The Three Questions of Retirement
If you prefer to listen while you are on the road, click below!
Zach – Everyone Zach Holcomb here with Michael Reese certified financial planner. For this week’s blog, we’re going to be talking about the three questions that you need to answer in retirement. So let’s just jump right into it. Mike what are these three questions.
Michael – Oh, by the way, a great. I think it’s a great topic for today because you know retirement planning certainly different, isn’t it. When you are working there are three questions that you’re trying to answer as well, by the way. So before we get into retirement, let’s talk a little bit about the questions you asked when you’re working and usually those questions are about your investments. You know, for example, question number one when you’re working, how much should you be saving. Zach how much should you be saving you are, what are you 20 something right. I mean, how old are you?
Zach – Twenty six I’m shooting for at least 10%
Michael – Okay 26 and you say, I’m saving 10% that’s fantastic. And if you do so inside of our 401K, then you get my match. And so you’re closer to 14 right that’s fantastic. So, how much should you save is question number one. Question number two. Once you’ve identified the answer to question number one, now, how do you allocate those funds, like how do you invest the money? So you know, in your case, you’re probably allocating pretty aggressively I imagine, right, because you’re pretty young. You have a long time horizon and I don’t know, I would tell you that as I look back I, I remember when I was your age, and I was doing a good job, saving as well. But man, it’s amazing how those little bits really add up over time, and that compounding works right. So question one: How much, question two: How to invest it, Question three. Is when you’re getting closer to retirement. You’re asking the question, How do I know when I have enough money to retire. Right, so that’s, that’s what we’re trying to answer when we’re working. Retirement on the other hand, is a very different. It’s a very different thing. We’re not adding money anymore. What we saved is all we have, we’ve got to make it last. I remember when my father retired, he said to me. I want you to protect my principal, give me some income and if you can grow it a little bit. So those are different things, right. So there are three questions that we need to answer. When you are retired to have that Successful Retirement they and they all revolve around first number one income. How are you going to generate stable and predictable income that will last your lifetime. Second is all about taxation, particularly on things like 401 K’s and 403 B’s and IRAS, and what are you going to do about the taxation on those accounts because it can be a lot worse than you think. And then third is protection and that is how are you going to protect all, I mean, you’ve worked your whole life to build up this nest egg, How are you going to protect it from things like health care expenses, market losses, and inflation perhaps down the road. So we call that the
HIT list healthcare, inflation, turbulence in the markets. So those are big three questions that we need to answer in retirement.
Zach- Right. And Mike that first question about, you know, generating income in retirement. That is so important because as you know when you retire, you’re essentially becoming self employed. If you aren’t, if you’ve already didn’t work, you know, by yourself. So you have to generate a paycheck.
Michael – Yeah, you’re right. It’s like if you think about it, I’ve heard it said, and I know I’ve said this myself. Retirement is like if you think about it, 20 to 30 years of unemployment.
Zach – It’s long time
Michael – Yeah 20 to 30 years of unemployment. That’s like your whole life. Anyway, I mean, if you think about it. Let’s say you retire in your 60s. You could live into your 80s or 90s, very common these days. That’s a long time that you need your money to last and, you know, one of the questions that we get all the time. Zach is, you know, is Well gosh I know how to save money. Right. What I don’t know how to do is use my funds to generate lifetime income. And we always get people asking questions like, well, how much can I spend and at the same time still have my money last. That’s always a big question. You know, how much can I spend, but still not run out of money. We get a lot of folks who who tell us that they want to live that retirement of their dreams and if you want to live the retirement of your dreams, obviously, that’s probably going to require some cash flow right you need that income coming in. How do you structure your account so that that income last as long as you do. That’s question number one. When it comes to your retirement planning. Right. And that’s an important question because you know in real estate. I like to joke about this. Now I know we’ve talked about this Zach. So, here you go. If you’re investing in real estate, there are three words that determine the success or failure of your real estate investing. What are those three words?
Zach – As you’ve told me before, and I know it’s they’re all the same. It’s the same every time. Is it security? Location, location, location.
