Can I Retire Yet?
Episode 152R
Episode Guide
Episode Summary:
Episode Timestamps
Episode: Drawdown Strategies for Retirement with Big Earn
Episode Summary:
In this episode, hosts Brad Barrett and Jonathan Mendonsa discuss comprehensive drawdown strategies for retirement with guest Big Earn from Early Retirement Now. They highlight the transition from asset accumulation to retirement spending, emphasizing the significance of understanding sequence of return risk. The episode analyzes case studies involving Becky and Steven, offering insights into optimizing financial plans, including social security strategies and tax implications related to withdrawals.
Key Topics and Takeaways:
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Introduction to Drawdown Concepts
Understanding the complexities of creating a drawdown strategy that addresses unique financial situations. -
Case Study Overview: Becky and Steven
Discussing their financial journey and the critical decisions they face as they approach retirement. -
Understanding Sequence of Return Risk
- Sequence of return risk defines the importance of investment returns during the initial years of retirement.
- Key insight: the first five years of withdrawal are crucial for long-term sustainability.
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Social Security Timing Strategies
Delaying social security benefits until the maximum age (70) can significantly enhance future payouts. -
Tax Implications and Roth Conversions
- Planning withdrawals from accounts strategically to minimize taxes.
- The importance of performing Roth conversions in a tax-efficient manner.
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Final Thoughts and Recommendations
Implementation of drawdown strategies should be personalized and adaptable to changing circumstances throughout retirement.
Key Quotes:
- "Embrace a confident withdrawal approach for a fulfilling retirement."
- "Key insight: the first five years of withdrawal are crucial."
- "Confidence is key; a solid plan makes a difference."
- "Automate withdrawals for a smoother financial transition."
- "Mortgage-free retirement leads to peace of mind."
Actionable Takeaways:
- Create a nuanced drawdown strategy by assessing individual cash flow needs.
- Prioritize delaying Social Security benefits until age 70 for optimal payouts.
- Utilize scheduled, automated withdrawals to simplify financial management post-retirement.
- Consider tax implications when planning withdrawals to minimize taxable income and maximize efficiency.
- Strive to be mortgage-free to enhance cash flow and reduce financial stress in retirement.
Discussion Questions:
- How can understanding sequence of return risk inform your investment strategy?
- What factors should you consider when planning Social Security benefits?
- How can automating withdrawal strategies reduce stress in retirement?
- Should the age at which you pay off your mortgage influence your retirement planning?
- In what ways can Roth conversions be beneficial during retirement?
Resources:
Related Episodes:
- Episode 035: Pay Off Mortgage vs. Invest
Conclusion:
This episode of ChooseFI provides valuable insights into retirement drawdown strategies. By understanding principles such as sequence of return risk and effective tax planning, listeners can approach retirement with greater confidence.
Navigating Retirement Drawdown Strategies for Financial Independence
Achieving financial independence and preparing for retirement can be an exhilarating yet daunting journey. One crucial aspect of this journey involves understanding effective drawdown strategies to ensure that your savings last throughout your retirement. Here, we offer actionable insights based on our recent discussions with expert guest Big Earn from Early Retirement Now, focusing on key strategies for managing withdrawals and maximizing confidence in your financial future.
Understanding Drawdown Strategies
A drawdown strategy refers to the method by which retirees withdraw funds from their retirement savings. It's essential to develop a nuanced plan that considers your individual cash flow needs while mitigating risks associated with market volatility and sequence of return risk.
Define Your Financial Needs
Begin by assessing your spending requirements in retirement. Calculate your expected annual expenses to better understand how much you need to withdraw. This assessment will help you create a realistic and flexible financial plan tailored to your lifestyle.
Sequence of Return Risk Matters
One critical concept to grasp is sequence of return risk, which emphasizes that the order of investment returns can significantly affect the sustainability of your withdrawals. The risk is highest during the initial years of retirement, which is why having a solid plan for this period is vital.
Case Studies: Learning from Real-Life Examples
To illustrate effective drawdown strategies, we can examine the case study of Becky and Steven, a couple on the brink of retirement. Their approach involved careful planning and strategic timing of Social Security benefits.
