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Episode #471 - Retirement Plan Live: The Impact of The Bear Market
Roger: Mental toughness is the ability to remain positive and proactive in the most adverse of circumstances. -Jim Afremow.
Hey there, welcome to the Retirement Answer Man show.
My name is Roger Whitney. Let me get that music down. This is the show dedicated to helping you not just survive retirement, but actually have the confidence, because you've done the work, to lean in and rock retirement.
Mental toughness is a big thing in retirement, because there is so much uncertainty that you can't exonerate yourself from. What's going to happen in the markets? What's going to happen with inflation? Rosie and Dwayne After retiring about a year ago and experiencing the bear market last year are having to exhibit some mental toughness, and what do we do to make sure that we are on course?
We're going to talk with Rosie today about where they're at. What kind of advice they're getting, what they understand about their situation, to help them assess are we still on a feasible path or do we need to make some minor adjustments. This is an important time to have that mental toughness because BAM! We just got popped in the face by the markets and inflation, and we can't ignore it.
We can't obsess about it, but we can't ignore it because the sooner we acknowledge where we're at now and affirm that we're on a safe course or that we are deviating from that safe course, the sooner we can identify that, the quicker we can mitigate damages and proactively get back on course.
Whatever that means, and everything is on the table in negotiating how do we get back on course. The extra travel, part-time work, all sorts of things. Everything has to be on the table so you can negotiate a plan of record that fits what you care about. It's important. You got to be mentally tough to do that.
Because we don't want to ignore it and just let somebody else tell us we're going to be okay without really understanding how they got to that decision and then wind up six months, a year from now and say, well, wait a second. We're like way off course now. We don't want that because that becomes bigger conversations, which are never fun.
So, we're going to talk with Rosie and get an idea of where they're at there. We're going to answer some of your questions. So, let's get going with the show.
RETIREMENT PLAN LIVE
I want to invite you to join me live on February 2nd at 7 p.m. central. We're going to do two things.
One is you and I are going to be live with Rosie and we're going to walk through her goals, their current financial situation, and we're going to assess whether that plan is feasible and then brainstorm risks and opportunities to make sure it Remains feasible or gets back on course and you're going to be able to be live with us and ask questions That's going to be a blast and you can register at live with rogerwhitney.com.
Secondly, I’m going to invite you to join the Rock Retirement Club and learn how to create a plan to retire with confidence and use the best-in-class retirement planning tools that we're going to give you a club member to create your own plan and get support from me, my team of coaches, as well as a thousand plus rock retirement club members that are all on the same journey. It's a pretty special group. Over the last four years because we're just entering our fifth year, I've seen people go from entering and being a little confused about how retirement works and a little leery about what is possible. I've seen them transform to having confidence to manage their plan and really lean into rocking life and retirement and I'd love to see you do that too.
So, you can register for this at livewithroger.com.
All right, Rosie, well, we are almost done, right?
Rosie: We are. Happy New Year.
Roger: Happy New Year. We have some discussion today and then on February 2nd, you'll be live with me with listeners, and we'll walk through everything that we talked about and put it into a form to do some feasibility analysis as is this feasible, and then we'll try to help you come up with some solutions.
Sound good?
Rosie: Sounds really good.
Roger: Now, before we started today, you said you had a number of random questions from our conversation. So why don't we close those loops as best we can before we get into what I'm going to talk about.
Rosie: One of my questions was regarding the budget, and when we talked last, you mentioned that we weren't including the health insurance in that, and so I was just curious why that is.
Roger: Good question.
The reason is because I have assumptions that I'll use for health care and medical expenses separately. I use a database that knows premiums, knows what Medicare expenses are and what average out of pocket is, and we'll use a different inflation rate. So, I'm going to account for that separate because it has its own rhythm of things. It's a little bit separate from just general spending. So that was the reason. We're going to account for it.
Rosie: Okay. A little separate. All right, and then related to the budget also, I don't think I mentioned, a good portion of our spending is coming from our investments. We did not talk much about it, we have a couple more, say 5, 000 worth of house updates we need to do. I don't know if we need to worry about throwing that into the budget.
Roger: That's a good question. So, do we have some that are high resolution that are going to be happening?
Rosie: Yes.
Roger: Okay, so give me those.
Rosie: Okay, we need to re-carpet like the basement. We have some in the garage shelving that needs to be redone. I would say overall maybe 5,000.
Roger: When do you plan on doing that?
Rosie: Would like to do it next year in 2023.
Roger: That's 5,000 total. So, the answer to your question is we definitely want to include things that are higher resolution, like, you know, you're going to have this expense, right? Then you're already planning on it. So, we'll factor that into the cash flow model that we built.
Rosie: Sounds good. Another question I had was that I sent you information on our annuity and I just was kind of curious what your thoughts, annuities are complicated, and I can't sit here and say that I fully understand what I own.
I have an idea, but I've read about different types of annuities and such and I wondered if you had any thoughts or what feedback from what I sent you.
Roger: Yeah, let's talk about it in general terms, and then I'm going to turn that question around if you own it, you bought it. What is your understanding of it but let me walk through the general terms of it as I see it. So, hold on one second.
Rosie: Okay.
