Mike was turning 60 next month. He had $400,000 in a pre-tax 401(k) and $200,000 in a taxable brokerage account. He wanted to retire at 65 if possible. In this sample case study we will discuss several things including:
- When he should take his Social Security (and his Survivor benefit).
- The pros and cons of adjusting his adjustment strategy and some key things to consider.
- Whether he should convert to a Roth IRA or not? If so, when should he?
- Whether he should pay down his mortgage with his money in the taxable account. *If he should work past 65 and if he should consider adjusting his spending in the future.
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Full Transcript:
(00:00):
We're going to take a look at a sample case study, which is based upon a guy that I had just recently met. So he's turning 60 next month. He wants to retire when he is 65. And we talked about a number of different things, including when he should take his Social Security, if he should adjust his investment strategies at all, whether he should incorporate any Roth conversions into the mix, whether he should pay off his mortgage or not. That was another key question that he had. So we talked about a number of different things. We'll talk about all those things and more in this video. So let's go ahead and dive in. Let me introduce you here to Mike is who I'm calling him. I've changed his name obviously, and I've changed some of the dollar amounts around as well. But here's Mike. So Mike's net worth is $984,000 and change.
(00:47):
His checking account balance is 12,000. He has about $400,000 here in a pre-tax. 401(k). He has $200,000 and taxable brokerage account and his home is worth $700,000 and he has a mortgage he just refinanced a couple of years ago. And so he's got a balance right now, 327,000 and change here. He is working, he's making $95,000 per year. And again, he doesn't mind continuing to work until 65 and then retiring then, that is his goal. So as far as his expenses right now, he has $2,700. This is just for his living expenses. So this is not his health insurance premium, this is not his housing costs. Anything related to housing, the mortgage, the property taxes, insurance, any of that. Okay. And in fact, let's go ahead and dive in over here so you can see more specifically, excuse me, what his expenses are right now.
(01:50):
So here we are today. This is, I'm recording this in December, 2023. He is turning 60 in January. So we're looking at the first full year here in 2024, and his total expenses are going to be $64,904, which does consist of again, the living expenses, the housing and healthcare. Okay? Now he's also going to have about $20,000 in taxes to pay split up between federal, state and fica. So at the end of the year, he's also contributing this $9,500. This is to his 401(k). He is saving 10% and at the end of the year he'll have about $196 left over. And I'm just assuming that he spends this. I'm not going to assume that he reinvests this at the end of the year because he's pretty much spending everything after, of course saving in the 401(k) plan and such. Alright, so let's take a look here.
(02:50):
This is the analysis page, and you're going to see it shows he has a 65% probability of success. Now we still have some more things to enter, but what that represents is that's the probability that he'll have all the money that he'll need and want all throughout his retirement years. And for him, we're assuming that he lives to be 90 years old. Okay? Now his plan, he was thinking if he retires at 65, he'll just go ahead and take his Social Security at 65. I said, let's take a look first, what would happen if you took it at your full retirement and see if we might be able to increase that a little bit and we can go from 65% to 67% and then let's look at age 70 here because we're going to be able to improve that probability of success even more so in this situation.
(03:37):
And as you can see, we went from now a 65 to a 72%. Now in the meantime, in those five years right there, he's going to have to rely upon his portfolio quite a bit more because Social Security wouldn't be kicking in until 70. But by deferring until 70, that benefit is going to grow and earn the delayed retirement credits. Now the other part about this that came up is when we started to talk about Social Security is that I also found out that he is a widower. So that was even more the reason why we decided to defer his own benefit until 70 because his wife had passed away a few years ago. And so he was entitled to a survivor benefit. And the difference between survivor benefits in your own retirement benefit, there's others, but one of them is that you can take it as early as age 60, and even as early as age 50 if you're considered disabled.
(04:35):
But in his case, he could take it at age 60, which he would be next month. So that's a possibility, but the problem is he's still continuing to work and that would be subject to the earnings test. So in his case, based upon the income that he's making, all his benefits would be withheld. So it wouldn't do him any good to take that Social Security benefit or that survivor benefit then. Instead, what we can do and what will help out his plan tremendously in his case, and he was a little surprised by this quite frankly because when he did look into seeing what his benefit would be, he understood that right now if he took it today, it would be around $1,100 per month. And I said, well, we're not taking it till 65. So that's going to continue to grow. So at 65, you would get $1,663 based upon the projections that we have here, which include that Social Security is going to increase at two and a half percent per year for cost of living adjustments.