Michael – Yes, location, location, location. Meaning that you can buy a horribly ugly junkyard, but if it’s in the right location, you’re probably going to make out like a bandit, right, whereas you could buy the most beautiful piece of property there was, that there ever is going to be. But if it’s in the wrong location. You’re going to really struggle to make money on it. Well, when it comes to retirement planning instead of location, location, location success in retirement is really all about. income, income, income. And really when you think about it, you’re trying to answer questions like this. When are your retirement paychecks going to start. What source are you going to take those paychecks from and when I say what. Now when is pretty obvious. But what source, what are we talking about there. Social Security would represent a source of income, a pension would represent a source of income. Your retirement savings, you know, maybe you have an IRA maybe 401K maybe have a Roth. Maybe you have after tax accounts just regular investment accounts. What source. When are you going to pull from those different accounts and why. What about some people, Zach. I know we talked to them. They have rental income right they have some people have those oil and gas royalties. Those are always fun Sometimes people have deferred comp plans, they have. What else have I seen out there. They have they’re working part time. Right. Maybe they’re working part time in retirement. Their consulting, you know, whatever it is they’re all these different potential sources of income when you’re going to turn each source on, how much are you going to pull from each source. How long do you want each source to last and, you know, how do you kind of combine them all. So that you get the most income for the longest time
Zach – Right, and I think another important question to is How secure are those sources, because if you’re going to be relying on those streams of income, they need to be secure.
Michael – Yeah, it’s a very good observation. So for example, we know I know in the media. The media wants you to think that Social Security is in big trouble. You know what, that’s kind of Unrealistic because, you know, politicians. Job number one for politicians to get reelected. They know that people over the age of 55 vote. They know that if your Social Security gets cut when they’re in office, they’re going to get booted from office. So I think that it’s not realistic to be worried about your social security. That’s going to be pretty stable. Pensions very stable. What about rental income is that stable.
Zach – It depends, you know, that’s a difficult question to answer because that that’s different for everybody. In some cases, it really might be, you know, if you have a tenant that’s in your rental home for, you know, just, year after year after year. That could be considered secure income. But what if that person loses their job. What if they can’t make those rental payments anymore. What if we’re in a recession. I mean those payments could stop overnight. Those are things that you have to account for.
Michael – Yeah, it’s an interesting topic of conversation here because, you know, if you think about rental income. When times are good. It’s usually flowing really consistently. good, it’s usually flowing really consistently. I remember though back in 2000 and 2001 during the .com crash and 9/11, suddenly those rental checks weren’t coming in very consistently. 2008 oh my goodness, people who were invested in real estate they were just hurting so badly 2008. I had clients. I remember this, client where they had sold their business. And so a big chunk of their income in retirement, was a combination of the payments on that business and they owned the building that business was in, and so the rent payments. So they were getting up pay out on the business plus rent. And both of those payments stopped like that like overnight. In fact, the person they sold the business to went bankrupt. And so suddenly this couple who were retired, they thought they were in great shape because of all this rental income and business income. They thought they’re in great shape and then bang suddenly it was gone, because the economy decided not to cooperate. or the or the person who own the business didn’t do a good job keeping it in business. So there’s certainly a risk. So the, I think that’s one of those things though Zach that everybody has to really consider for themselves, right, they have to think for themselves. Are they comfortable with the security of that income source or not. Now what about gas royalties. Oil and gas royalties, how stable are those
Zach – They’re great until they run out.
Michael – All over the place. All over the place, what and then there are other sources of income but generally speaking, there are only three, just three, guaranteed sources of retirement income. There only three sources that you can consider to be stable, predictable guaranteed. Those three sources of course are social security, pensions, and then annuities. Now, whenever I use that word annuity, sometimes people, you know, some, some people love that word, some people hate that word.
Zach – Hands go up for lot of people too.
Michael – Hard to say I’m, you know, I’m going to share that I’m very neutral. I’m more of a, you know, the question is if you want your income in retirement as stable as possible, you want, then you’re going to want to have as much of your income needs filled with Social Security, pension, and annuity. I mean, it’s really that simple. Alright, so let’s, let’s go on. So I think that covers income, you know, stable and predictable income that last your lifetime. How are you going to make that happen. That is, first and foremost, question number one. If you can get that covered, you are over halfway completed to a secure and stable retirement. So question number two, Zach, let’s let’s keep moving on.
Zach – How do we manage taxes in retirement. And this is a huge Question.