Roger: All right. I pulled it up here in front of me. And what we have here is I'm just going to read the general terms. Okay. It looks like you bought this in 2018. The current value is one hundred and sixty-five thousand dollars. The current surrender value. is 139,000. Let me ask, do you understand the difference between those two numbers?
Rosie: Well, the 165,000, I never really have totally understood why, what that number is. I think the 139,000 means if I were to cash it out, that's what I'd get, would be the proceeds.
Roger: Exactly. So, the current account value, so the actual value of it is 165, 900, and the surrender value is 139, 000. 139, 000.
The difference between that is this type of annuity, when you buy it. There is a back-end sales charge that decreases over time and so the longer you own it, that amount will go down and eventually will be equal and that is the compensation that the advisor received. Not necessarily that spread, but that's the structure of it. That's the difference between the two. Over time they'll equal out. That can be anywhere from three years to ten years, depending on the contract.
Now when we're talking about annuities, and this one is owned within an IRA, right? So, when we're talking about annuities, have you ever been in a wine store?
Rosie: Yes.
Roger: I was just at one the other day and I wanted to try a different type of Pinot Noir, and there were countless selections, right? All these different labels and then every label is from a different winery. So that's confusing, and then every winery has different years. It's sort of this tapestry of all these different colors and everyone is different and it's hard to understand what is different from one vintage and to the other, right?
Rosie: Yes.
Roger: It's a little bit of how variable annuities are. Every annuity has a vineyard, who produced it, and whatever they produced has a vintage, what year it is, because one year of the same wine might be different in character than another year because they changed some of the dynamics and the riders and the costs, etc.
Okay, it gets really confusing that way, right? So, it's going to be difficult for me to dive too deeply into this one without doing research on this particular vintage of this winery. So, we have the value, and you have a couple of riders which are haggle-on’s, right?
The first one is you have a guaranteed lifetime withdrawal benefit base. And that base is 216,000. So, do you know what that means?
Rosie: I don't know that I do.
Roger: Okay. So, this has a lifetime annual income rider as well, and so it has an income base of 216,000 even though it's only worth 165,000.
The 165,000 is real money that's invested in something. The cash surrender value is what you could get out of it in the sales charge that would be, would occur right now. The benefit base of 216, 000 isn't real money. It's a base for determining what a guaranteed payment might be to you based on the terms of the rider.
This has some type of annuity feature of giving you guaranteed payments likely for the rest of your life, what that payment to you will be based off of this benefit base even though it's not real money. Typically, what would happen is, let's assume you said, I want to start my guaranteed income and they're going to say, okay, well, your benefit base is 216, 000. You get X percent based off of whatever formula they have baked into the annuity, and then that would be guaranteed payments to you.
Typically, it also hits your cash value of the value of your policy, but again, typically, even if your value of your policy goes to zero, they would pay out for the rest of your life, right? So that's what the income basis. So, it's not real money. It's just for that guaranteed income amount and based on the documents you sent me it doesn't tell me what the income base amount Is. Well, it tells me the income base doesn't tell me the formula to calculate the payment.
Rosie: Okay, and for some reason in this what I’m remembering is that if we hold it 10 years before we do any withdrawal then it would be roughly and I’m going on memory here.
So, like 1200, 1250 something like that a month, somewhere in there.
Roger: So likely it's structured that benefit base for withdrawals, not real money would increase by at least a certain percentage each year. Okay. And after 10 years, the formula says it would pay you 1, 200 a month. It's good to get a summary as best as you can because these things can be complicated and refresh these understandings. Then most likely because it has investments, there's probably something, this is like an index-based annuity, it looks like, and it's invested. So, you're 165,000 is invested. Let me pull that page up in two investments. It has what's called the S and P 500 monthly sum index account and the Morgan Stanley dynamic allocation index account. Each of those has a charge, a rider charges them. Essentially what these are is you're not actually invested, like say the S& P 500 monthly, some index account. You're actually not invested in the S& P 500. It has a formula that is based on how it works on a monthly basis, if it goes up, you get credited some money, but if it goes down, you don't.
Rosie: Oh, they use it like as a basis type thing.
Roger: Right, and likely there is some type of feature that if it goes up more than your normal increase in your benefit base for withdrawals, that you might get a step up. Best not to count on those, though. For clarity purposes, I would want to have, worst case scenario, in 10 years I can get 1, 200 a month. That would be good to know, work off of worst case and then everything else would-be gravy, but I wouldn't count on that just because of the way they're structured. The drag is so much.
Does that jive with what you thought it was or what was your use case for buying this at the time?
Rosie: It was to secure some more guaranteed income, for the most part, since we don't have a pension.
This one is set up, like, if I were, I don't know what you call it, beneficiary?
Roger: Probably. Yeah.
Rosie: So, if I were to pass before my husband, he doesn't, he's out.
Roger: Okay. So, this is life only then?
Rosie: Right.
Roger: Okay. Life only for you. These types of products aren't necessarily a bad thing for finding guaranteed income, right? Because the traditional way you might do it is to buy a deferred income annuity, a very plain vanilla fixed type of annuity. Some of these products can actually give you better guarantees than those. So that's not necessarily a bad thing at all. They just are really confusing.
Rosie: Yeah, that was one of my questions.
Is this the type of annuity if you recommend annuities or even what you typically see is, are these common?
