How This 60-Year-Old Couple Plans to Retire in 2 Years | Case Study

So you're 60 years old, you're two years out from retirement, and you're trying to determine how to build the right retirement income strategy for you. Today we're going to walk you through a case study as we examine the pros and cons of four different retirement income strategies. Hey, I'm Casey Weade, CEO and founder here at Howard Bailey Financial, also a certified financial planner practitioner.

Today we're talking about a couple. They're both 60 years old, they want to retire in two years. So they're going to retire at age 62, right when they hit that social security age, like many families are waiting to hit.

So they turn 62, they're going to take their social security benefits, they've saved a million dollars for retirement, and they're trying to evaluate the right retirement income strategy to satisfy their income gap. What is their income gap? Well, they're spending about $5,000 a month, $60,000 a year, and they also have social security benefits that total just over $3,000 a month. So what is their retirement income gap? Their income gap is actually going to be about $34,000.

Why is that? Well, that's because those are pre-tax income numbers. They're going to need to take $34,000 from that million in order to net the amount that will fill in that gap, the difference between their social security benefits and their expenses that they're going to have each and every month. And now we say, what type of retirement income strategy should we use? And you might be watching this going, what do you mean retirement income strategies? I thought that we just took money out of our portfolio.

We just do what we've always done. We continue to invest in our balanced portfolio, our diversified portfolio, stocks and bonds. We take distributions, we adjust for inflation every year.

That's what worked during our accumulation years. We just invested, we created a rate of return, and then we put dollars in. Now we're going to be taking dollars out.

What's the difference? And you might also be saying, well, why don't we just spend the dividends? Why don't we just spend the interest? Well, today we're going to talk about some of these different strategies. We're going to talk about the pros and cons of each, and we're going to kick it off by talking about that one that's probably top of mind for you. And you might be thinking of that good old 4% withdrawal rule.

So it's kind of where we're starting here. Another way to say that is a systematic withdrawal approach, because we're systematically taking withdrawals from your retirement portfolio. Systematically taking a portfolio withdrawal and adjusting it for inflation year after year.

Let's take a look at it for this particular couple. So this couple, they're going to retire at 62 years old. Let's just say for the sake of simplicity today, that that portfolio doesn't change much in value over the next couple of years.

They're 62 years old. It's still worth a million dollars. Unlikely, but again, we just want to understand the pros and cons of these different income strategies.

So they're 62, and now they need to satisfy the income gap, drawing $34,000 a year out of this balanced stock and bond portfolio. So you're going to take $34,000 a year, and by the time they get to age, let's say 72, 10 years into the future. Now at the onset of retirement, what are they drawing from that portfolio? About 3.5% per year.

Shouldn't be an issue. They turn 72 years old. That portfolio, maybe it's growing to $1.5 million.

Now what's their withdrawal rate? Well, their income needs have increased. Now they probably have income needs that have approached closer to $90,000. They have to satisfy a larger income, and that's because we're factoring in a 3% standardized historical inflation rate.

Now their withdrawal rate is 3%. So their withdrawal rate has actually gone down over time because their portfolios continue to grow over time, outpacing inflation. So are they at risk at age 72? They're looking even better than they did at age 62.

But the biggest risk for retirees is having a major market meltdown, or market pullback, or just poor market performance in those first few years of retirement. And so what if in the first two years of retirement, the market gets that worst case scenario? At the onset of retirement, they stress tested that portfolio. They said, hey, we've got a 95% chance success.

We should run out of money in retirement. But we need to focus in on that 5% chance of failure. That 5% chance of failure is all related to having one of those worst case scenarios hits at the front end of retirement.

A financial crisis like we had during 2008. Maybe we have a tech bubble burst like we saw after the late 90s. We want to insulate ourselves against that.

And that's because we'll do some of the math. Let's say that when we're 62, we have $1 million. In two years, we're 64 years old.

Now that $1 million has turned into $700,000. And we have our income needs that have increased a little bit. And now we need to pull $35,000 from 700,000.

Well, the withdrawal rate is no longer 3%. Now our withdrawal rate is closer to 5%. Now we are decreasing our success rate when we stress test that portfolio at that time.

Maybe the odds of success at that point, depending on our inputs, maybe it's closer to 75% or 80%. And now we're running the risk of running out of money in retirement as we continue to increase the amount of money we need to draw from that portfolio over time and adjust for inflation. We might be running the risk of running out of money in our mid-80s, for instance.

And you say, Casey, I don't know that I'm comfortable with that risk. I would really like to do something that does make a lot of sense to me. Rather than just systematically and indiscriminately taking distributions from my portfolio, whether my positions are up and down, I'm just going to take a little bit out of each, maybe spend my dividends and interest.

I really want to do something that allows me to allow those equities and those at-risk dollars to continue to grow over time. And you might be thinking of the second strategy here, one that is also very widely popular today, and that's the bucket income approach. So the bucket income approach is bucket strategy.

