Secure your financial future to create the retirement of your dreams.

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Economics & Finance Finance

How to Plan for the Perfect Retirement

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Dana Anspach
Sensible Money, LLC

Dana Anspach is a Certified Financial Planner, a Retirement

Management Advisor, and the founder and CEO of
Sensible Money, LLC, a registered investment advisory
firm that specializes in retirement income planning. She is
the author of Control Your Retirement Destiny: Achieving
Financial Security before the Big Transition and Social
Security Sense: A Guide to Claiming Benefits for Those
Age 60–70. Recognized for her commitment to education,
she has twice been named to the Investopedia 100, a list
of financial advisors who are considered to be making
significant contributions to financial literacy.

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 Dana Anspach
Sensible Money, LLC

D
D ana Anspach is a Certified Financial Planner, a Retirement
Management Advisor, and the founder and CEO of Sensible Money,
LLC, a registered investment advisory firm that specializes in retirement
income planning.

Professor Anspach has been practicing as a financial planner since 1995 and
writing as an expert on retirement-related topics since 2008. She was About.
com’s MoneyOver55 expert for eight years, and her writing on retirement
decisions can be found at The Balance. She has contributed content to
MarketWatch and U.S. News & World Report, and she is the author of Control
Your Retirement Destiny: Achieving Financial Security before the Big Transition
and Social Security Sense: A Guide to Claiming Benefits for Those Age 60–70.

Recognized for her commitment to education, Professor Anspach has twice

been named to the Investopedia 100, a list of financial advisors who are
considered to be making significant contributions to financial literacy. She
also serves on the Strategic Retirement Advisory Council for the Investments
& Wealth Institute, where she helps expand the reach of the Retirement
Management Advisor designation.

i
Table of Contents

INTRODUCTION

Professor Biography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i
Disclaimer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii
Course Scope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

LESSONS

1 How to Think like a Retirement Expert . . . . . . . . . . . . . . . . 3

2 How Much Money Do You Need to Retire? . . . . . . . . . . . . . 10
3 Five Ways That Retirees Run Out of Money . . . . . . . . . . . . 20
4 How to Start Saving for Retirement . . . . . . . . . . . . . . . . . 29
5 Mid-Career Financial Strategies . . . . . . . . . . . . . . . . . . . 38
6 Investing for Safety, Income, and Growth . . . . . . . . . . . . . . 47
7 The Five-Year Countdown to Retirement . . . . . . . . . . . . . . 56
8 How to Make Your Retirement Savings Last . . . . . . . . . . . . 65
9 Planning the Go-Go Years in Retirement . . . . . . . . . . . . . . 73
10 Financial Strategies for the Slow-Go Years . . . . . . . . . . . . . . 82
11 Social Security, Medicare, and Tax Strategy . . . . . . . . . . . . . 90
12 10 Questions to Answer Before You Retire . . . . . . . . . . . . . 99

SUPPLEMENTARY MATERIAL

Quiz . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112
Image Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116

ii
 Disclaimer

The financial information provided in these lectures is for informational

purposes only and not for the purpose of providing specific financial advice.
Financial investing carries an inherent risk that you will lose part or all of
your investment. Investors must independently and thoroughly research
and analyze each and every investment prior to investing. The consequences
of such risk may involve but are not limited to federal/state/municipal tax
liabilities, loss of all or part of the investment capital, loss of interest, contract
liability to third parties, and other risks not specifically listed herein. Use
of these lectures does not create any financial advisor relationship with The
Teaching Company or its lecturers, and neither The Teaching Company
nor the lecturer is responsible for your use of this educational material or
its consequences. Please contact a financial professional to obtain advice
with respect to any specific financial investing questions. The opinions and
positions provided in these lectures reflect the opinions and positions of the
relevant lecturer and do not necessarily reflect the opinions or positions of
The Teaching Company or its affiliates. Pursuant to IRS Circular 230, any
tax advice provided in these lectures may not be used to avoid tax penalties or
to promote, market, or recommend any matter therein.

The Teaching Company expressly DISCLAIMS LIABILITY

for any DIRECT, INDIRECT, INCIDENTAL, SPECIAL, OR
CONSEQUENTIAL DAMAGES OR LOST PROFITS that result directly
or indirectly from the use of these lectures. In states that do not allow some or
all of the above limitations of liability, liability shall be limited to the greatest
extent allowed by law.

iii
iv
 HOW TO PLAN FOR THE
PERFECT RETIREMENT

N o matter where you are in your life, it is imperative that you plan for—
and continually reassess—your retirement. Without the advice of a
trusted expert, however, wrong decisions or misguided planning can have dire
consequences for not just your future, but that of your spouse, your children,
and your grandchildren.

This course offers a comprehensive roadmap to a happy and financially secure

retirement. Lessons proceed sequentially based on your life phase, so whether you
are just starting out, mid-career, about to retire, or several years into your retirement
journey, you’ll find advice that can help you prepare for what lies ahead.

This course will help you answer many questions, including these: How do
you determine where to live? How do you invest before and after retirement?
What kind of health insurance do you need? When should you take money
out of an IRA? And perhaps most notable are the intangible factors to
consider: How do you mentally prepare for retirement? How do you find the
activities to make retirement both fulfilling and enjoyable?

While it can be tempting to rely on rules of thumb to plan for your future,
this course will teach you how to calculate your specific needs throughout
your retirement years by creating a schedule of income and expense timelines.
These timelines can be developed into a personal financial model that shows
you where your retirement income will come from each year and what you
will spend it on. It helps illustrate how long your money will last. To make
this model, you’ll learn how to develop realistic inputs about the rate of
inflation, expected expenses, and estimated rates of return.

This course also covers the key risks to prepare for, including the top concern
of almost every retiree: running out of money. People run out of money
because they neglect to plan adequately for retirement risks. When you do
prepare for these risks, you will have an action plan that helps you navigate
your way through uncertain times.

1
One risk all investors face is the sequence-of-returns risk, which addresses
how the timing of withdrawals from a retirement account can reduce the
overall rate of return. For instance, if you retire during a recession or financial
markets decline, the reality is you’ll be living off more of your principal than
you would be if you could let it grow in a rising market. This course will cover
specific strategies that can help you prepare for this risk.

Goals and objectives also shift as you get closer to retirement. During your
younger years, you will typically want to consider an approach that gives you
the potential for higher returns. But as you near retirement, your primary goal
becomes generating a reliable outcome, as you need a retirement paycheck that
lasts. Often, that requires a different way of investing and a new way of thinking.

Those nearing retirement also need to pay particular attention to a 10-year

window called the retirement red zone. The first five years are the ones
leading up to—and including—the transition into retirement, followed by
the first five years of retirement. You will make a series of important and
often-permanent decisions during this time, and the stakes are high.

This course will also serve as an educational primer about several retirement
essentials, such as Medicare, the federal health insurance coverage; Social
Security; and retirement income taxation.

The course will also offer several techniques you can use to develop a
retirement savings–withdrawal plan, which is a mathematically tested concept
that helps you calculate how much you can withdraw without putting yourself
at risk of running out of money.

The lessons use case studies that illustrate the decisions that must be made as
you plan for, transition into, and relax into your retirement years, including
a lesson that covers what life may look like in your later retirement years,
perhaps in your 70s and beyond.

This course provides an overall framework that helps you think about and
plan for your own retirement so that you can take your planning to the next
level, avoid the big mistakes, and feel confident knowing you’re making the
optimal decisions for you and your family.

2
 1
HOW TO
THINK LIKE A
RETIREMENT
EXPERT
I n this course, you’ll learn what you need to do to plan for a stable
retirement and how to avoid the big mistakes. You’ll also learn how to
figure out how much money you will need to retire. The goal is to find a
sustainable balance between living for today and saving for tomorrow.

INVESTING FOR INDIVIDUALS

● Have you heard of the 4% rule? It states that you can withdraw about 4%
of your savings a year, increase that withdrawal to keep up with inflation,
and reasonably expect to have your funds last for your lifetime. But this
rule only works sometimes. In this course, you’ll learn how to use it, when
it works, and when it doesn’t.

● Another rule of thumb you’ll learn If you save, your money

about is the 80% replacement rule. It will earn money for you.
states that you’ll need about 80% of
your preretirement income to maintain Would you rather have
a similar standard of living during $1 million right now
retirement. In practice, depending or a penny doubled
on your current income and savings every day for 30 days?
habits, this rule can be way off as Many people choose
a guide. $1 million. But a penny
doubled every day grows
● Rather than relying completely on rules to more than $5.3 million
of thumb, you’ll learn how to calculate in 30 days!
your specific needs throughout
retirement by creating a schedule of Nearly two-thirds of all
income and expense timelines. You can retirees say they regret
develop these timelines into a personal not saving more.
financial model and a set of realistic
assumptions for your retirement projections. The model will show you
where your retirement income will come from each year and what you will
spend it on. It helps illustrate how long your money will last. To make this
model, you will use inputs such as the rate of inflation, expected expenses,
and estimated rates of return.

4
 Lesson 1 How to Think like a Retirement Expert

● If you’re just starting out in your career—or starting over due to divorce,
financial hardship, or unemployment—there’s a lesson dedicated to how to
get started in retirement planning.

● There is one essential skill that you’ll need to master: the power of tracking
where your money goes. You can call it a budget or a spending plan.
Keeping track of your spending might sound restrictive, but it can be
liberating. It will keep you out of trouble for your entire financial life and
be invaluable as you near retirement.

● Boosting income is also important. So if you’re in mid-career, you’ll

discover how to invest in your strengths. Probably the best investment
you’ll ever make is in your career itself.

PLANNING FOR RETIREMENT RISKS

● The top concern of almost every retiree is running out of money. People
run out of money because they neglect to plan adequately for retirement
risks. When you do prepare for these risks, you will have an action plan
that helps you navigate your way through uncertain times.

● One risk that might surprise you is called longevity risk. People routinely
underestimate how long they are likely to live. This means their planning
horizons are often too short, and this puts people at risk of running out of
money. But there are specific strategies you can use that can help protect
your income well into your later years.

● Several risk mitigators are how and when to claim Social Security; how
to take your pension, if you have one; and whether you should consider
buying an insurance contract known as an annuity, which can provide
long-term fixed income.

● Another potential risk to your long-term financial well-being is inflation.

During peak inflation years in the United States, the average mortgage
rate was in the high teens. The thought of seeing your housing payment or
other expenses spiral upward during retirement is scary. However, inflation
affects each household differently, and you can customize your inflation
assumptions based on your household income and spending levels.

5
● Another risk to plan for in retirement can be described broadly as a
household shock. This might be cognitive decline setting in unexpectedly
early, or the loss of a spouse, or the financial strain imposed by an adult
child who needs help. A big market crash right before, or after, retirement
is yet another reality you must plan for. But there are steps you can take to
plan ahead for these risks.

● In addition, the sequence-of-returns risk addresses how the timing of

withdrawals from a retirement account can reduce the overall rate of
return. For instance, if you retire during a recession or if financial markets
decline, the reality is you’ll be living off more of your principal than you
would be if you could let it grow in a rising market.

● Of course, you won’t know ahead of time what market conditions will
be like during your first 15 years of retirement. You need to be willing
to make adjustments so that your cash flows last, no matter what the
economy brings. You plan for this by focusing on what you can control.

● You can control how you save and invest and how much risk you are
willing to take.

● During your younger years, you will typically want to consider an

approach that gives you the potential for higher returns. But as you near
retirement, your primary goal becomes generating a reliable outcome. You
want a retirement paycheck that lasts. Often, that requires a different way
of investing and a new way of thinking.

● For example, you don’t want to plan for retirement using average returns.
In other words, you shouldn’t base your retirement plans on the assumption
that average investment returns will continue indefinitely into the future.
Instead, you must be realistic and conservative in your planning.

● To develop realistic expectations, you’ll need a filter to sort through the

vast amount of information that’s out there. Investment professionals
can often spot scams and dangerous strategies because they know what
range of outcomes is most likely achievable. Novice investors may be more
susceptible to being talked into bad investments, particularly when a seller
frames something as having high returns with low risk. You’ll want to
develop your own filter to help avoid such fraud and scams.

6
 Lesson 1 How to Think like a Retirement Expert

● One thing you can do is ask these two questions before you invest: Can
I lose any money? Can I lose all my money? You’ll learn how to use these
questions when constructing a retirement-investment strategy.

THE RED ZONE AND THE THREE PHASES OF RETIREMENT

● Two entire lessons are devoted to a 10-year window known as the
retirement red zone. The first five years are the ones leading up to—and
including—the transition into retirement, followed by the first five years of
retirement. You will make a series of important decisions during this time,
and the stakes are high.

● When you begin the transition into retirement, you’ll encounter specific
questions, such as these: Should you consolidate retirement accounts?
When can you take 401(k) withdrawals? And when does it make sense to
begin taking Social Security?

● During the red zone years of retirement—those 10 key years—you will

navigate a whole set of age-related rules. For instance, you may know
that if you withdraw from a 401(k) before age 59 ½, in most cases a 10%
penalty tax applies in addition to income taxes. However, most people
don’t know that if you leave your employer during or after the year you
reach age 55 and leave your funds in the 401(k) plan, a special law allows
you to take a penalty-free withdrawal. This special rule begins at age 50
for public-safety employees, including firefighters, police, and emergency
medical responders.

● To be ready for retirement, you’ll also need to know about Medicare, the
federal health insurance coverage. For most people, Medicare eligibility
begins at age 65. But Medicare covers only about half of your retirement
health-care costs. So you’ll learn about supplemental plans and how to
budget for them.