Roger: They are common. Yes. The type of thing that's sold, not sought. I'm working on a case recently where we wanted to secure income in the future, and we got quotes for an immediate annuity or deferred income annuity, just the very fixed organic type and got the guaranteed payments that would be expected. It was actually sort of like this. We wanted to start in like six years, and we were back into the amount of guaranteed income that we wanted. I think we want 60, 000 a year. So, we backed into the amount that we needed that, and we built quotes off of that. Not me, I have someone that does this because I don't have my insurance licenses any longer.
We looked at these organic ones and then we looked at a variable annuity index product that had a guarantee and it was much more attractive than the organic product, so we ended up doing that. After a lot of what am I missing here? Because of the complication you want to where are the time bombs, don't tell me about the features Just tell me am I getting this income at this date worst case scenario?
So yeah, these are somewhat common but generally they're over complicated people buy them for the complication rather than trying to keep the main thing the main thing I just want some secure income.
Does that help at all?
Rosie: Yeah. Yeah, it does just in general. For years I didn't see any value in annuities and even after we bought this, I’ve had conversations. Should we have done this? Is this the right thing? So, I mean, fortunately we didn't really put that much into it, and so far, I'm guessing it's an okay thing.
Roger: Yeah. The hard part is that you lose a lot of optionality because it sounds like there's probably a 10-year surrender on this, so it's a little bit like a timeshare. You can get into them fairly easily. You can't get out of them very easily at all.
When I say they're sold, not sought, usually it's somebody presenting it, and emphasizing the benefits and not really is this what you need to solve what you're trying to accomplish, right? So, it's normal to have, it doesn't look like it's anything horrible, and I've seen horrible by the way.
Rosie: Okay, and that's what we've all heard about. It's horrible.
Roger: So, if that answers that question, what's your next random question?
Rosie: I might have covered budget things. I think we got most of them right there.
Roger: You had one on the software, I think.
Rosie: Oh yeah, on the Monte Carlo tool. I mean, I've seen different tools, and our investment advisor has taken us through some and I just wondered if the Monte Carlo tool that you've used in the past on these live is what the Rock Retirement Club shares or teaches on.
Roger: Yeah, so I think you saw last year's with Jolene, and in that one, we use new retirement calculator. We had licenses for club members. We actually switched this year. We made a pivot to using what's called Money Guide Pro Elite. Which is what I use in my practice and then that's what you get access to in the club, so what you'll see when we're together and that is a tool that I used in previous iterations of retirement plan live So, yeah, so you'll see that as well.
All these tools aren't perfect. They're just a tool, right? It's how you use it.
Okay. Well, I’m glad that you had a list of random questions to clarify on things because that means you're active in collaborating with me.
What I want to talk about today is some risk and just your perspective on making this plan resilient. Once we get to a feasible plan, we have to figure out how do we make it resilient, so we don't get knocked off course and sort of some of the things we hope don't happen. I think when we were talking beforehand, what was it you said?
Rosie: I said, I think the worst case has already happened.
Roger: Maybe, right? It's a bear market and as you've stated before, your retirement security is based a lot on your retirement assets. You don't have huge pensions or multi millions of dollars.
Rosie: Right.
Roger: Let's first talk about what professionals call sequence of return risk. Why don't you describe what you understand it to be?
Rosie: I understand it as we know the market's going to fluctuate and we know there's just various cycles, and so sequence of return risk is what's the risk that early on in your retirement, when your balance is hopefully at one of its higher levels, that the market returns stay relatively well, hopefully at least 4 percent profitable, which of course they haven't, but when the market goes down, the risk is higher when you're early on in retirement than it is possibly later after you've gained some more equity.
Roger: Right, because you have less money working for you because you still need to take your paycheck out of it.
Now you have talked about your husband and you and your husband being very enamored with risk, comfortable with risk in terms of investments going up and down.
So, let's talk about his investment strategy on a high level first. If I were to look at his accounts, individual stocks, what kinds of things does he own? Individual stocks.
Rosie: So, there's a couple that he's loved for life. I know Microsoft is one of them. I can't think of the other one, but he likes to research and then he'll find what he thinks is a winner, and then he buys that and sees what happens. So had a really good run with Shopify, and there's been others over the years, but typically he'll have his two or three favorites that he doesn't get rid of ever, even when they're doing very well, and then he might find another one here or there.
Roger: How many stocks does he own usually?
Rosie: Today? I'd say three to five for his little play money.
Roger: Roughly how much is in the play money relative to your assets?
Rosie: At this point? Maybe 10%?
Roger: Play money is okay, but about 10 percent of the value of your investment assets, and so how are the rest of the investment assets allocated?
Rosie: Fairly risky. So how we did it is when we moved all of our employer 401k money, he had his 401k. I had mine. Over the years, there were periods of time when we primarily saved in mind because I had a better deal or whatever it was, or he didn't have it as an option. So, when we moved it all, he had the account that we say he manages 401k that rolled over for him that the manager is managing, but he's directing. Then my 401k money, and then our Roths, the annuity. His 401k money is a hundred percent stock, but it's way more diversified.
Roger: How much is in his 401k roughly?
Rosie: Probably maybe 12%.
Roger: Oh, 12 percent of the overall is a hundred percent stocks.
Rosie: On his, well really would be more than it'd be more like totally between the one that he manages and the one that's his four.
Roger: Okay. So, 22%.