Essentially what we're doing in this bucket strategy is we're setting aside dollars that we're going to spend down that are going to be our fixed dollars or our protected dollars that we know aren't subject to market risk. And then we set aside bucket number two that we may not need for five, 10, 15 years. Depending on your own risk tolerance, that's what's going to determine how much you set aside in each one of these buckets.

Then we have bucket number three or bucket number four. These dollars we're not going to be touching for 20, 30 years down the road. In this instance, we're going to be focusing on creating three different buckets.

Our first bucket, we're going to set aside around $200,000. So $200,000, and if we're drawing $35,000 a year and adjusting for inflation, that portfolio is probably going to last somewhere around 10 years. And so we've set aside $200,000 to satisfy about 10 years worth of income needs.

And that bucket could be made up of fixed income, could be made up of cash, could be made up of money market, maybe even some type of protected income strategy or annuity. And so we've set aside $200,000 to satisfy those needs. Now, what if we get the worst? Two years from now, and we're now 64 years old, our million dollar portfolio, it might be down a bit.

Maybe that million dollars is worth $800,000. And now what's happened though, we've only spent maybe $70,000 of our $200,000. So we now have about maybe $130,000, maybe $150,000 still left in that first leg.

And now we're not going to touch those equities. So they're going to continue to grow. That's going to allow us to recover any losses and have some pretty good growth over the next few years.

And that's going to put us in a position where we should be pushing out that date of failure, that potential failure date where we run out of money. And maybe we're pushing that out into our early 90s, our mid 90s. So we've pushed it out a little bit further.

And then we say, well, are there any other strategies that we might be able to use? We've evaluated the systematic withdrawal approach. We've evaluated the bucket income approach. And then we say, well, what if we use a strategy that maybe makes more sense to you where you're taking withdrawals, not from the risk-free assets or those assets that are set aside in a protected income bucket, but you say, you know what, I'm going to lock in my gains every year.

I'm going to take my income from my equities or that more aggressive portfolio. And if something bad happens, I'm going to jump over and start taking dollars from those funds that have been set aside to be in that protected bucket or that fixed income bucket. So in this instance, we're talking about a flexible withdrawal approach.

And this flexible withdrawal approach, it can be a little bit more labor intensive. You know, if we think about a systematic withdrawal approach, we're just going to be sending out a paycheck every single month, adjusting it for inflation. We think about the bucket income approach, we're just sending out a paycheck every single month, we're adjusting it for inflation, but it's coming out of a different portfolio that's been set aside specifically for those near-term income needs.

And now what we're talking about doing is we say, hey, if the market's down this month, if the market's down this year, I'm not going to take a distribution for my more aggressive dollars or that equity bucket. I'm going to take it over here. Because what are we doing there? We're trying to avoid, in both of these scenarios, bucket approach and the flexible withdrawal approach, we're trying to avoid violating the number one rule of investments.

And that is buy low, sell high. And so maybe we decide to set aside $200,000, maybe a half a million dollars aside in a bucket that we know we can go hit in the case that the market's down. And we also know the market can be down for a long period of time and take a long period of time to recover.

We know if we go back to 2000 and 2003, we saw three years in a row where the market was down. And so we might say, I want to set aside three years so I don't have to draw money from my equities while the market's down. However, how long did it take for that portfolio to recover after those three down years from 2000 to 2003? We didn't get back to even for about a decade.

That was what was known as the lost decade. And it was a little bit longer than that. It's actually closer to 11 years that it took us to get back to even.

We might say that rather than just not drawing from the portfolio when it's down, I don't want to draw from the portfolio until it's actually growing and it's net positive. So this is going to be that risk assessment work that you have to determine for yourself how comfortable I am with risk, how comfortable you are with risk. We have to assess that for ourselves.

And in this instance, we're also going to find, and what we most often find, we've pushed that date out a little bit further if we've set more fixed dollars aside. Rather than setting aside $200,000, we're setting aside a half a million dollars. If we're setting aside a half a million dollars, then yeah, we're probably pushing that day of failure risk out a little bit further, maybe our late 90s, for instance.

And for most people, they'll go, that's good. I'm comfortable with pushing it out to my late 90s. I've never had a parent that's lived past her mid-80s.

But you also might be somebody that says, my parents lived into their hundreds, or my grandmother lived until she was 103 years old. I'm really concerned that we could be running out of money in those later years. This is where the protected income strategy comes into play.

So we've talked about three fairly similar strategies when you really think about it from a risk profile standpoint, whether that is the systematic withdrawal approach, the bucket income approach, or the flexible withdrawal approach. Now we're looking at a protected income approach, where we're going to take a chunk of these dollars, and we're going to secure some income that's going to be there as a paycheck for the rest of our lives. This is most commonly using some type of annuity that's creating a guaranteed income stream.