● You’ll also learn about the concept of a retirement savings–withdrawal

plan, which is a mathematically tested concept that helps you calculate
how much you can take out without putting yourself at risk of running out
of money. There are several ways to approach this, but you’ll learn about
four of them: the guaranteed-income approach, the income-only approach,
systematic withdrawals, and asset-liability matching.

7
● In your planning, you’ll also want to consider the three phases of
retirement: the go-go years, the slow-go years, and the no-go years. The
go-go years are typically the first five to 10 years of retirement, when you’re
healthy, active, and traveling. Most retirees spend more during this time.

● Then, you enter the slow-go years, where spending usually declines. The
slow-go years often begin in your early 70s. This is also when tax law states
that you are required to start withdrawing from retirement accounts, a
provision called required minimum distributions.1

● After the slow-go years come the no-go years, where you typically spend
less on travel and entertainment and more on health-care needs.

INCOME SECURITY IN AN EVER-CHANGING LANDSCAPE

● Finally, this course will cover the ever-changing landscape of health care,
Social Security, and taxes. When you make the optimal decisions in these
areas, it can help your retirement income last much longer.

● For instance, one factor that often gets overlooked by married couples
claiming Social Security is how survivor benefits work. You can set up
your family to get the maximum survivor benefit by having one spouse
(usually the spouse who earned the most) wait until age 70 to take his or
her benefits.

● But many couples, not knowing this, have both members claim Social
Security early. Later in life, the surviving spouse could end up receiving a
Social Security benefit that is 35% less each month because of this choice.
When you factor in all the odd rules associated with this benefit, following
an optimal Social Security–claiming strategy can put an extra $50,000 to
$100,000 toward your bottom line.

● Alternatively, if you claim Social Security early and then continue working,
you could owe some of your benefits back to the government. This rule—
the earnings limit rule—also catches many people off guard.

1 Required distributions used to begin at age 70, but with the Secure Act, which passed in 2019,
they now start at 72.

8
 Lesson 1 How to Think like a Retirement Expert

● Taxes are another area where you might be able to save money.

● During their accumulation years, many people maximum-fund their

tax-deferred accounts because they get a tax deduction today and the
money isn’t taxed until you withdraw it in retirement. Most people figure
they’ll be in a lower tax bracket later in life. But for plenty of people, this
isn’t true.

● During your highest-earning years, your tax return often looks similar year
after year. But for most people, that changes sometime during the ages of
55 to 70. That presents a new set of tax-planning opportunities.

● During these years, you begin to draw income from many sources—such
as Social Security, IRAs or 401(k)s, brokerage accounts, or savings—and
each source has its own set of tax rules. When you look at each source of
income on an after-tax basis, they are not all worth the same.

● The taxes you pay vary depending on your tax rate and filing status. By
using strategic choices about where to withdraw your retirement income,
you may be able to reduce your overall tax liability.

● But rather than having you memorizing the tax code and other investment
and savings rules, this course will teach you how to adopt a mind-set that
helps you spot planning opportunities.

● When you’re smart with your money, a whole new world of possibilities
opens up for you.

READING
Ceizyk, “Historical Mortgage Rates.”

Pfau, “What Does Spending Look Like in Poor, Great, and Average
Retirement Conditions?”

Rappaport, “Post-Retirement Risks and Related Decisions.”

Taleb, The Black Swan.

9
2
HOW MUCH
MONEY DO YOU
NEED TO RETIRE?
 Lesson 2 How Much Money Do You Need to Retire?

T here’s no one-size-fits-all answer to the question of how much money

you need to retire. But there are ways to come up with an answer that
works for you. This lesson explains why there’s no one-size-fits-all answer,
offers rules of thumb to get you headed generally in the right direction, and
helps you accurately estimate how much money it will take you to retire.

TWO PHASES OF PLANNING

● Retirement planning can be broken down into two main phases: the
accumulation phase, during which you’re saving toward retirement; and the
decumulation phase, which is when you’re living off your hard-earned savings.

● Most people have a number in mind when they are saving in the
accumulation phase. In their mind, a target of $1 million or $2 million
represents a certain level of financial security.

● The question then becomes, How much do you have to save to reach that
number?

● This type of calculation is easy to do.

● For example, if you’re 40 years old and you want to save $1.5 million by
age 65, how much do you need to put away each year? The answer is about
$24,000 a year—that is, assuming you earn about 7% per year on your
investments.

● You can do this math using a spreadsheet or a financial calculator. It’s easy
because you plug in specific data, such as 25 years and a 7% return.

● But in the second part of your financial journey—the decumulation

phase—the math gets harder.

● As you begin the decumulation phase, the following are some questions
you want to consider:

• How long do you need your money to last? 15 years? 35?

• What will your investments earn? And what happens if they don’t earn
as much as you expected them to?

11
 ● When you were accumulating, if your investments earned less than you
planned, you could always think about working a few more years to make
up the difference. But once you’ve retired, working longer—or returning
to work—might not be an option.
There are many
● So your calculations become more variables that impact
complex during the decumulation phase. how much it will take
There are more unknowns. for you to retire. This
is why no one can
● Not only does the retirement savings math
tell you exactly how
become harder, but each individual also
much you will need
has different expectations about his or her
without analyzing
retirement.
your lifestyle, your
expectations, and
TWO RULES OF THUMB your financial
● Two rules of thumb in making this basic situation. Still, there
calculation for retirement are the 4% rule are rules of thumb to
and the 80% replacement rule. use to come up with a
general estimate.
● The 4% rule evolved from a 1994 research
paper by the financial adviser William Bengen. He looked at how long a
portfolio would last if you started drawing down 4% of the initial value
in the first year of retirement and then upwardly adjusted the withdrawal
amount each year based on future inflation.

● Bengen tested different portfolio mixes of stocks and bonds to support

a 4% withdrawal rate and advised a stock allocation as close to 75% as
possible and no less than 50%.

● Using this rule, if you have $1 million saved at the time you retire, you
could expect to take out $40,000 in year one; then, if inflation is 3%, you
could expect to take out $41,200 in year two—and so on.

● You can use the 4% rule to come up with a target savings number.

12
 Lesson 2 How Much Money Do You Need to Retire?

● For instance, suppose you want to retire on $100,000 a year of income.

Let’s say you expect to have $30,000 a year coming from Social Security.
That means you will need to withdraw $70,000 a year from your
investments. Using the 4% rule, you should have set aside $1,750,000 in
order to begin withdrawing $70,000 a year from savings.

● You can look at your own situation and calculate how much you need to
save in order to get there based on what you have now. Let’s assume that
you are 50 years old and have set aside $500,000 so far. If you can save
an additional $24,000 a year for the next 15 years—and earn an average
return of 6% a year—then you should reach your $1,750,000 target.

● Another question worth considering is whether this amount is really what

you’ll need. Here are some questions to help you figure this out:

• Will you have a mortgage? If so, will it be paid off by the time of
retirement (or soon afterward)?1

• Do you want $100,000 in gross income (before taxes) or net income

(after taxes)?

• Is all of your money in tax-deferred retirement accounts, such as 401(k)

plans, 403(b) plans, and IRAs?2

• Do you want to retire early (meaning before age 65, when you become
eligible for Medicare)?3

• Do you want to travel more during retirement?4

1 If you’re no longer carrying a mortgage, your cash requirements in retirement might be below
what they currently are in order to enjoy the same living standard.
2 While your tax bracket will probably change after retirement—when you’re no longer earning
a regular paycheck—you still face tax obligations on most withdrawals from retirement savings
plans, so you will need to figure taxes into your retirement savings and withdrawal plans.
3 If you want to retire early, you’ll have to factor in additional spending on health insurance
premiums during those early years.
4 If so, $100,000 a year might not be enough. Maybe you want to front-load your travel and
spend $120,000 each year during your first five years of retirement—earmarking $20,000 a
year in travel expenditures—before downwardly adjusting to an annual household budget of
$80,000 a year later on.

13
 ● The 4% rule does not help you account for these varied spending patterns.
The only thing it does is get you headed in approximately the right direction.

● And if you are close to retirement, the 4% rule might even work
against you.

● Numerous research papers demonstrate that when you look at your

withdrawals over your expected postretirement lifetime—rather than year
by year—your money might last longer by withdrawing in excess of 4%
during your first years of retirement while simultaneously delaying the
Social Security benefit until becoming eligible for a larger amount later.

● This becomes particularly relevant in low-interest-rate environments. In

other words, it might be perfectly OK for your initial withdrawal rate to be
as high as 6% or 8% for a few years, if later it will drop to 3% when other
income sources kick in.

● Another rule of thumb is the 80% replacement rule. This principle guides
you in estimating what you can expect to spend in retirement, using 80%
of your preretirement paycheck as your starting point.

● For example, suppose that you’re currently making $50,000 a year. After
taxes, you’re likely taking home about $40,000 a year, which is 80% of
$50,000. If that’s what you’re used to living on, then that becomes your
target retirement spending. And if you worked most of your life, Social
Security will cover a large portion of that.

● But suppose instead that you’re making $150,000 a year and putting
$20,000 a year into your 401(k). After taxes and retirement plan
contributions, you might now be taking home $90,000 a year.

● But the 80% rule of thumb signals that you will need $120,000 a year
to maintain your current living standard—more than you currently take
home. For higher-income earners who have high savings rates, using the
80% rule might significantly overestimate what you’ll need in retirement.

● A better way to go about estimating how much you’ll need is to start with
your current take-home pay. What do you make after all deductions? That
is the number your current lifestyle is based on.

14
 Lesson 2 How Much Money Do You Need to Retire?

● So, look at your pay stub. If $2,000 gets direct-deposited every two weeks,
then multiply $2,000 by 26 pay periods, and you can estimate you’ll need
$52,000 a year, after taxes, to maintain your current lifestyle.

● This still does not account for other changes in spending, such as paying off a
mortgage, health care, travel, and periodic automobile purchases. But it does
give you a way to come up with a general estimate of your future cash needs.

● So, if you’ll need $52,000 a year and expect to receive $28,000 from Social
Security, that leaves a $24,000 gap. Factoring in an additional $5,000 a
year for taxes (at least!), let’s estimate that you’ll need $29,000 in addition
to what you receive from Social Security.

● Returning to the 4% rule of thumb, if you have $725,000 saved, that will
deliver the $29,000 you’re looking for.

THREE TIMELINES
● When you are closer to retirement, you’ll want a more granular level of
planning than rules of thumb can provide. To reach the level of detail you’ll
need, you can use a series of expense, income, and withdrawal timelines.

● The first timeline lays out your expenses, and the second one lays out your
future fixed income. The difference between the two can be referred to as
the gap, or your withdrawal timeline.

● Let’s start with the expense timeline. You can draw this on paper or use a
spreadsheet.

● A timeline is organized by year and helps you visualize how your spending
might evolve over time. You’ll want to separate expenditures according to
items that are fixed verses items that will increase with inflation.

● If you have a fixed-rate mortgage, for instance, that expense won’t change
with inflation. However, property taxes and homeowner’s insurance are
likely to cost more each year. And you’ll be paying taxes and insurance on
your property even after the mortgage is paid off.

● You will also need to account for periodic expenses, such as car purchases
and major home repairs.

15
 Year 2023 2024 2025 2026 2027 2028 2029 2030 2031

Expenses & Taxes

Fixed-rate
mortgage

Home
taxes/
insurance

Car
purchases

Major home
repairs

Travel

Health-care
premiums

● In this timeline, you will also add expenses that might be front-loaded,
such as travel if you want to do more of that in your early years or health-
care premiums if you plan on retiring before age 65. These expenses might
be higher initially and lower later.

● Another thing to account for is taxes. Taxes during retirement will be

based, in part, on where your cash flow comes from.

● Consider, for instance, that you might have the same amount of retirement
income as your neighbor but pay twice as much in taxes. The difference
could arise from the underlying source of income.

● To come up with an initial estimate of future tax obligations, use the

following guideline: If retirement is still 15 years or more away and you
have a moderate level of income, use 25% as a rough estimate of your
future tax rate. But if you are a high-income earner, use 35%, and if you
are a low-income earner, use 12%.

16
 Lesson 2 How Much Money Do You Need to Retire?

● After creating an expense timeline,

you can create an income timeline As you get close
to see what sources of cash flow to retirement,
will be available. The income work with a tax
timeline is a projection of fixed professional to
sources, such as Social Security, more accurately
pension payments, and deferred- project what your
compensation payouts. It does not future tax rate
include investment income, such will be.
as interest or dividends.

Year 2023 2024 2025 2026 2027 2028 2029 2030 2031

Non-Investment Inflows

Social
Security

Pension
Payments

Total Non-
Investments
Inflows

● Once you have an expense timeline and a fixed-income timeline, compare

the two and calculate the gap, which is illustrated with a third timeline.
The gap shows you how much money you will need to withdraw from your
savings and investments each year to cover any deficit.

17
 Withdrawals

Number of Years Age Year by Year Withdrawals

● The number will probably vary from year to year because expenses and
fixed income vary quite a bit between the ages of 60 and 70. If the age
at which you plan to begin taking Social Security or collecting a pension
changes, or if you downsize, the gap will adjust.

● Things tend to stabilize once you—and, if you’re married, your spouse—

are 70 or older. At that point, income and annual expenses don’t change as
much from year to year.