Rosie: Probably.
Roger: Okay, and then the rest of the assets are the 78% percent are under your purview.
Rosie: Well, a couple of Roths, would be maybe another 5 percent Roths. We got a late start there. So probably not quite half is in my 401k because we have the annuity too.
Roger: So, if we put the annuity aside, let's look at it this angle.
What percentage of your assets are in stocks versus bonds?
Rosie: This is just going off the top of my head, but I would say 75.
Roger: 75 percent stocks.
Rosie: I think so. Okay. Because I think mine is 50/50, then factor in the other.
Roger: That's good enough for what we're doing here, and then roughly, I know we just had a bear market, do you have a clue for how much your portfolio went down for the year out?
Rosie: Yeah. It's a little bit muddy because we've taken some good size withdrawals too, so.
Roger: Okay. Your advisor hasn't given you the reconciled amount yet.
Rosie: Not really, but I, we have a spreadsheet and I'm thinking it's 20%.
Roger: You're down about 20%.
Rosie: Yeah. It's been worse. Well, that was at the end of November.
Roger: Okay. Sounds like an aggressive portfolio.
Rosie: Yeah.
Roger: Okay. It's a silly question to ask when you're down, but how do you feel about that? Being that aggressive.
Rosie: I didn't mind it at all until, if this would have happened, maybe I'm wrong, but if this would have happened three years from now, I feel like I would have felt less anxious because we would have had a few years under our belt, we would have had a bit of extra gain, we had no time to get any extra gain before this happened, so I feel pretty anxious.
We need to figure out what this means. What the impact is what do we need to do today to make sure we're okay tomorrow and at the same time It is time to go because we are at the age. We're definitely in the go-go. So, it's a conflict to me.
Roger: Okay, and have you and you and your husband and advisor had talks about okay now that we've lost 20 on paper, what that has done to the feasibility of your plan?
Rosie: We've not. We're probably not going to at any detail level. I mean, we've had just kind of short-term conversation about what do we do in the short term right now, but we need that conversation probably in January.
We will do that.
Roger: Okay. So, by the time these airs, we'll have had that conversation. And when we're live on February 2nd, you would have had that conversation.
Rosie: We did have one conversation where we ran the Monte Carlo, and it was very ugly. I mean, so we just talked at a very high level, just push the button, rerun it, and he's like, I don't even want to share these numbers with you without having a conversation, but we kind of just wanted to know.
Roger: So, were there any suggestions on what to do now or if we'll deal with this in January?
Rosie: I think it was more like we'll deal with this the next time we sit down. Okay.
Roger: Okay All right. So, you're about 75 stocks, the rest in bonds. Now. Do you keep cash reserves outside of your investments?
Rosie: No.
Roger: Okay, and then when you need money to pay for life, how do you get that?
Rosie: So, we have a monthly stipend that we've agreed upon. And then if we need anything extra, we try not to call every 10 minutes. Like at the beginning of the year, last year, we said, can we get an extra chunk, and so we just did it that way. That's the preference.
Roger: Okay. So, they send you money every month.
Rosie: Every month from the account.
Roger: Where is that money coming from?
Rosie: Well, my understanding is in our account some of the investments are lined up as to be liquid for those payments. When I go to the brokerage account, I look at the statement. I don't see a ton of money in the money market, maybe a month's worth. So, I don't understand some of the investments that feed that, I guess. I don't know how much of it is fixed income.
Roger: When you look at your like statement, does it show that it's selling something every few months to raise money?
Rosie: We do see transactions like that, and I feel like I see some income. I have to be honest. I don't look at it that much, because it doesn't come in front of your face. You just don't always look at it. But I see all these transactions that I don't always understand, but they're automated. I can tell they're automated. It's like 250 here. So, I think they're like dividend payments maybe.
Roger: How much is your monthly stipend right now?
Rosie: Gross? 8,500.
Roger: Okay. So, you're probably not getting 8,500 a month in income.
Rosie: No.
Roger: So, we are definitely drawing from principal, which would be either it's coming from cash, but you said there's not much cash.
It sounds like you have some systematic selling of investments. That would be good to know.
Rosie: Okay, exactly.
Roger: Maybe that's one thing we can put together is what should my agenda be when I have this conversation with the advisor.
Rosie: Yeah, that would be great, because we have talked about, I've asked kind of that question.
When I look at this account and this brokerage account and I look at these different investments that we have, which one of these are you getting this money from? I can't say that I really understand what the answer was necessarily.
Roger: You should.
Rosie: I should absolutely, but I don't know if I didn't ask enough questions, or I understood it at the minute or what?
Roger: Yeah, and it's been a while since you've had an in-depth conversation.
Rosie: Sometimes you understand at the minute and then you don't remember.
Roger: I totally get that. I totally get that.
Okay, and I think we talked about this briefly. Let's move on a little bit. You don't have long term care insurance, and no life insurance. Those are potential risks.
So, let's talk a little bit about your experience with advisors. You talked a little bit about this last time, and we said we would dive into it. I am interested in this, and I think it would be helpful for others, and let's start with what you had. It sounds like you've had a few iterations of advisors.
Rosie: I don't know how many years ago, probably, I don't know, 20 years ago. We had always just was, you're in the accumulation years, you're just throwing in your account. We didn't talk to anyone, didn't know anything.
