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.
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.
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.
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.
If you’d like to find out more about your own path to retirement, then sign up for our newsletter and score our free ebook! The guide can help you determine your own path to a successful retirement.
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!
MK recently released a new book, The Infinite Infinite. If you are looking for a fun mystery adventure, then check it out!