● Next, take your timelines and project them out for your estimated life
span. Here, instead of using a gauge like the 4% rule to estimate if you
have enough to meet your needs, you can use this timeline, which looks at
your withdrawals over your lifetime rather than one year at a time.

18
 Lesson 2 How Much Money Do You Need to Retire?

● The point of this exercise is to compare your total estimated withdrawals

over your lifetime to the total amount of financial assets available.

● The concept is called fundedness. And you get at it through a math

concept called present value, which reflects the amount of money you need
to have in your account today to meet future obligations.

● Consider a simple example. If you need $10,000 a year for 30 years, how
much do you need to have saved today to get there? The answer is easy if
there’s no inflation and no rate of return on your savings. Multiply 30 by
$10,000 and you know you’ll need $300,000 today.

● But if you assume inflation will be 3% and your money will earn 5%, the
calculation changes. You can use a present value calculation in Excel or on
a financial calculator to determine that it takes $219,193 earning 5% a year
to deliver $10,000 a year of inflation-adjusted cash flow for 30 years.

● You can also apply this calculation to your gap timeline.

● In some cases, this type of calculation shows you that you have enough and
that you can retire earlier than you thought, or maybe travel more. But if
you haven’t saved enough, you could then look at ways to reduce spending,
save more before retirement, delay retirement by a few years, or look for
ways to earn part-time income in retirement. Once a solid financial model
is in place, you can begin to make educated decisions.

READING
Bengen, “Determining Withdrawal Rates Using Historical Data.”

Shoven and Slavov, “The Decision to Delay Social Security Benefits.”

19
3
FIVE WAYS THAT
RETIREES RUN
OUT OF MONEY
 Lesson 3 Five Ways That Retirees Run Out of Money

A cademics and financial professionals have made careers out of studying

retirement—including retirees who had enough saved and those who
didn’t. And they’ve categorized and cataloged the circumstances that can
cause a retiree to run out of money too soon.

FIVE CATEGORIES OF RISK

● An actuary is a specialized financial professional who is employed by
insurance companies, pensions, and large corporations to assess financial
risk. Actuaries practice a discipline known as actuarial science, which
involves applying mathematical and statistical analysis to gauge various
financial probabilities and outcomes.

● Every few years, the Society of Actuaries conducts a retirement-risk survey

and draws up a paper discussing postretirement risks. At one point, the
society identified more than 15 different risk types, and these can be
grouped into five major categories:

1 Longevity risk. None of us knows exactly how long we’ll live, but we
do know that life expectancy has increased over time. If you are 65 in
2020, you can expect to live to 84 for a man and 86 for a woman. And
that’s just average—many will live much longer.

2 Sequence risk. This has to do with the pattern of good or poor market
returns and how it impacts you when you are periodically adding or
withdrawing money to or from your investments.

3 Inflation risk. Will the price of necessities—such as food, housing,

and health care—rise faster than your income?

4 Overspending. This is the risk of spending too much of your nest egg
too soon in retirement.

5 Household shocks. In retirement, this can be the loss of a spouse,

cognitive decline that causes poor decision-making later in life, or other
family emergencies where you offer financial assistance.

● To feel comfortable transitioning into retirement, you want to have a plan

in place to account for each of these risk categories.

21
 LONGEVITY RISK
● In gauging longevity risk, you want to start with an assumption about how
long you can expect to live. You can calculate this unknown with the help
of mortality tables. The government and insurance companies, among
others, use these actuarial tables when figuring out the likely cost of future
obligations, such as Social Security payments, life insurance benefits, and
pension payouts.

● Based on data from 2014, an You can find

unmarried female who is 60 years mortality tables,
old has a 60% chance of living to along with
85. An unmarried male, age 60, has associated
a 51% likelihood of living to 85. research, on
One common retirement planning the Society of
mistake is that people routinely Actuaries website.
underestimate how long they’ll live.

● A related mistake that married couples make is

that the husband and the wife each make decisions based
on his or her own life expectancy, as if they were single. Instead, they
need to look at their joint life span, which means looking at the probability
that out of two people, one may live much longer than expected.

● If you’re married, the odds are 80% that one of you will live to 85. And
there’s a 58% chance that at least one of you lives to 90. So unless you have
a severe heath condition, it’s pretty important to set a planning horizon
that goes out to age 90—or longer if you have a family history of long-
lived relatives.

● When you lengthen your planning horizon, you begin to view financial
decisions differently.

● One decision that can have a big impact on longevity risk is the timing
of when you start taking Social Security payments. Your Social Security
benefits are adjusted for inflation, and you get much more per month if
you start benefits at a later age rather than as soon as possible.

22
 Lesson 3 Five Ways That Retirees Run Out of Money

● If you’re married, you should also learn about Social Security survivor
benefits. A survivor benefit refers to payments made to family members of
a wage earner who has died. Among many couples, the ages of a husband
and wife might vary considerably. And in many couples, one person is
likely to have made the majority of the family’s income.

● However, all too often, the principal wage earner starts taking Social
Security benefits at a relatively young age, accepting a lesser rather than a
greater benefit. The long-term consequence is that this severely curtails the
survivor benefits available to the other spouse.

● There are additional financial

instruments to consider when The decision of when to
looking at how to protect your claim Social Security is
retirement income; for example, just one of many strategies
reverse mortgages and annuities both you can use to help
offer lifetime income. You have to protect you and your family
be open-minded and willing to learn against longevity risk.
how things really work.

● If you’re like most people, you might have a bias against certain
investments or financial instruments. Sometimes these biases are based on
outdated information or exist because products are sold in situations where
they aren’t a good fit. However, most financial instruments work well
when used in the right situation.

● For retirement, the criteria for defining the right situation changes. When
you’re younger, it’s usually about what you think will make you the most
money. But one of the most important considerations in retirement is how
effectively a financial decision or instrument can provide lifelong income.

● When it comes to longevity risk, look at decisions and evaluate financial

instruments based on how well they will protect your income well into
your later years.

SEQUENCE RISK
● Sequence risk is the risk that a poor series of investment returns can cause
your rate of return to be lower than expected.

23
 ● Poor market returns can have a significant detrimental impact during the
retirement red zone years—the last five years of working and the first five
years of retirement. If your retirement red zone occurs during a time when
the economy is booming, your retirement will likely look great. But what if
it is during a recession? These things make a big difference. And you need
to know that your plan will work either way.

● Most people use average past returns to choose investments and assume
those returns will continue for the future. But most investment disclosures
contain the warning that past performance is not necessarily an indicator
of future results. By nature, an average consists of times when returns are
higher and times when they are lower.

● When engineers build a bridge, they don’t build Averages can

it for average weather. They test for extremes. be dangerous
You must do the same thing when planning by giving you
for retirement. Test your approach to see if misleading
it stands up during bad economies as well as expectations.
good ones.
● Don’t rely on averages alone!

● You’ll also want to build some flexibility into your plan. For example, let’s
say you like to travel. If a recession materializes, you might need to travel
less for a few years.

● Another way to plan is to segment your investments using what is called a

bucket strategy, where you have one bucket with enough cash and liquid
assets to fund several years of retirement, with other buckets containing
riskier investments. The technical term for this approach is asset-liability
matching, where you are looking at your individual retirement the way
financial professionals manage large pension funds.

● For example, picture having enough low-risk investments to cover the

portion of your retirement expenses not covered by Social Security or
other fixed-income sources for 10 years. If you need $30,000 a year to

24
 Lesson 3 Five Ways That Retirees Run Out of Money

supplement your other fixed income, then you would have $300,000 in
low-risk investments. You would put the remainder of your portfolio in
higher-risk investments, such as stock index funds.

● When the higher-risk investments have years where they do well, you
would siphon off some of that growth and put it in your low-risk bucket to
replenish what you had been withdrawing.

● During market downturns, this type of approach helps protect you from
being forced to sell higher-risk investments at a loss in order to support
your expenses.

INFLATION RISK
● Perhaps the most common measure of inflation is the Consumer Price
Index (CPI), which tracks the collective price of a basket of goods and
services and is monitored by the US Bureau of Labor Statistics.

● The standard guideline in financial planning is to assume a 3% inflation

rate, as this has been the long-term historical average. But for much of
the last three decades, inflation was less than 3%; in fact, it was 2.4%,
as measured by the CPI. However, that’s no guarantee against higher
inflation today or in the future.

● Either way, when it comes to inflation risk, there is some good news: Most
people will not need their current level of spending to continue to increase
at the same rate as inflation.

● David Blanchett, head of retirement research at Morningstar, wrote a paper

on the topic titled “Estimating the True Cost of Retirement.” His research
shows that spending is at its highest when retirees are in the 60-to-65 age
range. Then it slows down, with those same retirees spending much less as
they enter the 75-to-85 age range.

● Blanchett puts it this way: “As people age, they tend to slow down. So they
transition from the go-go years, to the slow-go years and the no-go years.”

25
● In aggregate, the paper concludes that many retirees will need
approximately 20% less in savings than the common assumptions would
indicate and that retiree expenditures in real life do not, on average,
increase each year by inflation.

● However, Blanchett segmented retirees into three groups: those who spend
about $25,000, $50,000, and $100,000 or more per year in retirement.

● Inflation has the biggest impact on lower-income households. When you’re

on a tight budget, price increases on basics, such as food and gas, have
a big impact. Inflation is not as big of a risk for households with more
discretionary income, typically those spending $100,000 or more per year
in retirement.

● This supports the underlying conclusion that “the true cost of retirement
is highly personalized based on each household’s unique facts and
circumstances” and therefore must be accurately modeled.

● Once again, this is why you should be careful about using rules of thumb.
In your retirement projections, inflating all expenses by 3% a year might
result in oversaving for retirement.

● Instead, use a 3% inflation expectation if your household spending is

$50,000 a year or less, 2% if household spending is $50,000 to $100,000,
and 1.5% if household spending is $100,000 or more a year.

OVERSPENDING
● Quite simply, if you take out too much money from your retirement
savings too soon, you increase your risk of running out of money. That’s
one reason why in planning for retirement you must account for likely big
expenditures in the future, such as replacing your automobile and making
major home repairs. Many people forget these items when they’re figuring
out how much they’ll need in retirement.

● Another problem happens when your investments do well early in

retirement. People then tend to assume that things will continue to do well
and take out more money than they had originally planned.

26
 Lesson 3 Five Ways That Retirees Run Out of Money

● But remember how averages work. If you’re in the middle of a time period
when the market is performing really well, nevertheless you should set
aside some of the gains for the inevitable period when investment returns
come in below average. It’s how you ration your cash reserves.

● The best way to avoid overspending risk is to make sure you’ve accounted for
big-ticket items in future spending and develop the discipline to stick with
your plan. For most retirees, it makes sense to set up a direct deposit from
their investments to their checking account to create a retirement paycheck.

● Then, you create a budget from that paycheck just as you would’ve during
your working years. This way, you will be inclined to view the main pot
of investments as untouchable and live off the direct deposit instead. This
practice helps keep many retirees from spending too much too soon.

HOUSEHOLD SHOCKS
● Household shocks often come in the form of a family emergency, such
as a child who develops a medical issue or a parent whom you end up
supporting. To be prepared, you want to have some type of emergency-
reserve asset set aside.

● Such a contingency fund might reside in the form of your home equity,
or it might be a savings account that you don’t include in your planning
model. If you have to use every available asset you possess to make
your retirement plan work, then it’s not a good plan. You want to leave
some assets out of the projection so that you have a buffer in the event a
household shock occurs.

● Another type of contingency that sometimes comes along is cognitive

decline. To protect your future self, you can develop relationships with
a financial advisor, an accountant, or an attorney to counsel you on key
decisions later in life. There might also be key family members you’ll want
to involve.

27
READING
Blanchett, “Estimating the True Cost of Retirement.”

Dimensional Fund Advisors, Matrix Book 2019.

Dixon, “Historical CD Interest Rates 1984–2020.”

Hultstrom, “Joint Life Probability Spreadsheet.”

Kitces, “How Total Spending Declines over Time in Retirement.”

Roser, Ortiz-Ospina, and Ritchie, “Life Expectancy.”

Society of Actuaries, “RP-2014 Mortality Tables.”

28
 4
HOW TO START
SAVING FOR
RETIREMENT
W
W hen it comes to saving for
retirement, the key to starting
out—or starting over—is being aware
It’s possible to
accumulate millions of
of what you do with your money. Many dollars by maximizing
people resist the idea of making a budget your earning power,
and really don’t like the word budget. So spending beneath your
call it a spending plan instead. Having a means, and investing in
handle on your spending is the starting a disciplined way.
point to financial success.

YOUR SPENDING PLAN: TOP-DOWN OR BOTTOM-UP?

● The key to financial success is your spending plan, which helps align your
spending with the things that matter the most to you.

● There are two main ways to look at spending: top-down or bottom-up.

• With top-down spending, you pay your future self first. This means
that first you allocate savings to your 401(k) retirement account; then
you pay mandatory bills, such as your mortgage and utilities; and then
you’re free to spend what is left over, and you don’t have to track every
penny. You don’t worry about each category—home repairs, clothing,
travel, medical expenses, restaurant bills, etc. You save first and make
sure that your total spending stays within a defined monthly dollar
range that you can afford.

• The bottom-up approach is recommended when you’re trying to get

a handle on where your money is going. This is where you categorize
everything. In most cases, if you’re willing to cut back, you will thank
yourself later. Cutting back on spending can help you launch ahead.
And if you have children, it can be a valuable opportunity to teach your
children how money works and how to manage it wisely.