Then we finally decided we probably should have someone. So, we hired an advisor who actually was a tax person, and so he was doing investments, but. Also, tax person and probably only had him two or three years when the market crashed, and we lost a ton of money.
At the time our ignorance, I would say, because I don't think that he was necessarily not a good advisor I just think that we didn't know enough, but I was like, well, man, we could have been managing our own money and done that.
We were like, well, let's just go buy the S&P 500 and forget this. I mean, that's kind of what happened, it felt like. So, we decided to switch, and I had a friend at work that told me about someone, so we switched to them, and their parents were quite wealthy, so I thought, okay, this person knows how to handle this.
Well, that was a wrong assumption.
That advisor we probably had quite a while, and again, during the accumulation years, but no real advice being given, and when it got closer to retirement, and it was time to figure out where's cash flow, what do we need to be doing, couldn't answer any questions, could not even get us a cash flow statement and I'm like, I'm explaining what I want for a cash. What I need you to show me is ABC, there's no way your brokerage firm doesn't have something. They've got to have some software and after a while, why am I having these conversations? This is why I’m paying for them, right? So, it was just a real eye opener.
You really can get in some crazy situations and be paying for things that you're not getting any advice from. I was very unaware.
Roger: Let's fast forward to your current advisor and so I wrote down some questions.
What do they do for you?
Rosie: Early on, they do the investing and then manage the cashflow and the payments. So, the big thing that has happened for us was we've gotten a lot of education from them of really understanding how things do work. That was the first advisor that actually could do kind of these cashflow and this whole Monte Carlo scenario to give us some sense of where we are.
I think they're typical financial planner that does use traditional tools.
Roger: It sounds like the others way more aware. How are they paid?
Rosie: In like a percent of portfolio.
Roger: Are you willing to share that percentage, or not? It's okay. If not.
Rosie: You know, I am, but just today I was thinking about it last, I knew it was under 1%, but I don't know what it is. The last guy was half a percent. I'm willing to share, but I need to look it up.
Roger: Yeah. That's understandable. It's one of those things you don't look at very often. Right. Then how were your previous advisors paid? Same?
Rosie: Same.
Roger: Who sold you the annuity?
Rosie: The current advisor.
Roger: The current advisor. So that was actually a commission product. Did you know that?
I did. Which is not a bad thing. I'm not saying that's a bad thing. Just asking in reference to, did they explain that to you?
Rosie: Yes. I mean, we knew it too. But yeah, I mean, we had a conversation about it.
I knew that, and actually we had a frank conversation about it because I said, I don't know that I believe in these things. I know that you get a huge commission, and we don't even necessarily maintain value because you don't have to have one if you don't want it. I'm just suggesting this product as a way to secure some income.
Roger: There's a switching of hats there from fiduciary to salesperson. That's a thing that they're supposed to manage. It's like I used to have to manage when I had my securities licenses. So, I get that.
The last question I have. Maybe because I may think it's more, but if you have an advisor, you understand how you pay them. They help manage the investments they make with the administration of managing the cash flows. They've provided a lot of education.
On an ongoing basis, how do you judge how they're doing their job?
Rosie: This might seem a little simple, but in some ways, if I call or I text and I have a question, their response and willingness to address it is a big thing to me.
Like, yeah, we can talk today if you need to, but if it's just as well, I'd rather do Thursday or whatever it is. Responsiveness and then explaining the answers to the questions and that kind of thing is huge value to me.
Roger: Yeah, especially in this world of 800 numbers or no phone numbers at all, right?
Right, and I actually would be interested in, and as much as you're willing, maybe after you have the annual meeting, because this is a pivotal meeting. You know what's hitting the fan. His updated scenarios look really bad. How you navigate that's pretty important.
Rosie: Right. I think two at the time, he kind of wanted to hedge a little bit more time rather than to overreact at that moment. Let's just go with a couple more months or whatever.
Roger: Yeah. It's an interesting balance. When you retire in a bear market happens is you don't want to be reactionary. But you also want to act early enough to where you can mitigate things you have options Right? It doesn't spiral to where options get more limited.
That's a balance there, right?
Rosie: That's what you start thinking is. Okay. So then when do I just pull out, which you don't want to do.
Roger: Yeah, it makes me think of 2008 when we had 24, 25 percent down. Then the first quarter of 2009 was another 22 with no end in sight, it can just get worse, right?
I'm not saying that's going to happen here, but it could. It could, and you don't have a lot of shock absorber cash wise.
Rosie: No, that is a huge problem. Man, that whole idea of going back to work is awful. I would have rather just stayed working, hindsight's 2020, but I'm going to just stay.
Roger: So, what we're going to do when we meet live with everybody is we're going to do fresh analysis, integrating the values, the goals, the cash flows to those goals, all of your resources, the allocation that you have, and we're going to see whether it's feasible going forward.
If it's not, then we're going to try to navigate to something that gives us some feasibility, and we'll just have to brainstorm options, right?
Going back to work is like, the worst option. So, we don't want to hit it with a sledgehammer. If we can tweak a number of things to get to a solution.
I don't know what the answer is going to be or whether it's feasible or not. I haven't even done it yet.
Rosie: I feel like what we've outlined our spending desires are probably not feasible, but depending on when the market turns, you could possibly do some of that. It just might not be in the timeline. We hope for, I don't know.
