In this sample case study this couple was aiming to retire at age 65. As it turns out they were in a good position to retire even sooner than they hoped. In this video I will walk though some of the different strategies we considered to make this possible and we look at various scenarios.
Some of the strategies we considered include Roth conversions, adjusting spending in future years, purchasing an annuity for additional lifetime income and more...
Full Transcript:
(00:03):
In this video, I'm going to walk you through a sample case study. It's based upon a couple that I've been working with recently, but of course I've changed their names. I changed some of the dollar amounts around as well, just for the sake of simplicity here. But this is a fun one. This is a fun experience because these people are 58 and 56 and they could both afford to retire sooner than they thought they would be able to. That's always fun when I can deliver that good news. But what I'm going to do here is kind of walk you through their situation and take a look at some of the strategies that we looked at in order to help them to retire sooner. So let me share my screen. He's 58, she's 56 and I'm calling them Mark and Sandy Sample. By the way, they have 1,850,000 saved in their retirement accounts and savings in investment accounts.
(00:58):
So he's got a million and a 401k. She's got 500,000 in a 401k, and then they have 350,000 in a joint investment account. They're both working. He's making $150,000, contributing 15% to a pre-tax, 401(k) and getting a 3% match. She's making a hundred thousand, contributing 10% and also getting a 3% match. Their goal is for them each to be able to retire at age 65 on $10,000 a month in today's dollars. Now, the reason that they wanted to retire at 65 is because that's when they can go on Medicare and they know how much more affordable healthcare is when you can go on Medicare versus if they retired before that and had to pay the full cost of healthcare themselves. Right now in this example, I'm just assuming that their healthcare is fully subsidized by their employer. So let's take a look at their situation right now today, if they were to retire at age 65, each of them like they would like to on $10,000 a month in today's dollars, they have a 95% probability of success.
(02:15):
In other words, a 95% chance of having all the money they'll need and want all throughout retirement. And we're assuming that he will live to be 90 and that she'll live to be 95. Now, notice this number right here, $14 million and change. What that number indicates is that at the end of both of their lives, that's how much money they would have on a median basis. Median meaning half the times they would have more than that and half the times they would have less based upon the statistical modeling here in the software. Now, as you can see here in the confidence, the amount of money that they might have at different ages, there's a pretty wide range here, and the reason in large part is because they do have a fairly aggressive portfolio. They're 80/20, 80% stocks and 20% bonds.
(03:08):
So that's kind of why you're seeing this very large range of returns. But again, they're in great shape doing very, very well. They would have a very low withdrawal rate. You can see that right here based upon their situation, these numbers are very, very low. The only reason it's really kicking up here is because they have to start taking out the required minimum distributions. So the conversation quickly shifted to, well, let's take a look at if we were to retire earlier, what does that look like? What does our probability of success look like? And one of the key things for them was, again, they knew that at 65, that's when they could go on Medicare. And I hear this a lot that I want to wait until 65 because that's what I can go on Medicare. I want to wait until I'm 67 to retire because that's my full retirement age for Social Security, so that's when I should retire.
(04:01):
Of course, the reality is it's much more nuanced than that. It's based upon your particular situation. If they were to retire earlier, they would have to pay those health insurance costs now out of pocket, and it's expensive, there's no doubt about it. But the question is, could they afford to do it and what would their plan look like? Now, beyond the scope of this video, there are possible ways maybe to position their income in order to get ACA credits on their health insurance in those years before 65, but that's beyond the scope of what I want to get into here in this video. For our sakes, we're just going to assume they would pay the premium. So if that were the case, let's take a look at what we looked at is if they were to retire when he's 62 and she is 60, so that would be four years from now, both of them would be able to retire at the same time.
(04:57):
And if that were the case, they now only have a 74% probability of success. We can see this median number has dropped. You can kind of see what that looks like here. And as you can see over here, what we assumed as far as the health insurance costs at 62 is right down here. So let's look at healthcare for each of them. You can see these big numbers right here. We're assuming they'll each have to pay $20,000 a year, and this is again, adjusted for inflation. And then once they go on Medicare, their costs are dropping down considerably. So if they were to do that again, they've got now a 74% probability of success. So not quite where we want to be, right? We want to get that number up there. And so one of the things that we took a look at is just adjusting how they were planning to take their Social Security.
(05:50):
Their thought was they would just take it when they each got to their full retirement age. And instead what we took a look at is if she were to take it at her full retirement age 67, but if he were to take it at his age 70, and if that were the case, this would improve their plan a little bit. As you could see right here, going from 74% up to 77% probability of success, not a huge difference, but it does help a little bit. The other thing that it will help out with is that if when one spouse passes away, you're going to lose that smaller check and his Social Security check is the higher one. So that survivor check will be for a higher amount by going with that strategy. So that's one thing that we took a look at doing. The next thing that we took a look at was incorporating some Roth conversions.
(06:41):
And so if they incorporated a Roth conversion strategy, again, that raises it again now to an 80% probability of success. And specifically what we did there is we took a look at what opportunities there were to fill up the 12 and the 15% tax bracket. So the 12% tax bracket today will be the 15% tax bracket in a couple of years here when the Tax Cuts and Jobs Act sunsets. So that's what that is. If we take a look at some opportunities just to fill up that tax bracket, it does put them in a much better position to have a lot more tax adjusted ending portfolio value at their end of life. What we expect them to live and tell, and specifically what we're looking at here is the amount that they would convert based on their current projections. And everything right now is first three years of retirement, converting around $150,000 a year, but staying right in that 12, which will be that 15% tax bracket there.