Michael – Yeah, it is because I see taxes. Being particularly impactful when it comes to retirement plans. Right. So think about your retirement plans. Think about a 401k, a 403b, a 457 in fact anything that starts with four. And those, by the way, in case you wonder where do those you know where those names come from. It really 401K simply, is it corresponds to Internal Revenue Code 401, and then Section K Right, just like there’s a 401 section A. 457 is Internal Revenue Code 457. So, in any event, these are just Internal Revenue codes. Or you might have an IRA traditional. You might have a simple IRA, a SEP IRA, you might have one of those pension plans where when you retire, they give you a lump sum option. When they give you that lump sum. It’s going into an IRA. So these are, All of these types of things are what are called pre tax. And what that means is when money goes in, you don’t pay any tax. It’s like you get a tax deduction when money goes in, which is really kind of cool.
Zach – Yeah, sounds great.
Michael – Yeah, as the money grows You don’t pay any tax on the growth so Zach when do you pay tax?
Zach – When it’s time to take that money out
Michael – Yeah, you paid at the end. And and so the argument that is made, like if you’ve ever been to a 401k meeting, here’s what they say that you know the the 401k representative comes in and you know everybody’s sitting around the conference table and the 401k represent says, Okay, here’s the deal. These plans are the coolest thing since sliced bread, you want to save money today, save on your taxes today because let’s be honest, you’re working, you’re in a higher tax bracket. Pay your taxes later when you’re retired, that’s when you’re going to be in a lower tax bracket so save tax today pay tax tomorrow. Now doesn’t that sound to you like a pretty reasonable approach.
Zach – Yeah, absolutely.
Michael – And it does on the surface. Historically, by the way, that’s also the only option we had in 401 k’s. Now, today, we have a Roth option in a lot of 401 K’s and 403 B’s and that’s where you pay tax today. But then it’s tax free from that point forevermore. In other words, you pay tax on your income today. You don’t say the tax today but you pay tax later. So it’s kind of like this. Here’s the difference between them. Imagine you’re a farmer and every year, you have the choice. Do you want to pay tax on the seed that you plant or the harvest That you reap. So you want to pay tax on the seed, the investment upfront, or do you want to pay tax on the ultimate harvest that you bring in. Which would you rather pay tax on Zach.
Zach – Obviously the seed.
Michael – Why?
Zach – Because I want to keep my harvest
Michael – Yeah, I mean, let’s. But what if the tax on the seed were a higher rate, would you still want to pay tax on the seed?
Zach – Yes, because I mean stuffing money in these accounts for 30, 40 years. The harvest is going to be much more significant. I don’t want to pay tax on a million dollars potentially.
Michael – See, this is exactly the point. In many cases, what happens and you really hit the nail on the head. The harvest is so huge. Right, that even if it’s a lower tax. It’s on such a much larger pot of money that you end up paying way more tax. So this, this idea of save taxes today when you’re in your higher tax bracket, pay them later down the road when you’re in a lower tax bracket. We have from my perspective, I see three challenges with that. Challenge number one you’ve just said it’s like okay, wait a minute, but the money I’m depositing today compared to the harvest is such a it’s such a tiny amount of money. Even if I do have to pay a little bit higher tax rate its overall, it’s still a lot less tax then later on. So that’s problem number one. Problem number two is what makes you think taxes in the future are going to be lower. I mean, yeah, anything if you pay any attention. I mean, go to US debt clock.org. That’s a great website, it tells you what our national debt is it tells you, and how much that works out for each citizen in the country.
Zach – Lot of red on that website.
Michael – Oh my god, a lot of red. It tells you, like, how far in the hole social security and Medicare are. You know, the reality is taxes down the road are not going to be lower. They’re going to be higher. And here’s a news flash. It’s not going to be just on the wealthy. It’s going to be on everybody. So basically when your 401K person says, save tax today pay tax later. Really, do you really want to pay tax later in an unknown future when tax rates are likely going to be much higher than they are today.
Zach – Absolutely not.
Michael – I don’t think that’s a smart bet. And then here’s the third and the really the biggest challenge with all of this line of thinking. You work your whole life and you save money. So that someday you can reach the point of financial independence. So someday someday you can enjoy the retirement of your dreams. What is the retirement of your dreams look like. Is it a retirement where you sit around the house and watch TV game show network all day long, or Home and Garden TV. Is that your dream retirement. Or is your dream retirement maybe spending time with the grandchildren taking them to Disney, traveling with, seeing the world going to dinner with friends and, you know, hey, taking a trip to Napa, maybe with your friends to wine country. Isn’t that what you really want to do in retirement.
Zach – Absolutely.
Michael – But there’s one common thread with all the cool stuff that you want to do in retirement. What is that common thread.
Zach – I got to have income to do those things.
Michael – Yeah, it all costs money. Right.