But also, I guess the other thing is almost all these models, they don't run your money to zero on your projected, yeah, well, sometimes they do, but when you get the feasibility at 80%, almost all of them at 80%, you end up with almost the same amount of money you started with, it feels like, just take like Jolene's example from last year.
I mean, I know the feasibility analysis had a huge range, but in general, you're going to pretty much die with what you started with, and it feels like they're built in somehow.
Roger: The difficulty is we don't know, like a Monte Carlo scenario structure has say a thousand iterations, right? It's assuming everything acts exactly like we planned, and the only variable is returns. So, a Monte Carlo scenario that says an 81 percent confidence number, all that means is 81 percent of the trials did as good or better than expected. That's helpful, but the problem is, you, Rosie, only care about your iteration.
N is one for you. You don't care about N equals a thousand, right? You just care about your iteration, and we have no clue which one that's going to be.
Rosie: Exactly.
Roger: That's where it gets a little difficult and then you start to factor in if you have spending assumptions, inflation assumptions, tax assumptions that are forecasting for 30 years Those are just guesses. We can't see over the horizon because it's such a long-time horizon. So, the possible outcomes just gets wider and wider, which isn't as helpful.
This will be interesting to work through together.
Rosie: Interesting is a good word for it, Roger. I like that.
Roger: We're just working on the problem. We know what the issues are. We know what's happened. Now we just have to work on it.
Rosie: Right and this year, one of your goals was to get, you know, have a case that's more typical of an average, I guess average American. I don't know if that's what that is. But in this case, I think that while that might be true we're closer to an average American that maybe some of our investment choices or budget desires are not as typical, I don't know.
Roger: I don't know as a case. I don't think of it as a case just so you know, all I care about is at the end of this that Rosie and Dwayne have some pathway to work through their options. A case sounds sterile. That's what a doctor says about a subject. You're not a subject. This is your life, right?
I want to respect that and make sure you and I work to figure out what's right for you regardless of what it does for anybody else.
Rosie: Oh, I appreciate that.
Roger: All right So thank you for being so open and sharing during this month.
Rosie: Sure. Well, if we aren't just up front with where we are, then you can't get the right information.
Roger: Yeah, garbage in garbage out. Radically accept reality and go from there. So, thank you so much for your openness.
Rosie: Sure
LISTENER QUESTIONS
Now it's time to answer your questions. If you have a question for the show, you can go to rogerwhitney.com/askroger, or we should have a link in 6-Shot Saturday if you'll get our weekly email.
DO YOU CALCULATE USING TAX DEFERRED DOLLARS TO CREATE A PAYCHECK IN RETIREMENT?
So, today's questions, let's see, we're going to start with Rob, who has a question on withdrawal strategies, and this would be in the optimization phase of a retirement plan.
He says,
"I do have a question on the strategy of using tax deferred dollars to pay for life or doing Roth conversion. Do you consider the opportunity cost of letting those dollars continue to grow, less the taxes you pay eventually, versus taking the money now and paying the tax up front?"
That's a great question, Rob, so let's break this down and think through this logically.
First off, let's talk about what he's referring to. So, if you need to pull from your assets to pay for part of your retirement paycheck, that money has to come from someplace. And generally, you're going to have after-tax assets, which are your bank accounts and brokerage accounts, money you've already paid tax on that might be invested.
And that is the default scenario is that you deplete that bucket first. Once that bucket is depleted of all your after-tax assets, like money you have in your bank, then you would go to your tax deferred assets. which would be IRAs, traditional IRAs, and traditional 401ks, money that you've never paid tax on.
And then if you've depleted that bucket, then if you had some tax-free assets, like Roth schemes of IRAs or 401ks, then you would go to that. The traditional method of retirement planning is that you go in that order. You deplete the after tax, then you go to the tax deferred, then you go to tax free. Rob wants to know if you choose to take money from a tax deferred asset first, or partially, before you deplete your after tax assets, do you calculate the opportunity cost of doing that? Because if you take money from an IRA before you need to, you have a couple things happening.
One is, that will be a taxable event. It's going to be like taxable income. So, you're going to pay tax on that amount. So that's a drag. That dollar that you take out might only be 80 cents. Plus, that dollar is not going to be able to continue to grow in a tax deferred way. There's an opportunity cost there.
Do you calculate that in there, Rob? The short answer is yes. You can either do that in retirement planning software. If you run a what if scenario, taking money from IRAs, it will calculate the opportunity cost that you can compare against the base scenario, where you do it the more traditional way. You can definitely build spreadsheets to model that as well.
What I have found though when you're thinking through this question, Rob, is that the spreadsheets and the scenarios that you build in, say, retirement planning software is going to be a piece of the puzzle, but you have to be careful, it is not the entire puzzle.
When you look at a spreadsheet or you look at fancy software that is projecting out over 30 years, it's easy to see the black and white numbers and assume certainty. When in fact, it's just one guess about the future flow of things. Having a false sense of security with the numbers these projections make could lead you down to suboptimal decisions.
That's for a couple of reasons.
One is, you're projecting things that can't be figured out. You can't figure out what long term inflation rates are going to be, or what your sequence of return is going to be, what the taxable scheme is going to be, what tax rates are going to be, what your actual spending is going to be.