30
 Lesson 4 How to Start Saving for Retirement

PAY DOWN DEBT OR SAVE/INVEST?

● Once you know where your money is going, you can see how to reallocate
your spending to accomplish your goals. Most people carry at least
some debt—maybe a student loan, a credit card balance, a car loan, or
a mortgage. What should you do about that obligation? Should you pay
down the debt or put any extra income into investments?

● The answer depends on the type of debt you have and your savings.

● The first thing you always want to do is build up an emergency fund.

This can tide you over if you become unemployed or if you face a major
unexpected expense, such as a medical issue or the need for significant auto
or home repairs.

● How much money should be in the emergency fund? If you have no

dependents, work to accumulate at least three months of take-home pay. If
a spouse or children are dependent on your income, accumulate at least six
months of take-home pay.

● And if you work in an industry with a lot of turnover, shoot for a larger
emergency fund. But if you hold a tenured job with little chance of losing
it, a smaller emergency fund might be fine.

● There’s not an exact science to determining the proper amount for a family
emergency fund. But it needs to be enough to pay your bills in the event
that you have no income coming in for three to six months.

● Once you have an emergency fund, you can begin to tackle debt. Most
debt is structured as a short-, middle-, or long-term obligation.

• Short-term debt—credit cards with a monthly balance, for example—

should be used for things you plan to pay off quickly.

• Mid-term debt, such as a car loan, is designed to match the length of

time you’re likely to own and use the car.

• Long-term debt, such as student loans and a home mortgage, is

typically stretched out much longer, because your career and home
ownership are viewed as long-term assets.

31
 ● Some people get in trouble when they accumulate more short-term debt
than they can pay off quickly. Other people get in trouble because their
income is not high enough to cover their long-term debt.
● There are two approaches to If your income is not high
paying off debt. One is the enough to cover your debt,
debt-avalanche approach, where visit the National Foundation
you pay off high-interest-rate for Credit Counseling website
debt first. The other is the debt- and meet with a counselor to
snowball approach, where you try discuss your situation.
to knock off smaller balances first
and then take the available funds
to apply to the next debt.

● You can run an internet search on these approaches and find free
calculators to put your debt into and see how to pay it off the fastest.

● Once your short-term debt is paid off, you’ll have to decide whether to pay
more on mid- or long-term obligations. Again, the answer depends. Many
online debt calculators will help you calculate the financial impact of
saving more versus paying down debt.

● Here are the recommended guidelines to follow when considering paying

down debt versus investing:

• If you have access to a company retirement plan where the employer

offers a match, invest enough to receive the match before focusing on
long-term debt.

• If you are a high-income earner with a combined federal and state

tax rate at 30% or more, it usually makes sense to put money into a
tax-deferred retirement plan rather than using the money to pay down
long-term debt.

• If you expect your long-term investments to earn a return that’s higher

than the interest rate on the debt, it can make sense to invest any
extra funds.

• As you get closer to retirement, paying off debt becomes more

important. Most retirees feel better entering retirement debt-free.

32
 Lesson 4 How to Start Saving for Retirement

• If you are a household with a net worth in excess of $1 million, some

debt might benefit you.1

RENT OR BUY A HOME?

● Another question you’re faced with when starting out is whether to rent
or buy a home. Here are some of the considerations to think about: How
stable is your career? Are you in an area where you could find a new job
easily? Or would you have to move if your current position came to an end?

● For your first home, don’t consider buying unless you are two years into
your career, have a stable job, and are in an area where you know you could
find other employment without having to commute too far. You’ll also
want to have sufficient savings to cover the inevitable extra expenses that
come with home ownership.

● When you’re ready to buy, one strategy is to buy well below your means. If
you buy at or above your means, your lifestyle and other costs will scale up,
too. You could end up house-poor, with no funds to eat out, travel, or do
anything extra in life.

● At least a year before you think about buying, check your credit score
and—if needed—take action to improve it.

● There are several major components to your credit score. The first is how
long you’ve had credit. For example, rather than canceling a credit card
with a zero balance, consider keeping it open if you’ve had the card a
long time.

● Another factor is the total use of revolving credit—which refers primarily to

credit cards. Keep balances at less than 30% of your total available credit.

● Paying on time is a key factor, too. One or two late payments can seriously
hurt your credit score. And the types of credit you have matters, too.
Sometimes showing a consistent payment history on an auto loan can do
more for your credit score than paying it off.

1 In his book The Value of Debt, the financial adviser Thomas J. Anderson explains how some
forms of debt, such as a mortgage loan, can be a valuable tool for high-net-worth households.

33
 ● Work on these factors and aim to get your credit score above 750. That
will help you qualify for the best terms on major purchases, such as a home
or car.

INSURANCE OR NO INSURANCE?
● The next thing to get in place when starting out is basic insurance
coverage.

● Insurance is about managing risks—not only for you, but also for those
who care about you. You need health insurance. If you have a spouse or
children who depend on your income, you need life insurance, too. And if
you have a high-paying job, you may need disability insurance.

● When you’re starting out, insurance can feel like a waste of money.
Sometimes you might think you’d be better off saving the money rather
than paying for insurance. But if you don’t have basic coverage, one small
thing can set you back, and you might never get past the starting-out (or
starting-over) phase.

STANDARD ACCOUNTS OR RETIREMENT ACCOUNTS?

● Let’s assume you have an emergency fund, are paying down high-interest-
rate debt, have your basic insurance coverage in place, and are ready to
start saving. Where do you put the money?

● First you have to decide what type of account to use. Should you put your
savings into standard checking accounts, bank savings accounts, and
investment accounts or into tax-advantaged retirement accounts?

● In standard accounts, the funds are immediately available to you, but

they don’t enjoy the tax advantages of a retirement account. Retirement
accounts, on the other hand, offer tax advantages but also come with
restrictions on when you can access your money without a penalty.

● The most basic type of account is bank savings. You put money in and it
earns interest. You receive a 1099 tax form at the end of the year and report
the interest earned on your tax return. You can use the money any time for
any reason.

34
 Lesson 4 How to Start Saving for Retirement

● Then there are brokerage accounts, which are like savings, except you
invest your deposits into mutual funds, stocks, or bonds. This money
is subject to gains and losses in the financial markets, though you can
withdraw it at any time for any reason. Once again, you pay taxes each
year, this time on any interest, dividends, or realized capital gains that the
investments generate.

● Next, there are various types of retirement accounts, which enjoy special
tax treatment. But in exchange for this special tax treatment, you must
leave the funds in the account until you reach age 59½. And in most cases,
if you take the money out before then, you will incur a penalty tax.

● The two most common types of retirement accounts are 401(k)s and
individual retirement accounts (IRAs). And there are two distinct types of
401(k)s and IRAs, either traditional or Roth, and the way they are taxed is
quite different.

● Traditional 401(k)s and IRAs are tax-sheltered, which means you won’t pay
taxes right now on the amounts contributed to the account. The money
then grows tax-deferred, and there are penalties if you access it before
age 59½. When you withdraw the funds during retirement, then you
pay taxes.

● As your career progresses and your income rises, during years when
your tax rate is highest, you want to contribute to traditional retirement
accounts, as deferring taxes to a later, lower-tax-rate year will help reduce
your overall tax burden.

● With a designated Roth 401(k) or Roth IRA, you pay standard income
taxes up front, but the money then grows tax-free. When you withdraw it
during retirement, the funds are tax-free.1

1 There are yearly maximum contribution amounts (for both types of Roth accounts) and
income limitations (for Roth IRAs only) that increase over time with inflation, so check the IRS
website for current year rules.

35
 ● And the Roth IRA—but not the Roth 401(k)—also has a special provision
that allows you to withdraw your contributions to it at any time with no
penalty taxes owed. You can’t withdraw the earnings portion early without
penalty, but you can withdraw the contribution portion.

● When you’re starting out, usually you are not making too much money
yet, so the Roth IRA becomes a great account to use for several reasons:

• If needed, you can get your contributions back.

• The earnings on the investment in the Roth

grow tax-free as long as you don’t withdraw Roth IRAs
them before age 59½. are a great
• It’s best to contribute to Roth accounts account
during years when your tax rate is relatively type to use
low. That money will grow, and during when getting
future years when your tax rate is higher, started.
having access to tax-free Roth funds can be
quite beneficial.

YOUR EARNING POWER

● For most people, human capital is the biggest asset they have. Managing
spending is incredibly important—but so is managing your earning power
and investing in it.

● There are two approaches to maximizing your earning power. First, in

recent years, a movement called FIRE (financial independence, retire early)
has taken off. This is where you work hard, save as much as you can, and
retire as early as possible. If that’s your dream, go for it. People who go for
this approach are often in high-paying corporate jobs that they don’t like.
● A different approach can be called a life well worked. Find ways to excel
at what you do and find work you love. You might work at a reasonable
pace and into your 70s rather than work at a job you hate for 10 years and
retire early.

36
 Lesson 4 How to Start Saving for Retirement

● If you’re new in your career, find mentors. Reach out to people you admire.
Ask them what it takes to move your career to the next level. Look for ways
to increase your value.

READING
Anderson, The Value of Debt.

Internal Revenue Service, “Amount of Roth IRA Contributions That You

Can Make for 2020.”

LaPonsie, “Deciding between a Roth vs. Traditional IRA.”

National Foundation for Credit Counseling Website, [Link]

Roth, “Pay Yourself First.”

37
5
MID - CAREER
FINANCIAL
STRATEGIES
 Lesson 5 Mid-Career Financial Strategies

O nce they hit retirement, people don’t

typically express regret that they
saved too much. But many people say they
Research
demonstrates that
when people are
wished they had started saving earlier, and shown computer-
saved more. With a commitment to saving enhanced images of
and smart planning, you can set yourself what they might look
up for success and make adjustments as you like in 20 years, they
go along. tend to increase their
savings and improve
SOLID SAVINGS HABITS their health habits.

● When considering financial strategies,

you of course know there needs to be a balance between spending today
and saving for tomorrow. But by building solid habits early on, you can
find that balance without always having to watch every penny.

● The first step is thinking about how to handle increases in income. After
a promotion or taking a higher-paying new job, many people instantly
upgrade their car or buy a new house. That might feel good at the time.
But it could put your long-term goals at risk.

● There is a better approach. With each raise, allocate some of the earnings
increase to the current you—so you can spend it now—and some of it to
the future you—so you can live on it later.

BUDGETARY TRADE-OFFS
● As you are saving, there will always be budgetary trade-offs. Some are the
classic decisions to spend more versus save more that come with things
like whether to upgrade your car or drive the one you have until it can’t go
any more.1

1 One of the best ways to save money is to drive your car into the ground. A car is a depreciating
asset. Once it’s paid off, most of the depreciation has already taken place, and you are driving
almost for free.

39
 ● Other trade-offs involve two high-value items: Do you save for your
children’s college or for retirement? This can be an emotionally charged
topic. Parents want to give their children every advantage possible. But
paying for everything your children might want or need is not always the
way to provide that advantage.

● Sitting down with your children and coming up with a plan for how
you will mutually cover their education is probably a better option than
figuring it all out for them.

● Next, consider that you aren’t going to be able to take out a loan to finance
your retirement. By comparison, there are loans for college. If you sacrifice
everything now, who will take care of you in retirement? You probably
don’t want to have to fall back on your grown children.

● When you think about financing your children’s college educations,

help them think through the trade-offs. And think through your choices
objectively, not just emotionally. Try to find a way to balance competing
objectives—such as saving for retirement versus children’s college tuition—
rather than forgo one for the other.

● Another question that comes up is where to put college savings as they

accumulate. One type of account specifically for college expenses is the
529 plan. It grows tax-free and can be withdrawn tax-free if used for
qualified educational expenses, such as tuition. When you put money in
a 529 plan, you don’t get a deduction on federal income taxes. But many
states offer a deduction at the state income tax level. You’ll want to read up
on your own state’s rules.

● If you start saving when your child

is young, 529 plans are a great To learn more about your
vehicle for tax-advantaged savings options, check out the
and investment. But what if your website savingforcollege.
children don’t go to college? For com. It contains solid info
this reason, you might also want on just about anything you
to consider saving in a regular want to know about funding
brokerage account—because that a college education.
money can be used for any purpose.

40
 Lesson 5 Mid-Career Financial Strategies

YOUR PEAK EARNING YEARS

● As your career develops and you grow older, you’ll want to think about
how long your highest earning years might last.

● Be objective about your industry and your position. How likely is it

that your current income will continue to retirement age? For many
management- and executive-level positions, the risk of being laid off in
your 50s or early 60s is pretty high.

● To protect yourself, increase your savings during your peak earnings years.
This has several incredibly positive effects:

• You don’t get used to spending more and more.

• You’ll be prepared for any curveballs that might come your way.

• What’s the worst thing that can happen? Your position and income
stay stable and you can choose to retire earlier—or add in some
extras. You’ll be in control of the outcome, instead of having outside
circumstances dictate what happens.

COMPANY BENEFITS
● Company benefits from your employer come in various forms, including
health insurance, 401(k) retirement savings plans, and perhaps even
stock options and stock-
purchase plans.

● A common benefit is 401(k) The biggest mistake

plans—or, if you work for a among people who
public school system, church, have access to
or tax-exempt organization, company-sponsored
403(b) plans. Either way, both retirement savings
retirement savings vehicles work plans is not
in a similar fashion. participating in them.