Zach – Mm hmm.
Michael – If it all costs money. You got to have cash flow. And like you said you’ve got to have income. So let me ask you this, Zach. I mean, you’ve talked, you’ve spoken to hundreds of people over the years already. I’ve spoken to thousands. What percentage of the people you talk to there. There is a percentage. But what percentage of people say, yep, I am perfectly comfortable retiring to a significantly lower standard of living than what I’m living right now.
Zach – Probably about less than 1%
Michael – Yeah, see, you’re, you’re being nice, I mean it’s, I’ll bet it’s less than 10 yeah right. 90% of people say no, I don’t want to retire to a lower standard of living. I mean, if I’m going to retire to lower standard of living. I’m just going to keep working until I can retire to the same standard of living.
Zach – Right.
Michael – And a lot of times people say, oh, but no, no. Mike, you’re forgetting.
Maybe the House will be paid for. A lot of people don’t have their house
paid for in retirement these days. But even if it is Hey, great the house is paid for, but what do you have to pay that maybe you didn’t have to pay. A lot of health care expenses, travel expenses right. You don’t have deductions anymore. Your kids are grown. If the mortgage is paid off, you don’t have mortgage deduction. Here’s reality. Reality is, if you want to live at the same standard of living after you retire. Don’t you kind of need about the same kind of income. Need about same kind of income aren’t you kind of paying the same amount of tax.
Zach – Yep.
Michael – So exactly how do you retire to this lower tax bracket. Very few people retire to a much lower tax bracket in retirement. That’s not reality. If you’re retiring to a lower tax bracket, you probably failed with your retirement planning.
Zach – Right. And a lot of people have the perception that taxes are going to be lower in retirement, and obviously that’s not the case.
Michael – It just hardly ever happens and then. Holy cow. Nowadays required distributions that now starts at age 72 used to be 70 and a half. Whoo. We got a year and a half, break on that. But man, you start getting your late 70s and into your 80s, for a lot of people, those required distributions are so large. That they just, I mean you’re forced to pull so much more money than you ever wanted to withdraw. It’s unbelievable, the tax bracket that puts you into which also increases your Medicare premiums and all kinds of other stuff. This is why it is vitally important that every single year you’re sitting down with either your financial advisor, that’s ideal, a tax advisor is ok. But you need to be sitting down with your financial team to help you figure out all right how much of my money that’s in these pre tax accounts, how much can I move into tax free accounts like Roth IRAs, each year. How much can I move into, you know, specially designed life insurance, perhaps each year, you know, how do I take advantage each year of you know what the tax code is offering me. So that I can you know, maybe, maybe have the tax code work for me versus me working for the tax code, if you will. Right. So that’s what, that’s question number two is how do you master and manage the tax code because ultimately the goal is what? You want to get to what we call the zero tax protocol, which means when you’re retired, we want to get you, if at all possible to the point where you are legally legitimately in that zero percent tax bracket and it’s possible. I mean, I’ve got clients that are making over, they’ve got over 100 grand a year of income And they are legally paying zero income tax and that income because of the planning, we’ve done right.
Zach – That is awesome.
Michael – So that’s question two. All right, I think it’s time to move on to question three right
Zach – Question three. And we’ve kind of briefly touched on this, but really just sum it up. Question number three is how do I protect My money in retirement.
Michael – Yeah. And we talked about the HIT list right. Healthcare expenses, inflation, and turbulence in the markets. So what I’ll do is I’ll just cover this one healthcare. Look, if you’re on Medicare, you’re probably in pretty good shape. But watch out sometimes I’ve seen people have some you know, some health conditions where they require medication that’s pretty expensive. And so if you’ve got something like that that’s maybe not covered by Medicare your part D program. That could be a challenge, long term cares big issue here, right, if one, if you’re married the big risk is one of you need long term care and you’re leaving the surviving spouse with, you know, cause you blow through all your savings little to nothing. you know, after you’re gone. We see folks, these days, you know, long term care insurance. It just doesn’t really make sense anymore. We see a lot of clients these days, looking at using certain types of life insurance plans to cover some of that risk and you want to be sensible about it. Right. Anytime you talk about insurance. You don’t want to over insure yourself right but be sensible. Inflation, I think that’s going to be an issue down the road. The Fed has come out and they’ve said, and Zach we saw this, what was it just the other day that the Fed came out and they said look far as we’re concerned, inflation is not a problem. We’re going to keep interest rates low and in fact. We’re even going to promote some inflation out there which kind of weird. So expect that to be an issue later on turbulence in the markets. So that’s the big thing. We still have to watch out for. And really what’s key here is the question to ask yourself is simply this. What mechanism do you have in place to protect yourself from those big double digit losses in the markets, when they occur.