When you do these long-term scenarios, you're making a ton of assumptions of things that are going to be very fluid and not necessarily work out the way that you assume. You have to do that because the system needs it. That coupled with the fact that if you are, say, doing a scenario over your retirement lifetime, which may be 30 years, that means you have very uncertain assumptions being projected out over a very long period of time, which means that there's going to be a bigger spread of what the possible outcomes could be.
Those scenario planning from a software or spreadsheet standpoint are helpful, but they're definitely not the whole picture.
So what do you do about that? You definitely run these kinds of scenarios because they give you some pieces to the puzzle, but I would also, in the optimization phase, build a version 1, a V1, of tapping your assets the traditional way of taking out from all of your after tax assets, then going to tax deferred, and then going to tax free.
Make that version 1 of your feasible plan of record. Once you have that version 1, then you can make a what if scenario saying what if I take some money out of my IRA either to do Roth conversions or to fund my life. And you can start to model and compare them next to each other. The way that I do that is typically not in software, but in a relatively straightforward spreadsheet where I map out the cash flows for the first five to eight years, showing all the income sources and all the spending so I see with tax estimates showing the deficit that my income isn't going to cover. And that's the money I have to pull from my assets. Then I mapped that out over five to eight years. And once I've done that, Rob, then I can say, huh, look at that. Year two, I have a very low income and I have, let's say, 000 I need from my assets to cover the gap.
Yes, you could draw from your after-tax assets to cover that 100, 000 gap, and then Just move forward depleting that. But if you think a little bit, if you deplete your after-tax assets, what you're going to do is limit your optionality later in life when all you have is tax deferred assets. That means any monies that you need in the future, you're going to be handicapped as to your flexibility of where you get that money because you'll just have those tax deferred assets.
Whereas If I see in year two, I'm going to be, let's say, I'm going to have 10, 000 in income in year two, and I need 100, 000, so that means I need 90, 000 from my assets. The traditional method would say, just take it from your after-tax assets, because that's the most tax efficient today, and then keep deferring.
But, if you acknowledge that, you're never really eliminating your tax liability, you're just managing the timing of when you realize that tax liability. If you keep deferring, you're just pushing the tax liability out into the future, which may be beneficial to you, but you don't know what tax rates are going to be, you haven't figured out your RMDs, your required minimum distributions, where you're going to be forced to take money out, and you don't know what your needs are going to be 10 years from now.
Whereas, you do know. If I have 10, 000 in income and I need 100, 000, so I need 90, 000 for my financial assets, and I'm married and I'm filing jointly, the top of the 12 percent bracket with a standard deduction is right around 100, 000. I have the opportunity to not take 90, 000 out of my after-tax assets, but actually to take some money out of my tax deferred assets, pay the tax at the 12 percent bracket, and use that to help fund my life.
Essentially that choice, if you were to choose to make that, would be that, one, I'm willing to pay 12 percent tax on this money today versus I don't know what I will pay in the future. Another impact of that would be, now I can preserve my after-tax assets, so in the future I'll have more after tax assets that will give me more flexibility.
Then also what you will give up, as you're pointing out here, Rob, is that Well, I have less money growing in the IRA, which could be negative on the return, but it also means that it would reduce your required minimum distribution proportionally, which could benefit you later on.
You definitely want to include that opportunity cost in that, Rob. I think one thing that gets missed in a lot of this analysis is the concept of We're not actually avoiding tax. We're just choosing to pay a tax rate so we have more certainty on what it is today versus what it could be in the future. And two, we tend to greatly undervalue optionality or flexibility in our decisions.
That's probably more than you wanted, but hopefully that gives you some perspective of how I think about it.
USING A DRAW DOWN STRATEGY FOR A 401K
Our next question comes from Kelly about leaving her 401k assets there and using those resources within the 401k rather than rolling them out to an IRA.
She says,
"You may have covered this, and I missed it but I wanted your thoughts on drawdown strategies for those of us where most of our retirement assets remains in a 401k and we want to leave it that way.
After being a fiduciary on a 401k committee for years, I want to leave the funds there because of the lower institutional fees and professional oversight. But using the bond ladder strategy option isn't really available to us. I'm thinking a close proximity alternative would be simply keeping a healthy amount of cash or short-term bond opportunities then rebalancing at some point."
Essentially, Kelly wants to know, hey, I want to leave my money in my 401k. I got the concept of building out an income floor to help pay for my life over the first five years. But if I leave it in the 401k, I can't just go buy a treasury. I can't just go buy an individual bond that matures at a particular time.
So how do I manage that within a 401k structure?
That's a great question Kelly, and some of the reasons to leave in a 401k Rather than roll to an IRA or some of the ones that you mentioned the investment options are going to be reviewed by professionals you have the access to potentially institutional shares, which will have lower cost etc. They offer greater credit protection to some extent on a federal level. So, there's some advantages there.
How do you map in building an income floor within a 401k, and I think you're on the right track there Kelly.
First off I would say if your 401k has a brokerage option like a brokerage link option You do have the potential If your 401k gives you that option to move a certain amount of money over to that option and just go buy treasuries or individual bills, but let's assume that's not the case, Kelly, I would look first at your insured cash account, which most 401ks have, which is going to be like a money market account, and if it's an insured cash account, also called a guaranteed cash account. Some 401ks have very attractive options that are well above normal money market rates. So that would be an option. I would say if you're building out a five-year income floor, I would have the first two, maybe three. I'd have your contingency fund and the first two years in that.
