I'm 68 with $1.4 Million: What are the 4 Simple Steps to Build a Confident Retirement Plan?

You might be overwhelmed as you plan for retirement. Today, I'm going to give you four simple steps to build the retirement plan that will give you even more confidence for this next phase of your life. And we're going to be doing that using a case study of a couple that are 68 years old with $1.4 million in their IRA.

So our firm recently met with a couple that had $1.4 million in the IRA. They're 68 years old. And what I'm going to do today is talk you through some of the questions that they had and the gaps in their strategy and how we filled each one of those gaps one simple step at a time.

Now, when this couple first came in to visit with us, they said that their number one concern was taxes. They said they're pretty happy with the way their investments have performed over the last couple of years. And they weren't really concerned about their investment strategy.

They wanted to talk about taxes because that's something their advisor never talked to them about and never started helping them plan for. Now, we said, hey, taxes are great. That's an important and integral part of your overall financial plan.

But we need to follow the steps. We have some foundational elements of your retirement strategy we need to address so that we don't get that proverbial cart ahead of the horse. And so we walked them through our financial planning framework.

And for us, that starts with number one, your purpose. Now, for this couple, they said they wanted to retire confidently. They've already done it for a couple of years.

They wanted to continue to travel in their RV, which took a pretty good chunk of change. They wanted to spend time golfing. They want to spend time volunteering.

But they really just didn't want to worry about their investments. They wanted to fill in any gaps in their strategy so they could focus on those more important elements of their life. So they're loving retirement.

That being said, we wanted to structure their financial plan to support that and allow them to focus on those more important elements. So we call that piece of our framework the financial life plan, L-I-F-E, that is made up of four different pillars of your strategy. You could also think of each one of these pillars as a unique allocation.

We want to find the most efficient tool to accomplish each one of the major goals or risks that you're going to face in retirement. And there's a specific tool that helps you accomplish each one of those things most efficiently. Unfortunately, many people plan using all of one tool.

This couple was just that. They had $1.4 million in an IRA, which was all of their life savings. And that $1.4 million was 100% in an equity portfolio or a stock portfolio.

That was supposed to solve all of these different risks that they're going to face in retirement. It was supposed to be there for the L, liquidity for emergencies. In case they had an emergency arise, they'd go grab some cash out of that portfolio.

If they needed income, which they do, it was supposed to provide them consistent, reliable income for the rest of their lives. Then flexibility. If they had something arise that they needed to adjust for, such as inflation, it was supposed to provide them those inflation adjustments along the way.

And whatever was left over would be passed on to the heirs or go and be paid into their estate. If they had a long-term care risk, it should be there to fund that long-term care risk. There's a problem with that.

Not one tool is most efficiently going to accomplish all of your goals in retirement. We want to find the closest distance between two points, which is a straight line. So we started with liquidity.

When it comes to liquidity, this is being prepared for emergencies. We want to have cash that's available in case we need it someplace that's easily accessible in a moment's notice. Most of the time, we think of this as our bank savings.

Our bank savings, checking, money market. But sometimes in situations like this, they'll say, well, I have $5,000 in my checking account, which they did. But if we need excess cash, we need $20,000, $30,000.

The car breaks down. We need a new furnace. We need to put a new roof on the house.

We'll just go over there and grab it from the stock portfolio. What's the problem with that? If we have a real emergency, the kids need some cash for that matter. And we need to go get 50 grand out of our stock portfolio.

What if that stock portfolio is down in value? And we have to take excess cash out of that because it's all IRA to cover our taxes. So we want to start setting aside some cash to fill in this gap. They had $5,000 in checking.

We wanted to have at least $50,000 in case they had an emergency and they wouldn't have to worry about market fluctuations when that emergency arises. And the reality is a lot of times our emergencies, they arise due to other economic issues that we're seeing. And those economic issues may have depressed that portfolio.

And now we can't touch it when we have an emergency. So we want to fill in that gap about $5,000 currently in cash. They want to have about 50 grand.

So they have a gap of $45,000. And then we come to income, the eye and the life plan. And that is the most important element arguably of a retirement because without retirement income, we don't have retirement.

And so we want to fill this gap. Now for them, they're filling this gap in a couple of different ways. One with their social security payments.

So their social security is net after tax. They're getting about $4,500 a month in social security payments, but they're spending about $7,000 a month. So their gap is $2,500, $30,000 a year.

But we actually need a little bit more than $2,500 a month from their investments to get to a net 2,500, because again, it's all coming from a tax deferred IRA. They've done no tax planning. They have no tax diversification.

They have no flexibility across their tax buckets. So we're going to need to take about $3,000 a month, $35,000 a year in order to net enough to fill in that gap. Now, currently they're taking that whole $35,000 a year from that $1.4 million stock portfolio that they said were really satisfied with.