● You can elect to withhold wages

today to be set aside for the future. You
get special tax treatment on the funds you set
aside. And in exchange, you agree to leave your money

41
 in the retirement savings plan, growing, until you turn 59½ or retire at a
later date. If you withdraw funds before age 59½, you might pay a 10%
penalty tax.

● The number one rule in getting to your retirement goal is to save enough.
Saving enough is more important than anything else. If you think you
can’t afford it, consider this: If you were paid 3% less, do you think you
would get by? Probably. So put 3% into your plan. Start with something.

● Then, when you get a raise, keep half of the higher income for the current
you and contribute the other half to the retirement savings plan for the
future you. By consistently increasing your savings, before you know it,
you’ll be saving enough to fund a comfortable retirement.

● Next, find out if your employer offers a matching contribution. It’s free
money. All you have to do is put some money in the plan. If your employer
offers a match, don’t miss out on it.

● Another type of benefit your employer might offer is a profit-sharing

contribution. If they have a good year, they might contribute a lump sum
into the plan on behalf of all employees.

● Most profit-sharing contributions come with a vesting schedule. That means

the money put in the plan on your behalf does not all belong to you right
away. Instead, the money may vest over three to five years. So, under a five-
year vesting, for example, if you left after one year, you might get only 20%
of the money the company put in. But after five years, you would get 100%.

● If you are looking to change employers and are close to becoming vested in
your retirement plan, consider waiting to make a change until you’re
100% vested.1

● Another type of benefit account you might see your employer offer is a
health savings account (HSA), which you can contribute to as long as you
are enrolled in a qualified high-deductible health insurance plan.

1 Keep in mind that the money that you put in your retirement plan is always yours. 401(k) and
403(b) plans are closely regulated. No one but you (or your designated heirs, after you pass) has
the power to use or withdraw your money.

42
 Lesson 5 Mid-Career Financial Strategies

● The idea is that you make regular contributions to your HSA out of
your paycheck so that when a health event comes along, you have funds
available. The funds can be used to cover your deductible as well as for
certain dental expenses, medications, and out-of-pocket medical costs.

● Your own contributions to your HSA are tax-deductible. And if the

company contributes, that sum is typically excluded from your gross
income. Meanwhile, you can use the funds for qualified health-care related
expenses right away, with no tax penalty.

● And there is an even better way to use HSAs as your income grows. If you
have access to an HSA, it’s recommended that you fully fund it each year
and not use it during the year if you can avoid doing so. Pay for health-
care expenses out of pocket and let your HSA grow as another retirement
account. If you save your medical receipts along the way, you can withdraw
money penalty-free if you need it later.

● Of course, like most things with tax An HSA offers

advantages, there is a limit as to how much a great way to
you can contribute to an HSA. Contribution save more and
amounts are indexed to inflation, so look up get tax-free
the current limits. growth on your
savings.
● If you’re in the private sector—particularly
if you’re in the tech industry, or engineering,
or moving up the corporate ladder—at
some point you’re likely to have access
to a more advanced set of benefits, including things like employee
stock-purchase plans, stock options, supplemental retirement plans, and
deferred-compensation plans. And you can use these plans to greatly
enhance your wealth.

● With a stock-purchase plan, for instance, you typically have the right
to purchase company stock at a discount from the market value. If you
hold the stock long enough, and it goes up in price, you might also get
preferential tax treatment on some of the gains. These plans help you
accumulate savings outside of a traditional tax-deferred retirement plan.

43
 ● Of course, there’s no guarantee of a positive return. And owning a single
stock is not a diversified portfolio. There is usually more safety in greater
diversification. But if you can buy any stock at a 15% to 20% discount
from the current market price, you’ve almost certainly increased the odds
that you will see a positive return on your investment.

● Next, stock options give you the right to buy stock at a predetermined
price at a set point in the future. Let’s say you work for a company where
the stock is trading at about $30 a share today. Your company might offer
you the right today to buy 1,000 shares four years in the future at the
current $30 a share.

● The idea is that by the time four years have passed, you hope the stock
is worth a lot more. Let’s say it’s gone up to $40 a share. Now, you can
simultaneously buy 1,000 shares at $30 per share and sell them at $40,
pocketing a $10,000 profit before taxes.

● Next, supplemental retirement plans and deferred-compensation plans are

both usually designed as ways for highly compensated employees to save
more after maxing out the limits of what can be put into their 401(k) or
403(b) plans. This is yet another reason why working on your skill set and
moving up in your career can pay off.

● Another type of plan is a deferred-compensation plan. There are two main

types: a 457(b) plan and a 457(f) plan.

• 457(b)s are offered to state and local government employees and work
much like a 401(k) plan. If your employer offers both a 401(k) and a
457(b), you can contribute to both.

• 457(f)s are seen in the private sector. Under a 457(f), you can defer
a portion of your salary and select when it will be paid to you.
Your options often range from a lump sum in five years to 10 equal
installments that begin at your retirement.1

1 These types of deferred-compensation plans present some interesting tax-planning

opportunities, and professional help in planning can be quite valuable. At the very least, you’ll
want to read your plan rules to see what the risks are.

44
 Lesson 5 Mid-Career Financial Strategies

• Your employer might also offer various types of insurance benefits. And
these can be worth a lot of money. So if you’re comparing jobs, don’t
forget to compare the value of the benefits offered.

● If you’re self-employed, you can still set up an individual 401(k) plan,

which is a special type of plan just for individuals with no employees.
If you have employees, do research on self-employed pensions (SEPs),
commonly called SEP IRAs, and check out SIMPLE (Savings Incentive
Match Plan for Employees) plans.

A PITFALL TO WATCH OUT FOR

● One pitfall to watch out for is accumulating all of your retirement assets
on a tax-deductible basis only. The problem is people who put all of
their funds into tax-deductible IRAs, 403(b)s, and 401(k)s may have less
flexibility in retirement.

● Each dollar they withdraw from the accounts will be taxed as ordinary
income. And sometimes they will have done such a good job at maxing out
tax-deductible accounts that they end up paying more taxes in retirement
than they did while they were working.

● If you are in the highest tax bracket during your earning years, you should
prioritize maxing out tax-deductible savings before saving elsewhere. But
most people are not in the highest tax bracket.

• If you fall in the lower tax brackets, you might want to make after-tax
contributions to a Roth IRA or Roth 401(k).2

• For those in the middle tax brackets, consider making half deductible
contributions and half Roth.

• For those in the higher tax brackets, making all deductible

contributions probably does make sense.

2 With a Roth type of retirement account, your funds grow tax-free and are tax-free when
withdrawn later in retirement.

45
READING
Farrington, “How to Maximize the Value of Your Health Savings Account.”

Saving for College Website, [Link]

46
 INVESTING FOR
6
SAFET Y, INCOME,
AND GROW TH

Much of the time, investing mistakes occur

because of unrealistic expectations.
W here should you put your money
when saving for retirement?
Stocks? Mutual funds? Gold? Real estate?
When undertaking
a risky investment,
you shouldn’t invest
This lesson covers some basic investing more than 5% of
principles you can use when building your your portfolio. To do
retirement portfolio. It will help you sort otherwise is more like
through the jungle of information that’s gambling than investing.
out there and put together a solid long-term
investing plan. For the average person,
investing shouldn’t be
THREE INVESTMENT CATEGORIES that complicated. You
have your basic building
● An investment plan has several blocks of safety,
components: income, and growth.
• You must understand how different You build a portfolio
investments work and spread your using those blocks and
money out over various types of stick with your plan.
investments according to your goals.
Inexperienced or
• You need a realistic set of unrealistic investors
expectations about how things might may want the perfect
turn out—and over what time frame. investment: something
safe that produces
● To make a plan, you have to understand reliable income
your choices. In simple terms, and is sure to grow.
investment choices can be grouped into Unfortunately, that’s a
three broad categories: safety, income, lot to ask for.
and growth.

• Safety investments typically consist of low-risk, low-return vehicles that

might include bank-insured certificates of deposit, savings accounts,
money market accounts, and federally insured bonds.

48
 Lesson 6 Investing for Safety, Income, and Growth

• Income vehicles typically pay dividends, or interest yields, or monthly

rents from real estate. For income investments, you add a little risk,1
but for taking on that risk, you’re also getting more income than from
ultrasafe investments.

• Growth investments are riskier still, but with even greater potential.
You buy a growth investment for long-term capital appreciation.2 Many
publicly traded stocks—specifically start-up companies, initial public
offerings, and some tech stocks—are thought of as growth vehicles.

● These three objectives—safety, income, and growth—can be plotted on a

triangle.

SAFETY INVESTMENT
Low-risk, low-returns

Portfolio
Mix

INCOME INVESTMENT GROWTH INVESTMENT

Moderate-risk, moderate-returns High-risk, high-returns

● As you move toward one corner of the triangle, you move away from the
other two. This illustrates the trade-offs you must make. If you want
something safe, it won’t grow or produce much income. If you want an
investment that’s likely to grow, you must accept that it won’t be as safe,
which means the outcome is not guaranteed.

1 For example, stocks can stop paying dividends, bonds can default, and renters can miss
payments.
2 When you buy a stock, you own a share of the company. When you buy a growth investment,
you are investing for a longer time frame to pursue the potential for a higher return.

49
 ● When does it make sense to put money in each category? It depends on
your time frame and objective.

• If you know you’ll need to spend the funds soon (within the next three
to five years), it probably makes sense to keep them in a stable, safe
investment type. This helps preserve your retirement savings, putting
the money at your disposal without the risk of a decline in value.

• Growth investments are more aggressive, and you typically concentrate

investments there earlier rather than later in your retirement savings
cycle. For growth, you must have a distant horizon—generally 10 years
or more, but certainly a minimum of five.

• Income investments, such as bonds, are a fairly solid investment

that can provide a source of cash flow after your days of collecting a
paycheck are past.

BONDS
● A bond is a loan. Here’s how it works. If you were starting a corporation,
suppose you ask your friend Rachel to lend you $10,000 for 10 years. You
agree to pay her 4% a year. The $10,000 is her principal. The 4% is called
the coupon rate, and you send her $400 each year.

● At the end of the 10 years, assuming you’re a viable company and still in
business, Rachel gets her $10,000 back. She knows exactly what income
she will get and when she will get her principal back. But what happens if
Rachel wants to sell her bond before the 10 years is up?

● She goes to market, and what she gets for her bond will depend on where
interest rates are. Suppose she’s owned her bond for five years. The market
looks at her bond paying 4% with five years left to maturity and compares
it to other bonds that also have five years to maturity. If interest rates have
risen and new five-year bonds are paying 6%, while Rachel is paying 4%,
then the market will probably not value her bond at its full face value of
$10,000. She might get about $9,200 for it.

● Professional bond traders try to take advantage of potential changes in

market sentiments and interest rates by trading in and out of bonds. But
most people are not professional bond traders.

50
 Lesson 6 Investing for Safety, Income, and Growth

● For the average person, there are two ways to incorporate bonds into your
retirement portfolio: either invest in bonds through mutual funds that
specialize in bonds and contain a large
basket of them or purchase individual To build your retirement
bonds directly through a broker. portfolio, you’ll need to
outline your objectives
● Individual bonds are a particularly useful and cash flow needs
investment as you get near retirement, and then choose
because you can tailor your bond holdings investments that fit
to align to your specific cash flow needs. those objectives.

THE RELATIONSHIP BETWEEN RISK AND RETURN

● Riskier investments have the potential to earn returns that are higher than
safe investments.

● Let’s use a risk scale that goes from one to five, with one representing the
safest investment and five representing the riskiest. At each end are the two
most important questions you can ask before making an investment:

THE RISK SCALE

The Basis for Asset-Liability Matching

Can I Can I lose

lose any
1 2 3 4 5 all my
money? money?

• Can I lose any money? (If it is money you will need to spend in the next
few years, you want the answer to be no.)

• Can I lose all my money? (If this is money that you’ll need to live off
the rest of your life, you want the answer to be no.)

● When you buy an individual stock, can you lose all your money? The answer
is yes. History is filled with stories of many companies that did not make it.

51
 ● So how can you invest in stocks without taking on a level-five risk? You can
invest in a wide selection of stocks rather than betting on one company. You
do this by buying mutual funds or exchange-traded funds—and specifically
a type of fund called an index fund, which is a basket of stocks designed to
replicate the aggregate performance of an entire category of companies.

● The S&P 500 index offers one example. This is a measure of the collective
performance of 500 of the largest US-based publicly traded companies. You
can buy a mutual fund that owns all 500 of these stocks. So, by investing in
the fund, you own a small sliver of every one of those 500 companies.

● Now let’s ask the level-five risk question again: When invested in an S&P
500 index fund, can you lose all your money? Theoretically, for that to
happen, all 500 companies would have to go out of business. And if that
happens, there are likely much bigger problems to worry about.

● By diversifying, you shift your risk from level five to level four—because
while one stock can become worthless, when you own 500 stocks your risk is
diminished. You can still experience tremendous ups and downs, of course.

REAL ESTATE
● Not every investment falls neatly into the category of safety, income, or
growth. Take real estate, for example.

● If it’s rental real estate, you expect cash flows in the form of rent. But you
might also expect some growth on the investment. Just as with stocks,
though, a single property can turn out great, or horribly! If you get a bad
renter and need to make a slew of repairs because of them, your rental
property might not deliver much cash flow after all expenses.

● During the home-mortgage craze some years ago, many people jumped
into real estate. The market was hot. Many of these investors were novices
with little experience. And when the market turned upside-down, many of
them let go of their properties.