(05:41):
So $1,663 a month is $19,954 per year. So if we just plug that in there at $19,954, you're going to see that this is going to improve dramatically. I mean without the change here to the Social Security and adding in the survivor benefit it would go from 65 to 85%. So let's take a look specifically on what he is getting if he didn't take that survivor benefit versus if he did. So if he did not take that survivor benefit and just went ahead and took his Social Security, let's say when he retires at 65, he would be getting about $32,000 for the year. However, if he takes that survivor benefit first, he'll start out at about $19,000. That's almost $20,000 here. And then you'll notice that once he turns 70, his own benefit has now continued to grow. So instead of it starting like at $32,000, it would've been at age 65.
(06:48):
It's now about $52,000 for the year. So that's obviously a tremendous impact. And again, we saw that right over here on this side. Now the probability of success is much higher. It was higher in his case just by deferring to 70, but now obviously even higher with that survivor benefit on top that he was entitled to. So the other thing that could be a possibility that we spoke about is he could, because he was thinking he'd like to retire 65, but he might be willing to work a little bit longer if he needed to. And I said, well, if you're going to work longer, you can't take your survivor benefit again because of that earnings test, you have to wait until your full retirement age, which would be age 67. So if you went ahead and did that, your benefit at this time would be for the year $22,823.
(07:43):
So we can take a look and see how that would look if you did that and again, worked until 67 here, obviously this is going to improve this score dramatically. Just that extra couple years of working is really the key thing. Real quick, let's go over. So you can see that here, if you were to do that strategy and continue to work, you'll see his Social Security kicks in his survivor benefit now just for those three years, 67, 68, 69, then he's still switching over to his own. But let's go back now and let's take a look at something else. So let me fix this. He's not going to take it here at 67, most likely. Most likely he'll take it at 65, he'll get that $19,954. He's working until 65. Now, one of the other things that came up is, I've got to put a zero there.
(08:44):
One of the other things that came up was what should he do with his portfolio now? Should he continue with how he is? Should he make any adjustments now that he's starting to approach retirement? And it's always important to make sure we're taking a look at what is our assumed rate of return from the investments we're in, what's our mix? What type of risk are we taking? And especially in those years right around when you retire, typically about five years before, up until about five years or so after you retire, it's often called the retirement red zone or financial red zone because that's a key time period. And if you were to lose substantial sums from your portfolio at the time that you're needing to withdraw that money, that could put you at more of a risk of running out. And so I said, well let's take a look at that.
(09:36):
So his current portfolio was pretty much like a 60 40 mixture stocks to bonds. And in our assumptions, we're assuming that the annual average return is 6.9% and obviously that's not a straight line rate of return. It's going to have ups and downs just like the markets. But the standard deviation on this is 10.2%. All things being equal, we want a lower standard deviation than high, right? A standard deviation is a risk measure and the lower that standard deviation is, the lower that wobble factor of the portfolio, the less that it moves up and down. And now as he's approaching retirement, it can make a lot of sense to consider maybe if we have to withdraw large amounts, we should be getting a little bit more conservative. So we also took a look here, what if he dialed it back quite a bit and went to more of a 35/65 mixture here, stocks to bonds, and now we're assuming a 5.8% average annual rate of return, which is lower, but the standard deviation is quite a bit lower. We went from 10.2 over here down to 6.8. So let's take a look at both of these different portfolios within the context of his plan.
(10:57):
So currently right now, again, he's got an 85% probability of success, which is pretty good. It's not a hundred. I don't ever believe we need to be at a hundred percent because a hundred percent really means that you're in really, really good shape. And there's that balance. We want to make sure that over the years that you're spending your hard earned money on enjoying yourself in retirement, there's no point in living till 85, 90 years old and accumulating way more than you would need to spend or would want to spend at that age. And especially if it's money that you would've wished that you would've spent earlier. So it is kind of striking this key balance. I like to make sure we're above 85%. Even more comfortable though is in the 90 percentile, 90% and above. So if we look at the confidence level, we can see if he kept his portfolio, lemme just confirm, yeah, he kept his portfolio just as is at this more of the 60 40 type of split that he had by the time he's 70, we could see what the expected portfolio values would be based upon different confidence levels.
