TRANSCRIPT:
Welcome back to Financial Foundations, brought to you by Base Wealth Management, where we are the foundation to your financial plan. I’m your host, Dustin Taylor. I’m your co-host, Alex Wolfe, Certified Financial Planner. And I’m Kyle Howell, Financial Advisor at Base Wealth Management. Today we’re diving into a fundamental question. How do you know when you can retire? It’s not as straightforward as it seems, but today we have Alex and Kyle back to help us with this question. Alex, let’s start with the basics. How does one determine when they can retire? It’s a loaded question and it’s different for everyone because everyone is different. We don’t all work the same job. We don’t all spend the same money or live the same lifestyle. So there’s many different inputs that can determine when you’re ready to retire. You may never be ready and it may not even be a financial reason. It might be you just don’t, that’s not the right lifestyle for you or you just have a job you really like or it’s really fulfilling reasons why you may or may not be ready.
Before we dive in further, let’s unpack this a little bit. I want to talk about a phrase that I hear all the time, and that is that it’s better to retire to something rather than from something. Kyle, can you explain that a bit? All right. So yeah, I’ve, I’ve had a similar question to clients and I, and I asked them, I said, what does a typical day look like for you? When you, when you do retire and, you know, I get all kinds of answers and I, you know, just specifically, oh, we want to go travel, we want to go spend time at the beach with our feet in the water, I want to, you know, go spend time with my grandkids. I want to be on a cruise ship, you know, at least once a month. I don’t want to quit working. I want to go do something else. I want to stay busy. I want to go fishing, there’s all kinds of things that you can retire to, not necessarily retiring from, you know, a career at one company or something like that. I agree. And that can be some of our questions that we ask clients when putting together the financial plan, it can be difficult for us and the client when they don’t know what they want to do. One, it, it’s difficult for us to like put a spending number on, like what kind of type of income are they going to need?
When they don’t know and they, and they don’t know how they’re going to fill their time and one, it can be deteriorating mentally for your health. If you don’t have anything to do, right. And then two is from a spending standpoint, you have too many people that are afraid of leaving that paycheck life and have to start spending to create that income. They’ve, they’ve got, you know, their, their assets. They’ve, they’ve got to create an income from, but they’re afraid to do it. Right, because it’s foreign. They’ve never drawn money from an IRA or 401k. They’ve gone from saving and putting money into the account to now having to pull money out of the account and it scares a lot of people. So it’s important to know what you’re going to do in retirement.
What if you were, I don’t know, maybe you’re financially ready and you’re not emotionally ready, do you ever recommend that people maybe take a practice retirement?
They go to work from full-time to part-time. Sure, yeah. I mean, the first thing that you can kind of educate them or counsel them on is, well, what do you find fulfilling? What do you find fun? What have you always wanted to do? It could be reducing your hours to try to find that hobby that you’ve always wanted to do or find yourself. I don’t know. I mean, it definitely is a big part of thing where if you’re working 40, 50, 60 hours a week for 40 years that you didn’t really have time to discover activities that you enjoyed outside of work, maybe outside your family time or spending time with your kids or grandkids. So yeah, use up that PTO, you know, get it, take it with you. The reason why I bring this topic up and I ask this question is because I think that the way that the industry is built is not only is there the wealth management aspect of everything, but people are more and more becoming reliant on advisors and planners to kind of be like wealth coaches and find out, you know, what they want to do when they retire, whether that’s running that by you and seeing like, can they afford that lifestyle?
Can they afford to do that hobby or whatever? And advisors are going to be way more involved in that now and in the future, I believe. I agree. I think that’s a big part of the picture for that classic retirement planning client that we work with. Whether they’re, you know, a year from retirement or five years, those are definitely things that we talk to clients about before they ring that bell or decide to wind down. So bringing it back to the financial side of things, what are some of the key aspects we should consider when determining if we can retire?