● Watch out for jumping into any investment fad. If it looks like you can’t
lose—and everyone is talking about it—then it’s probably not the time to
get in. After all, if everybody knows, what’s your edge?

52
 Lesson 6 Investing for Safety, Income, and Growth

DIVIDEND-PAYING STOCKS
● If you have a growing company, it’s likely you will take most of your profits
and reinvest in the company. The end result is that if the company grows,
the stock price rises.

● If you have a more mature company, you may take some of your profits
and pay them out to the shareholders in the form of a cash distribution, or
dividend. In this case, the stock price might not increase as much, but the
owners receive cash flow.

● Dividend-paying stocks typically fall more toward the income corner of the
investment triangle rather than the growth corner.

● There are both qualified dividends and nonqualified dividends. Qualified

dividends, from most publicly traded companies, are taxed at a lower
tax rate than other forms of investment income. So, in taxable brokerage
accounts, there can be a tax advantage to owning investments that pay
qualified dividends versus owning investments that generate nonqualified
dividends, or taxable interest income.

ANNUITIES
● An annuity is a contract issued by an insurance company. Technically, it’s not
an investment; it’s a form of insurance. The insurance company is guaranteeing
an outcome in the form of a death benefit or future income stream.

● There are many types of annuities, such as fixed annuities, which work
most like a certificate of deposit; fixed-income annuities, which pay out
a guaranteed income for life; and variable annuities, which allow you to
invest inside the annuity in mutual fund–like accounts.

● The main thing to understand is that annuities are insurance products.

Your primary reason for purchasing them is to protect your principal or
future income or a death benefit amount that will go to your heirs. You
pay a fee for this protection.

● In terms of the investment triangle, an annuity can be plotted somewhere

along the line between safety and income.

53
 ● The insurance company has the same things to invest in that the rest of the
world has: stocks, bonds, real estate, etc. So when you own an annuity, there is
nothing magic happening other than the insurance company is wrapping some
type of guarantee around the investments—and you are paying for that wrapper.

● When used in the right situation, as part of a plan, an annuity can add
a layer of security to your future retirement income. But some annuities,
especially variable annuities, can have high fees and complex benefits that
are hard to understand. And most annuities have large surrender fees, so
it can be difficult to get out of them. Do your homework and read all the
fine print before purchasing an annuity.

ALTERNATIVE INVESTMENTS
● An alternative investment is essentially anything that is not a stock,
a bond, real estate, or an annuity—for example, currency trading,
commodities, or precious metals (such as gold).

● Almost every investment or investment strategy has an appropriate

use, including alternative investments. For example, if you have a large
corporation that buys products overseas, you need a currency-trading
strategy to protect against currency changes.

● Most alternative investment strategies started because they filled an

objective for a certain narrow type of clientele—often a corporate clientele.
But for the average person saving for retirement, most alternative strategies
are not appropriate.

ACTIVE VERSUS PASSIVE INVESTING

● Active investing is where you are trying to pick the best stocks or best
trading strategy. If you buy an actively managed mutual fund, the fees are
higher. They must employ additional research analysts and trade more,
and that adds to costs.

● Contrast that with an index fund, which is a passive strategy. The index
fund owns all the stocks that fall in a specific category and doesn’t try
to trade in and out of them. When you compare the results of actively

54
 Lesson 6 Investing for Safety, Income, and Growth

managed funds with passive, or index, funds, research has shown that over
long periods of time—after fees—you are almost always better off using
passive strategies that do not try to time the markets or do stock picking.

● If you are hiring a professional advisor, find out what approach he or she
uses. If it’s an active trading strategy, be aware that it may cost more and
not deliver superior results.1

SETTING EXPECTATIONS ABOUT RETURNS

● Most people tend to focus on either recent returns or averages, and both can be
misleading. Instead, look at rolling returns—what outcomes have been over the
best five years and worst five years, over the best 10 years and worst 10 years, etc.

● For example, if you look at the S&P 500 index from 1972 to 2016 and
break it into five-year time periods, you would have earned more than 29%
a year over the best five years. But over the worst five years, you would
have lost 6% a year.

● In the same way, the best 20 years produced average annual returns of
more than 18%, while the worst 20 years produced average gains of a little
more than 6% per year.

● If you invested $100,000 at the beginning of the best 20 years,2 it would

have grown to more than $2.7 million. That same $100,000 invested at
the beginning of the worst 20-year period3 grew to only $320,000.

● You did exactly the same thing, and both results were positive, but the
outcomes were very different. In order to plan for such varied outcomes,
you can’t rely on getting only the best results. Instead, you should rely on
investing principles, like those that have been outlined here.

READING
Cain, Quiet.

1 Also, be aware that there is a distinction between paying for active management versus paying
an advisor to set up an investment plan and manage that plan for you.
2 the 20 years ending in March 2000
3 the 20 years ending in May 1979

55
7
THE FIVE-YEAR
COUNTDOWN TO
RETIREMENT
 Lesson 7 The Five-Year Countdown to Retirement

T he stakes get higher as you draw closer to retirement. There are a lot of
moving parts to think about, and you have to make a series of decisions.
This is true both in the five years leading up to retirement and during the
first five years of this next stage in your life. Many of the decisions will be
irrevocable and permanent. For this reason, the period is sometimes referred
to as the retirement red zone, where avoiding big mistakes is extremely
important. This lesson covers some of the things you’ll want to consider in the
five years prior to your anticipated retirement.1

COORDINATING MOVING PARTS

● Some of the moving parts prior to retirement include such decisions as

• when to take Social Security,

• which of your financial accounts to draw down,

• how much to take out each year,

• whether or not you should downsize, and

• whether to take your pension (if you have one) as a lump sum or as an
annuity payout.

● In addition to these decisions, many age-related regulations kick in around

this time frame. For example, if you’ve invested in a 401(k) or 403(b) plan,
normally you’ll pay a 10% penalty tax on withdrawals taken before age 59½.
But a special provision in the law states that if you leave your employer the
year you turn 552—and if you leave your money in your employer plan—you
can start to withdraw the funds without incurring a penalty.

● But if you roll over funds from an employer retirement savings plan to an
individual retirement account (IRA), you will void your ability to take out
the funds penalty-free before age 59½.

1 The ideal time to start planning is even earlier, about 10 years before retirement. But as
humans, we tend to be procrastinators.
2 For certain types of government workers—specifically those deemed public-safety employees,
including firefighters, police, and emergency medical responders—this penalty-free access kicks
in even earlier, at age 50.

57
 ● So, if this early-access provision applies to you, it might make sense to leave
your funds in place, in your employer’s plan.

● Another area with many age-related rules is Social Security. Normally,

the earliest you can claim a benefit is at age 62. But if you are a widow or
widower, you might be able to claim a Social Security benefit as early as
age 60. Even so, if you do take the benefit early, it will be at a permanently
reduced rate from the maximum benefit.

● Just because you can claim a retirement benefit early doesn’t mean that
you should. Most high-income-earning Americans without a serious health
condition are better off claiming later.

● If you’re married, it almost always makes sense to have one spouse—

usually the highest earner of the two—wait until age 70, because that
benefit (the highest-paying Social Security benefit possible) becomes the
survivor benefit for a surviving spouse.1

● Another factor to consider is the earnings limit rule, which is triggered if

you claim Social Security before your full retirement age—for most, this
is in the 66 to 67 age range2—and continue to work. If you claim Social
Security benefits before this age and continue to work and earn in excess
of the earnings limit, then your Social Security benefits will be reduced,
in some cases to zero, depending on how much you make. However, once
you reach full retirement age, the earnings limit no longer applies to you,
meaning that you can continue to work and collect full benefits.

Every person should run their options through a calculator

before claiming a Social Security benefit. There are various
online calculators, such as a free one called Open Social
Security.

1 When one spouse in a married couple passes, only one monthly benefit continues after that.
The one that continues is the larger monthly amount.
2 Social Security defines your full retirement age by your date of birth. You can look up your
exact full retirement age on the Social Security website. You can also find the current year’s
earnings limit there.

58
 Lesson 7 The Five-Year Countdown to Retirement

● You also have health-care costs to consider in retirement. At age 65, most
people who have lived and worked in the United States will qualify for
Medicare, the government-provided health insurance benefit.

● Medicare Part A, which covers most hospital stays, is free if you or your
spouse have paid Medicare taxes for 40 quarters. But you pay a premium for
Medicare Part B, which covers doctor’s visits and other preventive services.
And if your income is high, you’ll pay a higher premium for the Part B plan.

● But many people plan on retiring before age 65. In that case, you’ll need to
carefully plan out your health-care costs. Depending on the current laws, you
might qualify for a tax credit to help pay for your health insurance premiums.

● Another tax-advantaged strategy relates Many retirees have

to how and when to begin drawing out of some discretion over
your various account types. when they begin a
● It used to be that you had to begin taking pension or start Social
withdrawals from tax-deferred retirement Security or withdraw
savings accounts by age 70½. That’s now from a 401(k)—and
age 72.3 If you don’t withdraw at least the the timing of these
required amount each year, a penalty tax items matters.
can apply.

● At the same time, just because you have to start taking money out soon
after age 72 doesn’t mean that you should wait until then. For example,
in some years between retirement and age 72, your tax rate might be
particularly low. In those relatively low-tax years, it often makes sense to
make withdrawals from your tax-deferred retirement accounts even though
you are not yet required to.

PROJECTING YOUR RETIREMENT INCOME

● To coordinate the moving parts you’re likely to contend with during the
retirement red zone years—and see which governing rules apply to you—
you should project your likely retirement income.

3 Technically, the withdrawal must occur by April 1 of the year after you reach age 72.

59
 ● You can start with online calculators. But the more complex your situation
is, the more it might pay to seek professional advice at this stage. The
objective is to calculate how much after-tax cash flow you’ll have, how long
it will last, and what strategies you can use to help reduce taxes and risk.

● However you decide to proceed, update your plan annually during the red
zone years.

BUILDING UP CASH RESERVES

● One of the first action steps you should take during your red zone years
is to build up cash reserves. Cash reserves are not savings inside a tax-
deferred retirement account; they’re cash in a money market or savings
account. Basically, it’s the same thing as an emergency fund: an account
you can get to easily without incurring taxes or penalties.

● There is this tendency to think that once retired, all your money is
accessible and you no longer need an emergency fund. But that isn’t
quite true.

● A lot of paperwork typically takes place around retirement. Delays happen.

There are cases where people thought they were going to start collecting a
pension check or Social Security check and it didn’t come on time. Having
extra cash helps you get through the transition.

● There are also expenses that people routinely forget to include in their
retirement budgets, such as home repairs, auto purchases, and dental
expenses. If you have savings on the side, you won’t be stressed when these
extra expenses pop up.

ALLOCATING INVESTMENTS
● Next, you’ll want to look at the level of risk you are taking on in your
investments. There are people who get within a year of retirement and still
have 90% of their investments in stocks or other growth investments.

● Some of these people who keep aggressive investments right up to

retirement get lucky. Their risky bets pay off, and they are able to retire on
time. And at retirement, they make the switch to more balanced portfolios.

60
 Lesson 7 The Five-Year Countdown to Retirement

● But what if you aren’t lucky? What if the stock market declines just as
you’re entering retirement? If you are willing to delay retirement in the
event your investments slump, then taking on more risk for a longer period
of time is an option. It’s not the only option, though.

● To keep things simple, let’s assume that your 401(k) retirement plan is
your only investment and that you have two choices: a stock index fund
and a stable value fund. A stable value fund is considered a relatively safe
investment choice, like a money market fund or savings account.

● Here’s the preferred approach: At 11 years prior to retirement, you’ll have

100% of your investments in the stock index fund. But at 10 years out,
you’ll move 5% into the stable value fund if stocks are having a good year.
The next year, you’ll move another 5%. And you’ll continue this pattern so
that by the time you get one year from retirement, you’ll have about 60%
remaining in the stock fund and 40% in the stable value fund.

● However, if stocks are down one year during the transition, you wouldn’t
change your allocation right at that time. Instead, after the stock market
bounces back, you’ll move a little more—maybe 10%—into the safer
choice to make up for the skipped year. This will give you some flexibility
to move your allocations in the right direction while avoiding selling
growth investments during down years.

● The key to any investment allocation is to know what you are doing and
why. If you choose to take on more risk right up until retirement, then you
must acknowledge that this strategy might be dangerous—and it might
not pay off. So you’ll need a backup plan, such as working longer.

● Or you can follow a more disciplined plan and start making small changes
about 10 years out. You might give up some future investment gains by
doing so, but you will be creating a more certain outcome. Those are the
trade-offs you have to weigh.

61
 EXPLORING RETIREMENT LIFESTYLES
● As you get about five years from retirement, you’ll want to start exploring
retirement lifestyles. Do you want to live in a different state—perhaps one
with a lower tax rate? Do you want to move closer to family? Or maybe
away from family? What activities do you see yourself engaging in?

● If you are considering moving to a different state, Kiplinger has an online

tool that allows you to see the states with tax systems that are most favorable
to retirees. This tool also allows you to select and compare up to five states.

● Another retirement option to explore is living abroad. Many foreign

countries offer quality health care and lower costs of living to large US
expat populations. Planned right, it’s possible to enjoy an incredible
retirement lifestyle on much less than what it would cost in the US. Check
out [Link] for a wealth of resources on expat living.

● Or you might want to think about working part-time in retirement—not

because you necessarily have to, but maybe you want to. For example, you
could follow a passion and work at a golf pro shop, teach ski school, take
up film editing, start acting, or begin tutoring.