(12:12):
So the very broad range of return that you can see there, a range of returns is anywhere from a 5% to a 95% confidence level. So depending on how the market's perform, his investments perform, he could have anywhere from perhaps $372,000 up to around 1.6 million, right? It's a real broad range. Now the lower that standard deviation, the tighter those range of returns would be. Again, all things being equal here. But we'll take a look at the other portfolio too in just a second because what you are going to see is that over time there's now this chance as he starts to get out here that he would run out of money, but there's also a chance he could be doing very well. It really depends on what happens with his portfolio and such in these next, especially five, 10 years here of retirement. That's going to make a huge difference.
(13:06):
So one thing that he could do is again, scale it back a little bit, maybe go with that more conservative portfolio maybe for the next 10 years until he's 70. And at that time his own Social Security benefit is going to kick in, which is going to mean much higher, which would mean he'll have to take less money from his portfolio to meet his spending needs. So at that time he could actually perhaps get more aggressive. And I know that's counterintuitive to how a lot of people think about this and how a lot of people have been told in retirement you just have to get more conservative over time, maybe, maybe not, right? So again, this retirement red zone is a key time period because let's take a look over here at what he's withdrawing right now. If we went with that strategy when he retires, he's having to withdraw 6.1%, 6.2 just over, gets up to about six and a half percent here at this time period.
(14:10):
Now it's not tremendously high and it's only for five years, but you'll see it drops down quite a bit right after that, the moment that his full on Social Security benefit, his own benefit kicks in. So now he has a lower withdrawal rate. And so now there would be more comfort, more of a comfort level. The lower that withdrawal rate is to maybe take a little bit more risk within that portfolio. So hope that makes sense. Let's take a look here at, if you were to go with that more conservative portfolio, and you'll notice how this changes right here, see how it got much tighter range of returns you can see now at age 70 for instance, he's somewhere between at a five to 95% confidence level, somewhere between $449,000 up to about $1.2 million. So not as much on the upside, but not as low on that downside either.
(15:08):
So again, it could be one approach. Now let's just say he keeps his current allocation just as is the 60/40 portfolio that he has right now. The next thing that we wanted to take a look at was did it make any sense for him to incorporate any Roth conversions into the mix? And for him, not really. For some people doing Roth conversions makes a dramatic impact or helps their portfolio or their retirement plan a lot. For him, not so much. I'll show you. So if we go over here and actually here, let me show you this first. So right here, this is his federal income tax bracket, okay? So right now he's in 22, he'll be at 25% here. This is when the Tax Cuts and Jobs Act sunsets by the way, in a couple years. So it's going up, but then he has this time period between 65 and 70 where he's going to be in a 10% federal tax bracket.
(16:10):
And that's where we identified some opportunity here where he could consider converting. And if he did, he's looking at converting not a lot about $12,000 the first year and up to as high as $19,000. And then he's not going to be doing any more conversions after that at that point. But that'll help him as far as get some money over here into the Roth account. And that's kind of what his asset mix, his liquid asset mix would look like between taxable tax deferred in the 401(k) or IRA, this case 401(k), and of course tax for your Roth account. Alright, so let's come back over here and take a look at what that impact was if you were to incorporate those conversions. He's at an 85% probability of success right now and the median amount of money that he would have at his life expectancy, meaning half the times it would be better than this, half the times it would be worse is about a million dollars.
(17:17):
But if he incorporates the Roth conversions, you're going to see here he still stays at 85% probability success. That didn't change, but on a medium basis this has increased by about a hundred thousand dollars, maybe a little bit less. So I forget exactly where that other number was, but it definitely a little bit of an improvement. So we went ahead and left that in here. Now if you recall, his mortgage was over three hundred thousand, I think it's about $330,000, something like that. He didn't have that much liquid. He had $200,000 in a brokerage account, about $12,000 in checkings. Not even just leave the checking money there.