Prioritize Social Security Benefits
Becky and Steven planned to delay their Social Security benefits until ages 69 and 70, respectively. By waiting, they aimed to maximize their benefits, which would reduce their reliance on withdrawals from their savings during the early years of retirement.
- Recommendation: Delaying Social Security benefits can lead to substantially higher monthly payments, making this a crucial part of your retirement income strategy.
Tax Planning and Withdrawal Structures
Understanding the tax implications of your withdrawal strategy is also essential. In the example above, Becky planned to execute Roth conversions in the years leading up to their Social Security benefits kicking in, which would help minimize their taxable income during retirement.
Optimal Withdrawal Sequence
Generally, it is advisable to withdraw from taxable accounts first to reduce your taxable income. This strategy is beneficial in maintaining a lower tax bracket and preserving your tax-advantaged accounts for longer.
- Actionable Tip: Use a tax-efficient withdrawal sequence that begins with accounts where previous taxes have already been paid, transitioning to tax-deferred accounts like traditional IRAs later in retirement.
Automating Withdrawals for Simplicity
Automating your withdrawal process can simplify financial management in retirement. This approach ensures that you consistently meet your cash flow needs without having to make frequent manual withdrawals.
- Key Insight: Automate your withdrawals to reduce decision fatigue and maintain a smoother financial transition.
Mortgage-Free Retirement: A Stress-Reducer
Another significant aspect discussed is the importance of being mortgage-free in retirement. Carrying a mortgage into retirement can add undue financial stress, so paying off a mortgage before retirement provides peace of mind and improves cash flow.
- Recommendation: Aspire to be mortgage-free to enhance your financial wellbeing and reduce monthly expenses during retirement.
Managing Market Timing Pitfalls
It’s crucial to avoid market timing when withdrawing funds from your retirement account. The temptation to withhold withdrawals during market downturns can disrupt your financial plan.
Maintain a Balanced Portfolio
Instead of attempting to time the market, focus on a consistent withdrawal percentage based on your asset allocation. A balanced portfolio that aligns with your risk tolerance can ensure that you are well-prepared, regardless of market conditions.
- Actionable Takeaway: Stick to your withdrawal plan without getting overly concerned with market fluctuations.
Concluding Your Drawdown Strategy
In conclusion, navigating the drawdown phase of retirement requires thoughtful planning and strategic execution. By understanding your financial needs, timing Social Security appropriately, managing taxes efficiently, and choosing to be mortgage-free, you can create a secure, fulfilling retirement experience.
Final Thoughts
As you embark on this journey, remember that the first few years of retirement are critical. Focus on creating a sustainable withdrawal strategy tailored to your unique situation, and empower yourself to manage your finances confidently. Embrace this stage of life as an opportunity to enjoy the fruits of your labor, knowing you have taken the necessary steps to secure your financial future.
By implementing these strategies, you can approach retirement with the clarity and confidence needed to thrive during your golden years.
Big ERN comes on the show today to break down the numbers of Becky's retirement plan. He works through their real numbers to determine how solid their retirement plan is.
[elementor-template id="143609"]Taking Stock
[embed]https://youtu.be/H3u-lAK37n0[/embed]A lot of retirees have this fear of touching their principal and part of it is justified. But there is also part of it that is unjustified, right, because unless you have a constraint that you have to maintain your capital because you want to leave a big bequest, it's ok to draw down your capital at a measured pace and slowly. So don't deprive yourself. Don't have a scarcity mindset. And you should do your withdrawals confidently because that is what your retirement should be about. It should be fun. It should be confident. It should be comfortable. Don't have this scarcity mindset where you live like misers in retirement because you are afraid to touch your principal.
Taking a look at Becky's story, the first thing Big ERN did was ask questions about their plan. Since this is a real-life study, it is not as simple as an academic study. There are different spending constraints and variables to consider in each individual's retirement plan.
A lot of times, your retirement is basically a multi-phase withdrawal strategy.
Right now, Becky and her husband Steven are in their early 60s. In six years, they plan to start taking their Social Security benefits at age 69 and 70. Steven will get $3,500 a month and Becky will get half of that through the spousal benefit.
There annual spending is $80,000, Social Security will come to around $61,000 a year. When Social Security kicks in, they will be able to basically live off of that and minimally withdraw from their reserves. But for now, they have a large cash flow demand on their portfolio of $1.35 million.