SIMPLIFYING YOUR FINANCIAL LIFE

● The next thing to consider during your red zone years is how to simplify your
financial life. People often collect accounts during their accumulation years—a
retirement plan from a few employers, an IRA or two, maybe several savings
or investment accounts in different places. You might want to consolidate
retirement and other savings accounts. In retirement, all of these things have to
work together toward one goal: creating reliable retirement income.

● When you consolidate accounts, it becomes far easier to manage

investments toward a common goal. In addition, you can often reduce fees.
And if you move or need to change beneficiaries, it’s much simpler when
you have one place where you can do all the paperwork.

● As far as the need to consolidate, consider the extreme example of Roger

and Beth, a couple who maintained 29 financial accounts, including stocks
they inherited, numerous IRAs, retirement plans from previous employers,
and annuities.

62
 Lesson 7 The Five-Year Countdown to Retirement

● Each year, Roger and Beth opened a new IRA account. They thought this
was required to make annual contributions. It is not. Once you open an IRA
or Roth IRA, you can continue to make contributions to that IRA account.

● They also thought that if they moved money from one IRA to another,
it would incur a tax liability. That is a common myth. But what Roger
and Beth didn’t realize is that when you transfer—or roll over—money
directly from one type of retirement plan to another, that is not counted as
a taxable withdrawal.

● Think of it this way: An IRA is not itself an investment. It’s a type of

account that designates how the money inside of it will be taxed. As long
as you follow the rules when transferring money from one IRA to another,
the funds are not taxed because the money stays sheltered.

● And you can roll retirement plans from former employers into IRA
accounts. When it is money coming from an employer plan to an IRA, the
transfer is called a rollover.

● Most tax-deferred retirement accounts, such as 401(k)s and 403(b)s, can be

consolidated in one IRA account at one institution. And the consolidation
is not a taxable event.

● Now, although you can consolidate your own accounts—and your spouse
can consolidate his or hers—you can’t pool them together into one joint
IRA account. Instead, retirement accounts must be titled in one person’s
name. Then, you’ll use a beneficiary designation to spell out who that
account should go to if something happens to you.

● In Roger and Beth’s situation, they each had about six traditional IRAs
and four Roth IRAs. A Roth IRA is a special type of retirement account
where the funds grow tax-free and, when you follow the rules, can be
withdrawn tax-free in retirement. Roger also had a 401(k) from a previous
employer, and Beth had a 403(b) from a previous employer.

● Two of their IRA accounts were invested in annuities. Most annuities

incur surrender charges if the annuity is canceled within 10 to 15 years of
purchase. Roger and Beth were past the 10-year threshold, so they were
able to exit out of their annuities and move the funds into a regular IRA.

63
 ● By the time Roger and Beth were done consolidating, they each had one
traditional IRA and one Roth IRA.

● Next, Roger and Beth had to tackle their nonretirement accounts.

● Roger had an employer stock-purchase plan, and Beth owned three

individual stocks that she’d inherited. She’d also inherited a Morgan
Stanley brokerage account invested in other stocks and mutual funds.
Additionally, the couple was investing money in a Vanguard mutual
fund each month, and they had other money managed by Fidelity. That’s
seven different accounts! They received 1099 tax forms from each of these
accounts every year and had to keep track of it all.

● Roger and Beth didn’t want to sell their investments because their holdings
had gained in value over time and selling them would trigger capital gains
taxes. What they didn’t realize is that they could have safely undertaken an
in-kind transfer, in which the investments are transferred from one firm to
another without being sold. The benefit is no realized gains and, therefore,
no immediate tax consequences.

● Ultimately, Roger and Beth discovered Before you

that they were able to consolidate their move money,
nonretirement stock and mutual fund always ask
accounts into one joint brokerage account about the tax
without selling a single investment. Now implications.
it would be much easier to manage these
investments, and tax time would certainly be
easier, too.

READING
Blanton, “The Rise of Financial Fraud.”

Haskins and Prescher, The International Living Guide to Retiring Overseas on a

Budget.

Social Security Administration, “Retirement Age and Benefit Reduction.”

———, “Retirement Benefits: Receiving Benefits while Working.”

64
 8
HOW TO
MAKE YOUR
RETIREMENT
SAVINGS LAST
N o retiree who makes a mathematically sound withdrawal plan—and
sticks with it, making necessary adjustments along the way—should ever
run out of money. This lesson covers four approaches to making a withdrawal
plan that lasts: the guaranteed-income approach, the income-only approach, the
total-return approach, and the asset-liability matching approach.

THE GUARANTEED-INCOME APPROACH

● The guaranteed-income approach provides a surefire way to make sure
that you don’t run out of money. But most people don’t like this approach
unless their employer provides it for them.

● In the 1970s or earlier, once you retired, you received a monthly pension
check. If you’d also paid into Social Security, then you received both. And
between those two income sources, you could hope to live comfortably.

● Today, so few companies offer pensions because the cost is high to provide
guaranteed income for life. If pension investments underperform, then the
employer has to pay the difference. This can wreak havoc with a company’s
financial statements and in meeting the cash flow needs of the company.
Most employers have decided to do away with pensions so that they don’t
have this hassle and don’t bear this risk.

● So, guaranteeing income for life is not easy or cheap. However, you can
secure a guaranteed-income stream by buying an annuity—which is a
contract with an insurance company whereby you put down a lump sum
and the company provides some type of guarantee.

● With an income annuity, the insurance company guarantees the amount of

the future income payments you’ll receive for life. You don’t bear the risk
of running out of money; the insurance company does.

● The guaranteed-income approach is a fail-safe way to ensure you have

income for life. But it’s not for everyone. Your payments are typically
fixed, so they may not keep up with inflation. And an annuity is a contract
that you enter into, and it can be difficult to get out of it if you change
your mind.

66
 Lesson 8 How to Make Your Retirement Savings Last

● How much future income you can get depends on such factors as how old
you are at the time you start; whether the income annuity pays out over
your lifetime or as a joint payout, where it covers two lives, such as for you
and a spouse; and whether you add extra features, such as a death benefit.1

● There are annuities where you put down a lump sum and the income starts
right away, and there are also deferred-income annuities, where you add a
sum today and it guarantees the income you get at a set point in the future.
This product can help protect you against the impact of a major market
downturn that occurs near your planned retirement date.

● Annuities that guarantee future income can be solid products to use in a

withdrawal plan. But with a variable annuity, the money inside the annuity
is invested in subaccounts, which are basically mutual funds, which allow
you to potentially capture some upside in a strong stock market.

● Variable annuities are often presented as Swiss Army knives that do

everything. They supposedly provide future income, the potential for
growth, and a death benefit. But many variable annuities put all kinds
of extra features on the products, and the fees often add up to 3% to 4%
per year. It’s like taking a normal mutual
fund account and then adding a 4% fee on Putting all your
top of it. financial assets
into annuities is too
● While countless surveys show that among extreme for many
a retiree’s biggest fears is running out of people. The good
money, many people won’t buy an annuity news is it’s not an
when presented with one. This is because all-or-nothing choice.
once you purchase an income annuity, You can put some
you’re usually locked into the contract and money in this strategy
can no longer access your principal at will. and also use some of
Yet that is the type of discipline it takes to the other approaches
make a lasting withdrawal plan.2 in this lesson.

1 a guarantee as to how much is paid out to a named beneficiary

2 In the book Die Broke: A Radical, Four-Part Financial Plan, the financial advisor Stephen
Pollan and his coauthor Mark Levine recommend putting pretty much all of your financial
assets into annuities to avoid worrying about investment markets during retirement.

67
 ● Along with annuities, pensions and Social Security also fall into the
guaranteed-income approach strategy. The biggest mistake many retirees
make in this area is that they compare their savings choices based on a
potential for rate of return.

● When you are accumulating assets, usually you want to focus on options
that maximize returns. But when getting near to retirement, you need to
look at various investing risks and how your investment decisions may
protect you against these risks.

● It’s best to look at guaranteed-income decisions in terms of how they can

protect your income for life rather than the classic trap of comparing them
to what other, riskier investments might earn instead.

THE INCOME-ONLY APPROACH

● Under the income-only approach to retirement savings, you plan to live off
your investments’ interest and dividend income.

● First, let’s consider dividend-paying stocks. As an example, there are a set

of companies known as the “dividend aristocrats” that have consistently
increased their dividend payout for 25 consecutive years or more. Some of
the companies on the list in 2020 are 3M, ExxonMobil, and Pepsi. The
yield on an exchange-traded fund owning this collective group of stocks
was less than 2% in 2020. With a 2% yield on $1 million invested, you’d
have $20,000 a year of income to spend.

● If you begin looking for stocks or other investments that pay more than
2%, they can be found, but those higher yields often come with more risk.

● Take a closed-end fund, for example. With a normal mutual fund, you
buy and sell shares of the fund at any time. This is an open-end fund.
With a closed-end fund, the fund issues only so many shares, and they
trade on the secondary market like a stock. When you buy a share, you are
purchasing from another investor who is selling it.

● Closed-end funds will have a defined objective, and many of them are
income-generating and will often pay higher yields than the dividend
aristocrats. One strategy they use to accomplish this is leverage, where the
closed-end fund buys dividend-paying stocks and then borrows against the

68
 Lesson 8 How to Make Your Retirement Savings Last

portfolio to buy more stocks. This works great so long as the interest rate
on the loan is less than the yield on the stocks. But if interest rates go up
too much, the value of the funds will also drop.

● This is an example of the hidden risks that sometimes lurk behind the
scenes in an investment. When interest rates are low, it can be tempting
to go out and chase higher-yielding investment options. If you’re an
experienced investor, great! But if you aren’t, watch out for that rookie
mistake of buying something just for the yield without understanding the
underlying risks.

● Overall, for super-high-net-worth individuals1 who don’t ever need to

touch the principal of their investments, the income-only approach is
probably fine.

● If someone absolutely needs to maximize current cash flow, the higher-

yielding choices can also be considered. But if you are a novice investor,
you might want to hire an advisor to help you construct the right portfolio.

● Overall, most people can achieve a more reliable outcome by using

alternatives to the income-only approach, such as the two approaches that
follow.

THE TOTAL-RETURN APPROACH

● With the total-return approach, you build a portfolio of stock and bond
index funds and determine how much you can reasonably withdraw each
year without taking on the risk of running out of money.

● If you expect your portfolio to average a 6% to 7% annual return, then you

might estimate that you could withdraw 4% a year and continue to watch
your portfolio grow.

● At retirement, you would withdraw 4% of the starting portfolio value and

then, in subsequent years, keep taking that amount out and gradually
increasing it with inflation regardless of market performance in any year.
This type of withdrawal plan is referred to as a systematic withdrawal.

1 mostly people with $5 million or more in invested assets

69
 ● When you withdraw funds using a systematic approach, you usually
liquidate investments to keep your portfolio mix static. For example, if you
were invested 60% in stocks and 40% in bonds and taking $10,000 out,
you’d withdraw $6,000 from stocks and $4,000 from bonds.

● You would also rebalance from time to time. So, if stocks grew to 65% of
the portfolio one year, you might take all $10,000 of that year’s allocation
out of stocks to bring the portfolio back in balance to your target
allocation of 60% stocks and 40% bonds.

● Additional research has contributed to the idea of dynamic-withdrawal

rules. For example, in a year when your portfolio has a negative return, you
might not add inflation into your allocated withdrawal.

● On the flip side, if your portfolio value grows quickly and you are
withdrawing 2% or less a year, you might take out an extra chunk
that year.

● The primary challenge with the total-return approach is behavioral. When

markets go down, it’s scary. It becomes hard to stick to the approach. And
that’s precisely when you must stick to it.

● Some mutual fund providers will implement the total-return approach

with systematic withdrawals for you. They are called retirement-income
funds. Financial companies that offer such funds generally use diversified
portfolios and a set of rules that determines how much income the fund
can distribute each month.

THE ASSET-LIABILITY MATCHING APPROACH

● With asset-liability matching, you try to match future cash flows coming
in from investments so that the cash is available at the right time to cover
your upcoming liabilities1 or expenses. Sometimes referred to as liability-
driven investing, asset-liability matching comes out of the pension and
corporate finance worlds.

1 A liability is something you owe.

70
 Lesson 8 How to Make Your Retirement Savings Last

● Pension plans are obligated to cut a lot of retirement paychecks into the
future, so these plans try to pick investments that will deliver the cash
flows at the point in time when the money will be needed. Sometimes this
is described as a bucketing, or time-segmented, approach.

● The idea behind asset-liability matching is that safe investments are

squirreled away so that you can use them for withdrawal early in
retirement, and riskier investments are left to accumulate in the portion of
your portfolio that has more time to work for you.

● Picture a person who will retire in five years and needs to withdraw
$50,000 a year. Today, this worker might buy a safe investment, such as
a bank certificate of deposit or a bond that will mature in five years and
be worth $50,000 at maturity. So this person’s first year of withdrawals
during retirement will be 100% covered by this investment that matures in
the same year.

● Now extend this process. The upcoming retiree also buys a CD or bond that
matures six years out, seven years out, and eight, nine, and 10 years out. This
strategy of having bonds or CDs maturing each year is called laddering.

● When the retiree gets to retirement, he or she now knows that the first five
years of withdrawals will be completely covered. Some $250,000 in future
cash flows have been secured.

● But the saver didn’t have to invest a full $250,000 at once to get there.
Instead, it might take $200,000 to $215,000 today to secure $250,000 of
future cash flows.