Zach – Right.
Michael – You know markets, you know, here’s the thing I’ve learned over 25 years if you can keep your losses to less than 10%. So if you can in bad market years if you can lose something less than 10% You’re probably going to be fine. You’re probably going to be in great shape. It’s when you’re losing 15, 20, 25, 30% in retirement. That’s when you get hammered. And that’s when you get to a point where you can really run out of money really fast. That’s where you get into trouble. And so here’s some statistics for you that you might find helpful. Number one. About once a year markets lose about 10%. That’s really common. So don’t, markets lose 10%. Don’t be, you know, losing sleep, that kind of stuff happens. It’s about once a year, sometimes more. About once every three years markets lose about 20% Okay that’s on average every three to four years. That’s about 20%. Now think about this. If you lose 20% and you’re taking income that’s when you start getting in trouble, really fast. And then about once a decade, about once a decade, you’re seeing losses of 30, 40, 50% that’s where you go broke. If you’re not protected. So if you’re going to live a retirement of 20 to 30 years and you should be focused on the things that provide value in Retirement meaning fulfillment. Living the best years of your life. That means you shouldn’t have to be worried about your money. And so if the markets are going to lose 10% every one of those 20 to 30 years, not every year but, you know, pretty much. It shouldn’t bother you. It shouldn’t be a big issue. You should be you know you shouldn’t have enough money in the markets where you’re you know you’re worried about that anyway.
Zach – Right.
Michael – But you have to recognize that If you live 20, 30 years in retirement. And if markets lose 20% every three, four years, you’re going to have anywhere from five to 10 years where you’re going to see 20% losses. That’s where you got to make sure that you making smart choices with your investments, where you have mechanisms in place. To kind of say okay down 10 that’s about as far as we’re willing to go. And oh my goodness. If the markets are down 30, 40, 50% you absolutely cannot, cannot, cannot participate in that. Now Zach, what happened in March of this year.
Zach – We lost a lot in the markets.
Michael – Markets were down 30%, yeah 30% in four weeks. Right. 30% in four weeks. For a lot of you out there, now if your clients you saw, if your our clients you saw. Wow, I didn’t lose 30%. No because we have mechanisms in place to stop those losses when they’re going too far. But for a lot of you out there who lost you said, Holy cow. I lost 20%, 30% in March when the markets were crashing. That should tell you loud and clear. You got problems in your portfolio if, if you’re getting close to retirement or if you’re already retired. Now if you’re like, Zach, and your would you say you were 27 or something.
Zach – 26. Yeah.
Michael – If you’re 20, you look older because of the beard, maybe. But if you’re in your 20s, like Zach is or like my daughter is, who cares. In fact, markets dropping that’s a positive because it’s if your dollar cost averaging in that’s awesome.
Zach – Right.
Michael – But if you’re retired. If you’re nearing retirement. That’s not good, that can kill you. So if you’re in that kind of position and you saw that happen in your portfolio. That’s where I’d be picking up the phone given us a call because you know, that’s where maybe you’re not in the position that you should be as random retirement, maybe a risk review, maybe a retirement review meeting might make sense. You know, we do them for free. If you want that you can just give us a call 512-265-5000. You know, you got this video, this blog. Maybe you’re on our website, you can just go ahead and hit the contact us and send us an email, give us a call. Maybe this was emailed to you just say, hey, I want to talk to you guys. So let’s have a conversation, let’s see where we’re at. That’s free to do. You’re always welcome to do that. But there you go. That’s our three questions one income, two taxes, three protection. You’ve got to answer those questions, effectively, so that you can if you do that, then the odds are very high that you’re going to enjoy that incredible retirement that you always dreamed of. Zach anything that we need to talk about before we wrap up today?
Zach – I don’t think so. This is a great blog. Thanks for joining us and we are looking forward to next week.
Michael – Yeah, great conversation, you guys. Listen, we’ll let you go remember, as we sign off. Remember, retirement should be the best time of your life. Right, you deserve to enjoy that great retirement. So let’s make sure that together we’re making those smart financial planning decisions so that it supports the retirement that you’ve always dreamed of. All right, that’s it. I’m signing off. Take care. All right. Bye now.