One of the biggest things, as Kyle mentioned, is income. And how are you replacing that job or salary paycheck? And what can your portfolio sustain? And for some people, they might have more income than they need if they have a pension, they’ve got RMDs or other sources of guaranteed income and annuity or something like that, where they’re totally set. They almost have like 100% income replacement. But for others, that is not common, where they actually need an income strategy or plan for how to withdraw money from their accounts. They’re gonna have taxable accounts, retirement accounts, maybe some Roth IRAs, and you wanna construct their income to keep them in a low tax bracket as possible, which helps when you’ve got multiple sources of accounts and different taxability of those accounts, and then what they can sustain. And we use software and programs to show them based on the assets that they’ve saved in each of those buckets and how their assets are invested. The investment side of things is a big piece of the puzzle.
What can they sustainably live off of, especially as people are living longer and longer due to many factors in healthcare, and we can show them what type of income we can generate from their portfolio and how to take it in a tax-efficient manner. And I would add to that, we always talk in these podcasts about having multiple buckets or multiple types of accounts, whether it be IRAs, Roth IRAs, taxable accounts, non-qualified accounts, whatever. But we run into a lot of people that have the majority of their money in their 401k plan. That’s the most common, right?
Or they’ve moved it into an IRA and they’ve got a million dollar IRA, but they don’t have a Roth and they don’t have a taxable or a trust account. And that makes the earlier planning that much better to where we can start generating income from different streams. So just say a teacher, for example, has put money into their 457 plan and they have a pension and they have social security, nine times out of 10, they’re going to have more income in retirement than they did when they were working. And now we have to factor in a retirement account on top of a pension and social security, which is going to then increase their income higher than it was while they were working. So now we’ve got a lot of different planning aspects that we need to get in front of before retirement.
So trying to get a little bit more specific, what would a sustainable withdrawal rate look like, or what might it look like?
Well, I mean, the old rule is that 4% rule that most people have probably heard of. Um, and we’ve talked about a few times on the podcast when the 4% rule was established or originally drawn up. And you’re looking at like a 60, 40 portfolio, 60% stock, 40% bonds. Those midterm bonds were like a 12 to 15% interest rate, which great at a time, but that is just not the world we live in these days when we talk about the average returns of different asset classes, they’re much different now than they were back then. So that’s why I don’t, you know, live and die by that 4% rule. You want to have some flexibility or if the market goes up, you can take a little bit more. But also if the market goes down, you may have to take a little bit less.
So you want to be flexible and not just live but die by that 4% or what do you think Kyle?
I tend to in the past when I’ve built my own portfolios tend to create as much a dividend income as possible whether that’s you know 4 or 5 percent you know these days that 4 to 5 percent we can do we can do that very easily in the in the environment that we’re in right now we don’t have to worry about potentially running out of money at that 4 to 5 percent interest rate but when rates 10 years ago were 2 and 3 percent that 4 percent rule was very tough to follow so again being flexible and making sure that you can withstand the ups and downs of the market if you don’t have those guaranteed you know income streams whether it’s pensions or annuities yeah you got to have that flexibility you got to be able to withstand those storms so to summarize the 4% rules benchmark, but there are other approaches out there such as the guard rails approach, which we’ve, we’ve touched on before. And that it just allows for more dynamic withdrawal strategy. What about projecting future financial needs? How can retirees plan for the future?
The biggest thing that we utilize is our planning software and Monte Carlo simulations to show clients what their essential like future income needs are when factoring in inflation and their rate of return of their assets that they have in the software, there’s also things that you can show clients or demonstrate. If the tax cuts and job acts sunsets, like it, it may here in the little over a year and a half in the planning software, you can show them what like an increased rate of inflation does to their portfolio, which is something we recently had to introduce a higher inflation rate in a financial plan where the last 20 years we were using 2%, which more than covered what we were averaging during that time period. But as we all know, inflation as of the last two years was much higher than 2%. We are obviously working on getting it back down, but we bumped up the average inflation for retirees over the next 20 years to 2.5.