Then I think it's appropriate to use a short-term bond fund for the remainder of that floor and then rebalance. The key would be in the first two years, at least. You want to have that just in an insured cash account or something that's not going to go up and down. The short-term bond funds 99 percent of the times should work for what you're doing.
The exception would be this last year where we had almost the worst bond market in history. Probably didn't work so well then, so you will end up taking some principal risk because you're in a fund rather than in something that matures. But I think that's how I would fold this into a 401k.
So let me know if that helps answer your questions and if not, we'll address more later on.
HOW TO GET A BETTER INTEREST RATE FROM CASH?
Our next question comes from Cammy, who is looking at bonds.
Cammy says,
"My husband and I have recently retired. We have a significant amount of cash in an interest income account in our 401k. It earns about two and a quarter percent a year. These are the funds that we are living on for the next several years while we pray for the stock market to go back up again."
I get that.
"We would like to find a way to earn higher interest on that cash if we pulled it out and put it into treasury bills or a good CD as those rates are getting better. We'd have to pay taxes on it at the time of the withdrawal. Is there a way to roll those funds into an IRA and purchase T bills or CDs within an IRA?
I know there are bond funds, but I don't really understand them, and the current rate of return doesn't look that attractive."
That's a great question, Cammie. Two and a quarter percent actually isn't that bad in an insured cash account within 401k, but the interest rate environment has changed dramatically over the last year or so.
So, you do not have to pull the money out of the 401k and pay taxes on it in order to buy treasury bills, CDs, or individual bonds. What you could do is, as you stated, roll your 401k into an IRA via a direct rollover, which will be a, essentially a trustee, which is your 401k, to the trustee of your IRA, and that could be any brokerage firm, Schwab, Fidelity, Vanguard, etc.
It would still stay under the umbrella of tax deferral within the IRA, and within that tax deferred umbrella of your IRA account, you're free to buy lots of different types of investments, including treasury bills, individual bonds, and CDs. So, you would still have a lot of flexibility in what you could actually put the money into, even if you moved it outside the 401k.
You definitely don't have to take it out just to buy T bills, and looking at T bills, at least at the time of this recording, a six-month T bill is about 4. 7%. Now, if you move the entire 401k out of the umbrella of 401k to an IRA, just realize, this insured cash account that you referenced where you're getting two and a quarter percent a year, those type of accounts are specific to 401ks and if you take the 401k money out, you just won't have that option again.
So, you'll have to stick with individual bonds, CDs, and or T bills, which is not necessarily a bad thing at all, at least in this environment.
You can accomplish what you want. by just moving it directly to an IRA, doing a trustee-to-trustee transfer, or a direct rollover. The key there is you don't want to have the money paid directly to you, meaning that when you see a check, it doesn't say "To Cammy", it should say to the custodian of your IRA for the benefit of Cammy.
You can work with your benefits department to navigate that.
TODAY’S SMART SPRINT SEGMENT
On your marks, get set,
and we're off to set a little baby step you can take in the next seven days to not just rock retirement, but rock life.
All right. In the next seven days, assuming you did the sprint last week where you updated your net worth statement. I want you to reassess the trajectory of your goals relative to retirement.
If you're using retirement planning software of some sort, get everything up to date, see how that feasibility number comes out. Are you still on a feasible course given the fact that you likely lost money in your financial assets last year? If you're not on course, then you're going to have some additional steps of, okay, what do I need to focus on to get back on course?
What risks do I need to shore up? What opportunities might I take advantage of could involve saving more. It could involve moderating some of your goals. It could moderate when you retire. It could moderate your portfolio. It could change whether you do some part-time work or not. This is going to be a basis for negotiation if you're off course because you got to get back on course.
Hope is not a strategy if you don't have agency and pathways to go along with it. So, reassess where you're at, and detach yourself a little bit. This is a problem to be solved. Maybe give yourself, if you're really far off course, give yourself a day, maybe an hour, to just sort of, oh, crap, what am I going to do now?
Give yourself some time to just emotionally feel it, and then put that aside, and focus on, how do I make this better? Use your agency. So that's your task. If you choose to accept it.
CONCLUSION
Man, I can't believe January is almost over. Ah, that was a good month.
I'm 56 now, so that means rounding I go up to 60 if you were to round it to the decade, ha ha. I am now only one year younger than my wife, for I have about a month and four days every year when she's two years older than I, so I no longer can hold that over her head, so now I'm only a year younger than she is. But that fun will come around again. I hope you're having a great start to the year.
Oh, by the way, February is going to be all Q& A. I'm just going to answer your questions. So, if you have a question, go to rogerwhitney.com/askroger and then in March, we're going to go back to themes and we're going to do going from two to one, whether that's being divorced or having a spouse pass away and some of the issues and opportunities that come up with that kind of transition.
So that's what we're going to do in March. I'm excited to walk this with you. Have a great day.
The opinions voiced in this podcast are for general information only and not intended to provide specific advice or recommendations for any individual. All performance references are historical and do not guarantee future results. All indices are unmanaged and cannot be invested in directly. Make sure you consult your legal, tax, or financial advisor before making any decisions.