Because many retirees like them today, they've never been through a financial crisis while in retirement. They might have during their working years, but didn't feel that pain while they were retired. And there's some real issues that need to be addressed if we're going to have everything at risk in retirement, and we're going to be taking distributions from that portfolio.

And I want to illustrate some of those for you. So what we're doing during our working lives, as we put money into that 401k, just like this couple did for their whole working life, there's a reason they became millionaires because they systematically put money in their 401k. They put a dollar amount in that 401k out of each and every paycheck.

As they did that at different intervals, they did what's called dollar cost averaging, reducing their overall costs for buying into the market. Because when the market was high, they were putting dollars into that account at each one of these different intervals. And when the market was high, they were buying less of the market, essentially fewer shares.

That's dollar cost averaging. When the market was cheaper, they were still putting the same dollar amount in, but they're getting more value because they're buying more of the market when it's depressed in value. That's dollar cost averaging.

Now, if you look at the stock market over time, what you usually hear talked about is the stock market averages maybe 6%, 10%, 12% per year. But even if it's averaging 10% a year, it's not doing it linearly. It looks a little bit more like this.

We all know the stock market is a bit of a roller coaster ride. And being 100% equities, they're going to feel all of those ups and all of those downs of the stock market. And now that they're in retirement, instead of dollar cost averaging, they're going to be reverse dollar cost averaging.

They're going to be taking dollars out of that account at each one of these intervals. They're now violating the number one rule of investments. When they take income from that portfolio, when it's down in value, they're going to be selling low, which we all know is not what we're supposed to do when we're investing.

But they were just doing this as a default because this is the plan that they had in place. We're just going to take a percentage out of our account and set that income for the rest of our lives. And they're indiscriminately taking income as they shave a little bit off of each one of those positions every year in their account, which hasn't been a problem as good as the market's been over the first few years of the retirement.

However, they know just as well as we know that the market doesn't move in a linear fashion. We stress tested that portfolio. And as I said, it's 100% stocks.

And we actually found it was a little bit more aggressive than the S&P 500. And so we know the S&P 500 has lost significant value in the past. We know it can lose half of its value in 12 months.

We know it can lose more of its value than half of it in 18 months. So what happens if that $1.4 million in their IRA today loses half of its value? Now it's worth $700,000. And then of that 700,000, I said, what would you do if the market was down? They said, well, we just continue to take our income and take our $35,000 out.

If they take that $35,000 out when the portfolio is down to $700,000, now they have $665,000. It's going to take what return to get back to even? 110% is the return it's going to take to get that $665,000 back to $1.4 million. Probably unlikely that that happens as they're going to continue to hit up that portfolio for $35,000 each and every year.

Even if they stop drawing, it's going to take many years for that portfolio to get back to even. And if nothing else, this is going to cause some unnecessary stress on them personally in a time in their lives that they want to be spending out driving around in that RV, spending time volunteering and spending time golfing. Now, as I'm going through this case study, I want you to know that I'm here to answer your questions.

If you have a specific question about anything I've said thus far, just drop it down in the comment section. I'll answer as many of those questions as I possibly can. But let's get on with our plan.

So back to our strategy and looking at our framework again. Now out of our $1.4 million, we set aside $50,000 to be available for emergencies. And now we're going to carve that out of the stocks.

We're going to set that aside in a money market. We're not going to strip it out of the IRA. There's really no reason to start taking it out of the IRA right away.

We may want to do a little bit over time. But then as I said, we get to the most important element. Let's start building a real income strategy.

So we walk them through a couple of different basic income strategies. Let's call that option A and option B. Over here in option A, we're using a segmented approach or maybe what you've heard of as a bucket approach, a very popular retirement income strategy. That segments out your income needs into two or three different buckets.

In this scenario, we're looking at three different buckets. We're saying, all right, for leg one of your income strategy, we're going to set aside around $300,000. And that'll be there to satisfy your income needs over the next 10 years or so.

Then we're going to set aside around $200,000 that we know we don't need to touch for at least 10 years. We're going to be a little bit more aggressive with those dollars. And another $100,000 that we know we don't need to touch for 20 years as we spend down these first two buckets.

So we're going to be even more aggressive with that piece of the pie. And if you think about this another way, I like to think about it as making you a bit younger, because a lot of retirees will say, all right, I'm in retirement. I can't take risk anymore.

And I say, well, why can't you take risk? Because I need the money. The fact is they have 1.4 million, but they don't need the whole 1.4 million. They have some income needs that they need to meet in the near term.