(07:47):
So that's the calibration change that we looked at on that side. Again, putting them in a little bit better shape. And actually, let me show you right here kind of just as a comparison, you could see the difference right here and a lot more would be tax free dollars down the road as opposed to fully taxable. The next thing that we wanted to take a look at was adjusting their spending needs throughout retirement. Most people tend to spend less as they get older on just basic living expenses. Now healthcare costs are separate, so we're not talking about that. But as far as other living expenses, what we wanted to take a look at is instead of them spending $10,000 a month and then adjusting that for inflation all throughout retirement, that we would start at $10,000, adjust it for inflation, and then at age 75, scale that back by 10% and then at age 85, scale that back again by 10%.
(08:45):
And if they were to do that, we can see that the probability of success here moves from right now it's at an 80% and then it will jump up here to an 87% probability of success. So pretty big improvement just by adjusting those spending needs. This is typically how most people spend in retirement. So let's look at the next thing we wanted to look at is just kind of taking a look at their portfolio. Right now, they're again, 80/20 mix as I mentioned earlier, and our assumptions here are that their average rate of return over time is 7.9% with the standard deviation of 13.2. And so that's that wobble factor I call it. The higher that number is, the higher the volatility is of that portfolio. So that's them right now, and what we're going to take a look at is if they were to right here to move to more of a 60/40 type portfolio, we're looking now at an assumed 7% average rate of return and a 10.2% standard deviation.
(09:53):
So if that were the case, let's take a look at the effect of that on their portfolio. So we're going to change to more of a 60/40 mix here. So if they change to a 60/40 portfolio, as you can see, it improves the probability of success from 87 to 90. It does reduce the median amount of money that they would have at retirement, as you can see here, because they're not being as aggressive, but because they're not being as aggressive, they have a little less of a likelihood of running out of money either. So that's what the impact would be there. So we can look at the trade-offs on that side, and here's what that confidence looks like of that 60 40 portfolio. The next thing that we wanted to take a look at is what if they were to purchase an annuity, what a portion of their portfolio to provide them that guaranteed income for life on top of the Social Security.
(10:54):
So specifically what we're going to take a look at is what if he were to take $500,000 from his portfolio, buy an annuity that he would defer, not touch for five years, and then in five years he would turn on an income stream that would last for as long as both of them would live. So if they were to do that, let's take a look at the results here first and then we'll dive in. So if they bought that income annuity for $500,000, it would improve their probability of success here. As you can see, it does reduce this median amount of money because what you're doing basically is you're trading having more security, more of that guaranteed income in exchange for the possible upside down the road. And so there's not necessarily any right or wrong answer here, it's just it is personal preference.
(11:45):
But if they went with this and put the $500,000 into the annuity, dive into the cash flows a bit so you can kind of see what this looks like. You'll see that we deferred this for five years. They're actually retiring here in four years, so that won't start here, but it would start here in the fifth year, and then they would get about $45,000 that would continue on for life. And if we look down here at these cash flows, we see the annuity payment here, we see their Social Security start to kick in, and by the time he takes his Social Security, if he waits till 70, like we were looking at between that and the annuity, they've got $166,000 of income. Their total expenses are 182k, they've got $23,000 in taxes. So the total that they need between their income needs and taxes is about $205,000. So the annuity and the Social Security would cover most of that right here, and then they would just have to get the additional amount there from the portfolio.
(12:49):
So if they wanted to just for fun, I'm not saying that they would want to, but just to see, compare and contrast more of an extreme example. If they took a million dollars and put that into the annuity, that would really increase their probability of success now up to 99%. And so you could see that right here with the confidence you're not going to have as much of the upside as you had before, but there's also a lot more peace of mind and security just because you know have that income coming in. And you'll see that right over here. If we look at the income flows, let's look down the road. By the time he's 70, they've got $211,000 now coming in, and they only need $208,000 total between their expenses and their taxes. So they're actually getting more coming in, guaranteed from the annuity and from Social Security, and then their portfolio money is just extra and just for kicks, how much would they have at that age?
(13:52):
Again, the rest of the portfolio is invested at 80/20. And so down the road here, forget what age we were looking at, but they still have, this is the annuity money, so that's running out. Once that goes out though, the payments will continue on the annuity. So they still have about a million and a half dollars, something like that on top of the annuity in their portfolio that they want need for income. So that's not necessarily the right way to go. There's different choices here. Everyone has to make the choices that are right and that are comfortable for you. But these are some different things to think about in making the decisions on when to retire. The other thing here, by the way, which I realize I didn't cover in this video, but one thing that we talked about is, well, what if they just stopped contributing to their 401(k) now?
(14:45):
That would've been another route that they could go and not make contributions, but for them, they didn't mind contributing to the 401k. They still had more money now than they needed to spend and wanted to spend. And so they figured might as well do it, get the tax deduction while they're making some good money now today. But that could have been another thing that they could have considered. There's a lot of different things. These are just some different foods for thought and different planning opportunities and such. So hope you found it helpful. If you did, make sure that you liked the video and make sure you subscribe and I'll see you in the next one.