And I cannot state enough how big of an impact that had on people’s probability by increasing it a half a percentage for 20 years, it dropped some people’s probability of success by 10%, which is astounding. So it is very critical that the government works on getting inflation back down and we don’t have stagflation because that will be detrimental to many retirees who are on like a fixed income or they’re withdrawing from their portfolio. So how do market fluctuations affect retirement planning?
The biggest one is sequence of returns. So we’ve talked about this on previous podcasts as well. If you retire at a point in time where the market is starting to go down versus you retire in a down market as the market’s starting to go up, you’re gonna have two completely different scenarios by the time you’re 80, 85, 90 years old. The person that’s retiring in a peak market where it’s about to start to go down is more than likely going to run out of money versus somebody that’s retiring into a market that’s about to start going up again. And that’s the sequence of returns. So you have two completely different scenarios based off the same retirement age and the same life expectancy. Yeah, so in that example, if person one is retiring and the market drops 20%, and they’re withdrawing 5% that year off of a portfolio that’s worth 20% less than person two when they retire, the market’s up 20%, wildly different outcomes.
So that sounds complex, but the Monte Carlo analysis that you mentioned earlier can kind of account for these fluctuations, right? Yeah. So in the Monte Carlo simulation in the planning software, you can show clients how their portfolio would have reacted during certain time periods of the market. Show them what it would have been like to retire with their assets right before 08, or right before 2001. And a lot of it is easing the pressure. They can say, okay, no problem. You can handle that. Or they can say, I can’t stomach that. And that might trigger you to say, well, we might need to adjust your portfolio based off of your risk tolerance, or we might need to work a little bit longer. Yeah, unfortunately.
Monte Carlo analysis is pretty comprehensive. Is it enough on its own? It is, but it isn’t. You know, if you see someone who’s got a 99% probability of success in the Monte Carlo, you’re like, either we’re not capturing everything or you need to adjust your lifestyle. Maybe you’re not spending enough. Or if it’s really low, say it’s 50%, that might trigger us to say, okay, what can we do to boost your probability? But at the end of the day, we want to make sure that they’re able to maintain the quality of life that they have while working green retirement. So it’s just one of our tools we use.
So in summary, what do retirees need to focus on to ensure that they can retire comfortably?
The biggest thing is knowing your goal and then starting to kind of fill in behind it with how much income you’re going to need. How much income can your portfolio support? Working with a financial advisor or financial planner, that can help with these scenarios, because everything is getting more complex in the world we live in. There’s tax considerations, there’s income considerations, insurance, all these items that go into a financial plan and continue to run those Monte Carlo simulations to understand, like, if we need to make adjustments based off of increased inflation, or did my portfolio go down 20% this last year, like in 2022, there may be things to consider now that you want to plan for in the future.
In one of Kyle’s examples, he talked about that teacher, and the more time you give your advisor or planner notice, the more solid your plan will be. And I was getting ready to say that, you know, we definitely need time. This is not something that you can come to me and say in six months, hey, I’m willing to retire six months from now. No, we need, you know, typically we need a few years to start making adjustments, preferably 10 years. I would love to see somebody in their early to mid fifties come into me versus somebody that’s in their early sixties saying, I’m ready to retire now.
What can we do? You know, so having that longer term plan is, is best. So definitely, you know, seek, if you don’t already have somebody, seek somebody out while you’re in your late forties, early fifties, and start putting a plan together. Not to be cliche, but you don’t build your house overnight. It takes, not years, it takes a while to build the foundation and put it together to kind of get your dream house ready to live in. All right, great.
So if you would like any more information about this topic and more, you can visit our website at basewealthmanagement.com. You can subscribe to this podcast or YouTube channel. We also love questions. So if you have anything you’d like us to answer or address on the podcast, send those into us at question@basewealth management.com.
I’m Dustin Taylor, I’m Alex Wolfe, and I’m Kyle Howell, and happy listening.