We just need to buy them some time to continue to invest as aggressively as they want with those remaining dollars. So we're essentially investing that $300,000 as if they're 68, which is where they're at today, that $200,000 as if they're 58, that $100,000 as if they're 48. Because if you were 48, would you invest differently? So that's option A. But we want to give them all of the options so that they can make the decision on what the best thing is for them in their own unique personal financial situation and their own unique disposition and preferences.

So then we look at option B. Option B is carving out a portion of this portfolio to create a guaranteed income stream for the rest of their lives, leveraging insurance products called annuities. And so now we say, hey, if we carve out $500,000, that's going to create between $35,000 and $40,000 a year for the rest of your life. Regardless of if you spend that whole half a million dollars down or not, they're always going to continue to give you those payments.

And if there's anything left over in the account, then it'll pass on to your heirs. Now, if we look at those two different strategies and our liquidity bucket, we've used $50,000. We've used about $600,000.

So if we do the more at-risk strategy using traditional fixed income and equities, or we can go with the solution using about a half a million dollars, that leaves us over $1.4 million, somewhere between $800,000 and $900,000 after we've solved for all of their income needs. So solve for their income needs and leaves us $800,000 to $900,000 that we could set aside in our flexibility bucket. Now, how much should we really be setting aside in this flexibility bucket? And what other flexibility does that give us once we determine what that number is? Well, they ultimately chose that income solution to reduce the overall risk and just not worry about the paychecks coming in each and every month.

Going with that solution, we ended up with $500,000 in income, $50,000 there for emergencies. And then how much do we need to set aside for inflation? Well, they're drawing about $35,000 a year out. And that $35,000, they would like to have the option to have that adjusted for inflation.

Now, are they going to need inflation adjustments each and every year? Typically not. I know many of the families that I've worked with for 10, 15 years, they're taking the same amount of money out of their portfolio today as they were 10 or 15 years ago. Why is that? Well, there's something called the retirement spending smile and kind of how retirees typically spend over time.

And it looks a little bit like this. It's called a smile because this is a typical spending pattern that you'll see of a retiree where they spend about the same in those early years. And then they start spending a little bit less, maybe go down to one house or one car.

They're not eating out as much. They cancel the country club membership. And then it increases a little bit over time for things like healthcare and the back end of retirement.

But overall, a lot of the research shows us that most retirees will spend less over time, meaning they won't need those inflation adjustments each and every year. But we don't know what's going to happen. So we want the flexibility to adapt.

Now, if they want to increase that $35,000 by 3% each and every year, 3% of $35,000 is a little over $1,000 a year. So they want to increase their income by $1,000 a year. Their social securities already has a COLA attached to it, a cost of living adjustment.

So we're really only talking about that $35,000, increasing it by about $1,000 a year, a little bit more than that each and every year. So if we took $100,000 and set it aside in inflation of protected assets, they said that would be more than enough to cover our inflation needs. Because $1,000 of $100,000, that's only 1%.

We know that we can continue to take as much income as we need to adjust for our inflation over time with $100,000, more than enough. And then we said, how much excess would you like to set aside for the unknown, just to have some adaptability? So they landed on a number of $200,000, leaving us now, we have $50,000 for emergencies, $500,000 for income, $300,000 for flexibility, left us with $550,000. Where is that money going to go? We said, are you going to spend this $550,000? They said, we're probably never going to spend it.

Now for you, maybe that number is higher, maybe it's lower. Maybe you decide you want more income at this standpoint. Many times what we find is once we go through this process, a retiree will say, you know what? I want to spend a little bit more money.

So we shift a distribution because we're going to do a one-off vacation with the kids. We just find that we may adjust our thinking after we go through this process. And then we still deal with what's left over.

Maybe they want to set that aside and say, you know what? We're never going to spend it. It's actually going to be paid into our estate. So we want to find the most efficient tool to leave those assets to the kids.

Well, life insurance was created for that very reason, to pay out tax-free upon death. So maybe they want to establish a life insurance policy and start converting some of those IRA dollars over to a tax-free death benefit for the kids. Maybe they want to fill in a different gap in their plan, which is long-term care needs and use portions of these dollars to fund a long-term care policy.

Maybe they decide they're not big fans of insurance and they just want to start converting those dollars over to a Roth IRA that they can leave to the kids, where the kids won't have to take taxable distributions. They will receive those dollars on a tax-free basis. But those are the kinds of decisions that you have the freedom to make once you go through that four-step process.

Go through those four steps, and then we can start filling in the gaps, including your tax strategy. Now, if you'd like to go through this process and create a customized, personalized financial plan for yourself, schedule an opportunity to visit with one of our financial planners for a personal financial review at no cost by simply calling the number on your screen, and we'll meet with you virtually, no matter where you find yourself in the United States.