Check out Big ERN's full post about Becky's numbers here.
Listen to Becky's full episode here.
Recommendations
Big ERN recommends that they not be afraid of the drawdown during the early period of their retirement. If they draw it down by half over or all the way to $500,000 in the first 6 years, they will still have a viable plan to supplement their social security.
He wants everyone to get away from the mindset that you can't ever touch the principal. Although it can seem scary to withdraw around 6.9% of their portfolio this year with the market highs, it is only for a short amount of time.
Tax Liabilities
Their budget of $80,000 a year does not include their tax liabilities, so they will need to withdraw a little bit more to pay their taxes. It is important to have a tax strategy in place.
The first $30,000 of their income will be tax-free. Everything else will be based on brackets. These brackets start a 10% and 12% but then jump to 22%. The goal is to avoid the 22% tax bracket. Plus, they live in Colorado, which has state income taxes around 4.6%.
In the earlier years of retirement, they also plan to do Roth conversions of around $10,000/year. However, the majority of their assets are in a taxable account. Less than 50% of their portfolio is in a 401k. Unlike many retirees who face minimum distribution requirements with their 401k, Becky and Steven do not have to worry about this. After they spend down the taxable accounts, they will be basically living tax-free because most of their money is in a Roth. Except for their Social Security which will be taxed at the federal level.
Each year for the next six years, they will need to look at where they stand in the tax brackets. After they determine how much taxable income they've already produced, they can use the rest of the bracket allowance to do Roth conversions. To do this, simply subtract your year-to-date income from your brokerage account from the tax bracket limit and convert that amount. Since $100,000 in total income will keep you in the 12% bracket, they will have some room to work.
An important note is that if you go over into the 22% tax bracket slightly, your entire income will not be taxed at 22%. Only the amount that is over the 12% tax bracket limit will be taxed at the higher rate.
Preparing For Your First Year Of Drawdown
Big ERN is cautious about the bucket strategy because it sounds a lot like market timing.
My personal preference would be that in retirement that you would do the exact same thing as what you did saving for retirement, you automate your savings. Right, you do regular contributions to your 401k, regular savings into your other taxable accounts, you do the whole pay yourself first approach. I think the same approach works very well on the way out when you withdraw money. So you automate it.
If you have a cash bucket and the market goes down, then you are likely to wait until the market recovers. However, there is no guarantee that the market will recover quickly. At some point, you'll need to replenish your cash bucket so if you wait too long you might end up hurting yourself.
He would recommend setting up withdrawals in an automated way to match your budget. The only thing that you would need to take out manually is any big expenses that pop up.
Automatic withdrawals could start with the interest and dividends that your portfolio throws off. No need to continue dividend reinvestment. For Becky, this would equate to around $14,000 in income. After that, you can start withdrawing from the highest cost stocks. This can be identified by a lot number that is based on the day you bought your stock. Also, you should avoid short term capital gains of less than a year to be more tax efficient.
To Have A Mortgage Or Not?
In retirement, Big ERN likes not having a mortgage. Although it can be useful in the accumulation phase, a mortgage is like a short term bond. Most retirees will favor a 60/40 split of stocks and bonds in retirement. If you have bonds in your portfolio, then why would you have a mortgage?
There are some exceptions like the tax consequences of paying it off in one big chunk or having an extremely low mortgage.
Can Becky Retire Yet?
Yes! According to Big ERN, Becky and Steven are safe in their decision to retire. Even with the worts bear markets of the past, they would have survived. They should even have money left over in 30 years.
Head over to Early Retirement Now to get the full breakdown from Big ERN.
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New Podcast Announcement
Thank you for taking a minute to tell us why and how you feel stuck along your journey. After reading through your responses, we started to look for patterns. It seems like some of you want someone to speak to you on your journey.
We've partnered with Jillian Jousarnd from Montana Money Adventures to launch a new podcast that seeks to meet you where you are at. "Everyday Courage"
She wants to help listeners lead a better life through bite-sized chunks of inspiration and small tips to improve their life. This podcast will launch soon, stay tuned for more information!
Book Release
MK recently released a new book, The Infinite Infinite. If you are looking for a fun mystery adventure, then check it out!
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