would receive $150,000 tax-free from the life insurance proceeds, and that'll boost her probability of success up quite a bit. Now of course, they don't need to do this. Another option would be just to reduce that spending and say, Hey, even beyond the 15%, I'm comfortable just bringing this down. So let's say if we put this down to $5,000, I forget what this actually gives us. So that gives us right up to 59 or 69% probability of success. And maybe she wanted to be a little bit higher than this. Let's see what 4,800 does or probably boost up quite a bit. Yeah, so it's quite a bit. Let's just look at 4,900 and then look at the confidence.
(25:07):
So right now, about 79%. So this would be the trade-off. If she's comfortable reducing that spending even more, then no life insurance would be needed. But if not, if she wanted to have that additional spending available, then buying life insurance might make sense. And a 10 year term policy is typically the shortest term that you can buy. You don't need to keep it that long. And in fact, in their case, it might only make sense just to keep it for five years up until he turned 70 and was able to maximize that Social Security benefit. Maybe that would've put them in a fine position and we could stress that too. In the end, there's so many different things that we could look at and do, and I didn't even get into any of the taxes and things that we did talk about there as far as tax planning and withdrawal strategies. I mean as far as having to potentially minimize that they had some opportunity for some Roth conversions. Not a lot in their case, but didn't want to get into all of that. There's only so much we can get into in each case study. So I do hope you found this to be valuable. If you did, make sure you subscribe to the channel. I'm going to continue to put out more content, but subscribe to the channel if you haven't already. Make sure that you like the video and I will see you soon. Take care.