(18:04):
He could take money from the IRA, but to do that and take a lot of money from the IRA, he's got to pay taxes and then pay off the mortgage from that. I said, so let's just take a look if we take this money from the taxable brokerage account, you've got let's say $200,000, we could do that, put $200,000 down, what would happen? And if he did that, it actually reduces his probability of success quite a bit here. And really the reason is, is because he locked in a couple years ago at a 3% rate. So he's doing pretty good and it's a 30 year fixed rate mortgage. Now, if this were today, this is December of 2023 and interest rates are quite a bit higher, it might be a different situation here. But for him to do this, it really didn't make a whole lot of sense.
(18:54):
And let's just go over here to the cash flows and let's look at his net worth. So you could see right now if he did not pay off the house, you'll see his mortgage, it was 319,000. Okay? So if he did not pay it off, it would be $319,000. Here, the non-qualified assets, which is the taxable brokerage account, is now over here. This assumes some growth after the first year. That's why it's higher than the $200,000. And it also includes the checking account money. But if he did pay off the mortgage, that would drop it down to $114,000. He's paying that off by 68 and that feels good. But those non-qualified assets just went down tremendously. And the other impact that that has had here is that he now doesn't have that money in order to help pay the Roth conversions or pay the tax on the Roth conversions. Okay? So that's a key thing to consider and that's another part of the reason why this didn't work out so well. It would be interesting if he had a lot more money in non-qualified assets, maybe he could pay down some of the mortgage over here on this side. In fact, let's just take another look and see, let's say he didn't do $200,000 in his case. Let's just say he did $100,000.
(20:29):
Now notice what happens. See now it went from a 79 up to an 82%. And why is that? Is because what I just said, and this is what we discovered too because of how much he has, we just didn't have enough to pay the tax on the Roth conversions. Let's leave some. So when he leaves some, he could potentially do that, but again, it's still not as good. It is just not paying off the mortgage at all because his interest rate is quite low. And that's the situation based upon what we're assuming that he's going to earn on his portfolio. Now the other question of course came up, well, what if I did go? He said, what if I did go a little bit more conservative in my asset allocation here? Said, well, all right, so if you did that, what you'll notice, by the way, this is without paying off the mortgage, is his probability of success goes up a little bit from 85 to 87.
(21:30):
This median number here has dropped though by about what? About two, $300,000. So you have less upside here. So this is where when we go back where it might make sense, if he's going to go a little bit more conservative to maybe do that for the next five, 10 years, and then once his Social Security kicks in, maybe then start to get a little bit more aggressive, maybe we can gradually do that over time. So anyways, a lot to consider there and a lot of things that we could change kind of going forward. Now, right now he's at 87%, and at $743,000. Let's take a peak. If you went ahead and paid $200,000 to the mortgage, again, that's going to drop it substantially down to 77%. Let's say he only did $100,000.
(22:21):
Again, we go right back up here to 81, but still not as good as the 85% where we were before with this other portfolio or with his current portfolio, not the conservative one. So we'll switch back to his current allocation, higher upside, little bit less probability of success, not much. Now the next thing that we wanted to take a look at is what if he were to change his spending needs over time? So with most people, I find that people want to spend more on certain things early on in their retirement years, more money on vacations, more money on different trips, entertainment, just going out to eat different things like that. And then slowly over time, people tend to want to spend less on those things. And so one way that we could set this up is to say that, hey, when you're 75, we're going to have 10% less available for living expenses in today's dollars.
(23:18):
And then at age 85, we're going to reduce that again by 10%. Now, we're not going to change anything related to the housing costs. Those are going to stay the same, not going to change the healthcare costs at all. In fact, we actually are assuming that the healthcare costs are going up at twice the rate is our assumed inflation rate here. Assumed inflation rate we're assuming is 2.5%, and we're assuming healthcare is going up at 5% here. So if you were reduce his living expenses by 10% at 75 in today's dollars and 10% at 85, let's take a look at what the impact would be on that plan. So if he did that, he's going from an 85% now to a 91% probability of success. So this is another strategy. Another thing that he could consider, another way that he could go is maybe to gradually reduce his living expenses over time. He may also decide, hey, I could work one more year and maybe start my living expenses a little bit higher for the first few years of retirement. So there's different ways we can go, but he's in good shape. Just needs to incorporate a few of these things and get a handle on the right strategies for him for his retirement. So I hope this was helpful. If it was, make sure that you like the video, make sure that you subscribe and I will see you in the next one. Take care.