So you take a chunk of these dollars. Let's say in this instance, we're going to take about a half a million dollars, give it over to an insurance company in exchange for a paycheck that's going to come in the rest of our lives. No matter if we spend down that half a million dollars or not, no matter if we live to 105 or 110 or 115 years old, we know we're always going to have this paycheck come in.

Many of our grandparents, for instance, my grandparents had a pension, and fewer and fewer retirees have that pension payment that offered them a lot of security in retirement. This is kind of like creating your own pension that's backed by the claims paying ability of an insurance company. So in this instance, let's say again, we set aside a half a million dollars.

It's going to create about $35,000 a year in income. And we fast forward two years into this retirement strategy. Maybe the half a million dollars we've set aside to be more aggressive, that half a million, maybe it's worth $300,000, $350,000.

But we say, you know, that's okay because I don't need to touch it yet. We've put enough dollars in that protected income strategy that all of our income needs are still being satisfied, and we don't need to touch those at-risk dollars at all. We fast forward to age 72.

Now we're starting to eat into that portfolio because now, because of inflation, our income needs have went up. As we've ran this particular scenario at a 3% inflation rate, now the dollar amount that we need from that at-risk portfolio, $8,000. So now we need $8,000 from a bucket that, let's say it went through a decade.

So over a 10-year period, worst case scenario, historically, now that half a million dollars, let's say it's still worth a half a million dollars or a little bit more than that, $525,000. It really hasn't grown much over the last 10 years, but our income needs from that bucket are very minimal. We're going to need about 1.5% per year from that equity bucket, from those aggressive dollars.

So 1.5% per year is going to be our $8,000 a year that we need from this half a million dollars that's still remaining. And now we're 72 years old. So we know that a 1.5% withdrawal rate, now we've reduced the risk that we're going to drain that bucket to near zero on a stress test point, maybe 99% chance of success.

And so that gives us a lot of confidence. Furthermore, we know that when we get to our late 90s, maybe worst case scenario shows us that, yeah, you're not going to have anything left in that equity bucket when you get to your late 90s. And you say, well, that's okay, because my needs have went down.

I'm spending less at that point. Maybe I went down to one car. I sold the vacation rental.

I'm not traveling as much. I'm not going out to eat as much. And so my income needs have actually went down, but I still have this paycheck.

I still have my social security that's been adjusted for inflation. And I still have this paycheck that's coming in from my protected income strategy every month, as long as I live. I don't have any legacy dollars left, but that's okay.

Now, when you look at all four of these different strategies, you're trying to determine which one's going to be the right one for you. And I can tell you, every family we work with is different. Some want the protected income strategy.

Some want the systematic withdrawal strategy. Most people want something in between. Quite often, we see the majority of the families we work with going with that bucket income strategy, that bucket approach.

And that really comes down to your own personal goals in three different areas. That is one, which is certainty. How much certainty is important to you in retirement versus two other pieces.

That is flexibility and legacy. When we talk to most of the families we work with, they'll say, well, whatever's left over the kids can have. I'm not too concerned with what they get.

I just want to know that I'm never going to run out of money. So they overweight certainty instead of that legacy piece. And then you get to the flexibility piece.

When it comes to flexibility, we know we're giving up quite a bit of flexibility when it comes to that protected income strategy. When it comes to that protected income strategy, we're giving up flexibility, and we're probably also giving up some growth potential at the same time. When we look at those other three strategies, the systematic with approach, the flexible approach, the bucket approach, quite often all three of these strategies can come out with very similar risk profiles.

So we can have similar legacy potential with the first three strategies. So maybe it comes down to flexibility. And when it comes to flexibility, I would challenge you to ask yourself how much flexibility you really need with your retirement account specifically, your IRAs.

Why were 401ks and IRAs created? They weren't there for an emergency. They weren't there for you to grab $100,000 out because you would be hit with too much in taxes. Your flexibility bucket should hopefully be set aside outside of that IRA, set aside in a 1099 bucket or an after-tax bucket.

But you might be saying to yourself, you know what, Casey? It just feels good to have flexibility. It feels better for me to have flexibility, and I would rather have that flexibility over the certainty. That just gives me a greater peace of mind than those paychecks coming into my mailbox every single month.

And you might also say, legacy is really valuable to me. That's more valuable than the certainty that I might get from having some type of guaranteed paycheck coming in every single month. And so maybe you end up going with those first three approaches.

But in order to really understand which one of these strategies is going to work best for you, you have to run the numbers. You have to know the math. And we want to give you an opportunity today to start running those numbers for yourself.

So if you want to see what these different strategies might look like for you, the upside, the downside, the risk overall, and how this improves your situation, all you have to do is call the number on your screen to schedule a free personal financial review and an income analysis with one of our financial planners. We can visit with you anywhere you find yourself in the country. We can do that virtually.

We can do that in person. That's going to be completely up to you. And then we can ultimately find the income strategy that will give you the confidence that you need in retirement.

Then we can deliver the income strategy that gives you the confidence that you seek in retirement.