● Suppose this retiree has a $750,000 portfolio. With $215,000 earmarked

for the bond ladder, that leaves $535,000—or slightly more than 70% of
the retirement-savings portfolio—that can be invested in something like
stock index funds, which have higher potential returns.

● With this approach, the retiree has a 10-year runway before he or she needs
to use a single dollar from the growth, or stock, portion of the portfolio.

● During those 10 years, the growth investments are bound to have good
years and bad years. During the good years, you might skim some of the
gains off the top and add them onto your bond or CD ladder. During

71
 the down years, you won’t worry about a temporary setback because that
growth portion of the portfolio is funding longer-term liabilities—not your
near-term needs.

● There’s no guarantee that the asset-

liability matching approach will work The asset-liability
better than a total-return approach. matching approach
But it feels better for many retirees. gets you away from
worrying about
● We all like to think we’re logical the day-to-day and
decision-makers. But a field of study month-to-month
called behavioral finance shows that moves in the market.
for emotional reasons, we often make
illogical economic decisions.

● Asset-liability matching helps

manage emotions. In many cases,
that makes it easier to stick with the plan. And using a disciplined plan and
sticking to it are critical to long-term success.

READING
Kitces, “Dynamic Retirement Spending Adjustments.”

———, “The Portfolio Size Effect and Using a Bond Tent to Navigate the
Retirement Danger Zone.”

Pollan and Levine, Die Broke.

72
 9
PLANNING THE
GO - GO YEARS IN
RETIREMENT
I n general, retirement can be broken into
three phases: the go-go years, which
are in early retirement, generally between
As you enter retirement
and plan your go-go
years, it’s important
ages 55 and 70; the slow-go years, which to run through many
typically start somewhere in your 70s; and “what-if” scenarios
the no-go years, which usually commence before making certain
in your 80s. This lesson discusses the go- fundamental decisions
go years, illustrated by the story of Gabe about pensions, Social
and Mary. Security, annuities, and
all the other financial
GABE AND MARY considerations.

● Gabe, a construction superintendent,

and Mary, an administrative assistant in state government, wanted to retire
early—when Gabe was 62 years old and Mary was 58.

● The couple had a $200,000 inheritance from a few years back, and they’d
put all if it in deferred-income annuities.1 They also had $400,000 in
Gabe’s 401(k) retirement savings plan. They owned a home and had a
mortgage on it, but also about $350,000 in home equity. Each would
be eligible for Social Security, and Mary would receive a pension from
the state.

● Mary and Gabe wanted to live on about $80,000 a year after taxes. And
they wanted to make sure this amount per year was secure for life.

● Could they retire early?

● Their first concern was health insurance. So long as Mary was employed,
her job covered almost 100% of the couple’s health insurance costs.

● Medicare2 coverage doesn’t kick in until age 65. Since neither one of
them was of qualifying age, it would cost them $1,500 a month for health
insurance if both were to retire early.

1 a type of insurance contract that pays fixed income in retirement

2 the federal government health insurance program

74
 Lesson 9 Planning the Go-Go Years in Retirement

● Gabe and Mary hadn’t built the cost of health insurance into their
retirement budget. After factoring this in, they realized that Gabe would
need to work until age 65, when he at least would be covered by Medicare.

● It would be even better if Mary also worked until she was 65. If she retired
early, her health insurance would still cost the couple $900 a month, or
more than $10,000 a year. But they didn’t want to wait several years. They
said they’d rather find a way to pay out of pocket for health insurance so
that they could both retire at the same time.

● To come up with the extra money, they agreed to eliminate their mortgage
by downsizing. They sold their home and redeployed the cash to buy a
smaller home with lower maintenance costs and lower property taxes.

● Next, they figured out what their income stream and cash flow would look
like in retirement. Gabe would work through the end of the year in which
he reached age 65. At that time, his deferred-income annuity would begin
paying the couple $8,000 a year.

● Mary would be 62 and eligible to start taking her $14,000-a-year pension.

Her birthday is in July, so it would provide only a half year’s income, or
$7,000, that first year. But she would receive $14,000 each year thereafter.

● Mary would also start taking Social Security early. Because her birthday
falls at midyear, that means they estimated she would receive about $7,000
of Social Security income the first year. Gabe would wait and claim Social
Security later.

● Altogether, in the first year of retirement, Mary’s Social Security, the

pension, and the annuity added up to slightly more than $22,000 of
guaranteed income. They would withdraw the rest of what they needed
from Gabe’s 401(k) account.

● Each dollar withdrawn from Gabe’s 401(k) plan will be taxed. After taking
taxes into account, they discovered that they need to withdraw about
$72,000 from savings during the first year of retirement. That combined
with the $22,000 of fixed income provided them the $80,000 after taxes
that they desire.

75
● By year two of retirement, they expected to receive a full year of Mary’s
Social Security and pension along with the continuation of Gabe’s annuity
income. Total guaranteed income would be $33,940. In year three, their
situation would be the same as in year two, with the next major change
occurring in year four, when Mary turns 65.

● In years two through four, they would withdraw about $60,000 per year
from savings to supplement their guaranteed-income sources.

● They have one more deferred-income annuity titled in both of their names.
To maximize the amount of income they can get from this, they need to
wait until Mary turns 65 to start taking its payments. At that time, it will
pay out $6,000 a year. But since Mary’s birthday is midyear, they expect
$3,000 the first year and $6,000 each year after.

● That means in year four of retirement, they expect to have $37,422 of

guaranteed income, with that total rising again in year five, when Gabe
turns 70 and begins taking Social Security.

● By waiting until age 70, Gabe is able to take advantage of a Social Security
rule that allows you to accumulate so-called delayed retirement credits.
This means he gets a much larger monthly benefit at age 70 than he would
have received had he started taking payments at age 66 or 67.

● Gabe’s birthday is in April, so the first year he collects Social Security

payments, he’ll get eight months of checks. That year, the couple’s
guaranteed income is projected at $68,319. Now they only need to withdraw
about $23,000 from savings in order to supplement their fixed income.

● In their sixth year of retirement—when Gabe turns 71—all fixed-income

sources are finally kicking in. That’s when they will have $82,396 a year of
guaranteed income.

● Their total planned withdrawals from savings during the first six years
will add up to about $286,000. After that, they won’t need to withdraw
much in the way of additional funds because their fixed income should be
enough to cover their needs.

76
 Lesson 9 Planning the Go-Go Years in Retirement

TIPS TO HELP WITH KEY DECISIONS

● The first decision for Gabe and Mary to make was when to retire. The costs
and availability of health-care coverage can play a big part in this decision.

● If you’re lucky, you’ll have company-

provided health insurance even in Many people who
retirement, though this benefit is are preparing to
not extended to most employees. retire early are
And if it is offered, you might shocked at how
pay a much larger share of the much health
benefit’s premium than previous insurance will
generations did. cost them before
they reach age 65.
● Some early retirees plan to rely on
COBRA1 coverage, which allows you
to continue your insurance for up to 18 months
after leaving employment—if you are willing to pay for
it yourself. If you work for an employer with 20 or more full-time
workers, you should be eligible for COBRA coverage.
● If you need to buy coverage on the open market, visit the official source of
information, [Link], where you can also find cost estimates. This
is a great tool to project what you might expect health insurance to cost
you in the years before you are eligible for Medicare.

● The next decision for Gabe and Mary was when to start taking Mary’s
pension. With some plans, you receive substantially more income by
waiting until a later age to start. This was not the case with Mary’s. There
was almost no benefit to waiting until she turned 65, so the couple decided
to start receiving her pension payments when she turned 62.

● For evaluating your own pension, if you’re eligible for one, a source
of information that might help you is hosted by the financial planner
Financial Architects, LLC. On their website, you can download free

1 This refers to the Consolidated Omnibus Budget Reconciliation Act of 1985, which
introduced this post-employment insurance policy.

77
 spreadsheets for pension analysis and joint-life probability. By inputting
your data into these spreadsheets, you can compare pension choices and
evaluate life expectancy as an individual or as a couple.

● Another important decision for Gabe and Mary—and likely for you as
well—is when to start taking monthly Social Security payments. You can
use a free online calculator called Open Social Security to decide on the
best option for you.

● They also had to plan for taxes. While you are employed, your employer
will automatically deduct estimated federal and state tax obligations. In
retirement, that responsibility falls to you. And you will likely have a diverse
set of various income streams coming in from Social Security, a pension,
annuities, and/or withdrawals from tax-deferred retirement accounts.

● Your annual tax liability might change from year to year, so you will need
to evaluate your tax status on an annual basis and adjust tax withholding
amounts accordingly or set up quarterly estimated tax payments.
[Link] offers a free 1040 tax calculator, which allows you to plug
in your sources of income and estimate your tax liability for the year.

● Another transition Gabe and Mary experienced was downsizing. Can you
get a mortgage once you retire? Yes, you can. To verify your income in
retirement, mortgage underwriters will count a pension, Social Security,
and annuity income and ask to see a monthly statement showing transfers
from your investment or retirement accounts into your checking account.

● If you expect to need a new mortgage in retirement, you’ll want to start

working with your bank or mortgage broker several months ahead of time
to get everything lined up.

● What if your home is paid off? There are other ways to use home equity in
retirement. For example, you can set up a home-equity line of credit, which
provides immediate access to cash for things like major home repairs.

● Another way to use home equity in retirement is through a reverse

mortgage, which is a special type of home loan only for homeowners who
are 62 and older. With a reverse mortgage, the amount the homeowner

78
 Lesson 9 Planning the Go-Go Years in Retirement

owes goes up—not down—over time. It allows you to turn your home
equity into monthly income or use it as a line of credit.1 You can also use a
reverse mortgage to buy a home.

● You can search online for reverse mortgage calculators, plug in your zip
code, look up current limits, and see how they work.

LOOKING FURTHER AHEAD

● At age 72, you have to start taking required minimum distributions
from most retirement accounts, with the exception of Roth IRAs. While
there are no required distributions on Roth IRAs, you will have required
distributions on a Roth 401(k). To avoid this, you can roll over any Roth
401(k) funds to a Roth IRA.

● The year Gabe reaches age 72, he will want to look at his IRA balance
from December 31 of the previous year. He will then look up the IRS
divisor that corresponds to his age at the previous year-end—which ends
up being 25.6. This means that the government specified that at age 72,
the amount he must withdraw from his IRA that year is his IRA balance
from the previous year-end divided by 25.6.

● Gabe plans to have used most of his IRA to support living expenses during
the early years of retirement, before all his sources of fixed income kick in.
So he expects his required distribution to be small. For example, if he has
$150,000 remaining in the IRA at age 72, he will have to distribute $5,859
from the account that year.

● Technically, Gabe could wait until April of the following year to take his
first distribution. But if he waits, he will have two required distributions
that following year. Each distribution is considered taxable income. And
having two drawdowns in one year might result in extra taxes. So it might
not make sense for Gabe to wait.

1 Reverse mortgage terms are regulated by the government, and there is a set of rules that
determines how much you can borrow. You are also required to attend a financial counseling
session before you complete a reverse mortgage application.

79
 ● Most people will use the standard uniform IRS divisors are
lifetime table. But if you have a spouse who found in published
is 10 years or more younger than you, then tables on the IRS
you can use an alternate table, which allows website. Each divisor
you to take out a little less. The idea is that reflects an age and
the money saved needs to last not only for corresponding life
your lifetime but also across your spouse’s expectancy.
lifetime.

● If you don’t take out the required minimum distributions, you will face a
tax penalty of up to 50% of the amount you were supposed to withdraw.

● But what do you do if you don’t need all of the money you are required to
take out?

● One option is to gift the money directly to charity using a qualified

charitable distribution. And there’s a tax advantage to this. Normally,
when you take money out of your IRA, it shows up as taxable income. But
when you gift it directly to charity, it doesn’t show up as income.1

● Another option is using an in-kind distribution. This means that rather

than distributing cash from your IRA, you can distribute shares of an
investment. The amount distributed is reported on a 1099-R tax form—
and included in your taxable income—but the money stays invested.
However, now it’s invested outside of that IRA account instead of
within it.

● You can’t contribute your required minimum distributions to an after-tax

Roth IRA. But you can undertake a Roth conversion, which is where you
draw money out of a tax-sheltered conventional IRA, pay regular income
taxes on it, and then shift it to a Roth—thereby sheltering any future gains
from taxes.

● There’s also a separate set of rules that apply to inherited IRAs. When
inheriting retirement accounts—traditional or Roth—from someone who
is not your spouse, you must take out all the money within 10 years.

1 You’ll want to check the current IRS rules to see the maximum amount you can donate to
charity this way.

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 Lesson 9 Planning the Go-Go Years in Retirement

READING
Consumer Financial Protection Bureau, “Reverse Mortgage Loans.”

Financial Architects LLC, “Resources.”

[Link] Website, [Link]

KJE Computer Solutions Inc, “1040 Tax Calculator.”

Piper, Open Social Security.

81
10
FINANCIAL
STRATEGIES FOR
THE SLOW- GO
YEARS
 Lesson 10 Financial Strategies for the Slow-Go Years

O
O nce you’re in your 70s, you might find
that you start to slow down. You might
find yourself more content at home than out and
How can you
protect yourself
from being a victim
about. And you probably won’t spend as much of eldercare fraud?
as you have in the past, in part because you’ll
probably be shopping, traveling, and eating out The best thing you
less. It’s a normal transition from the earlier can do is involve
go-go years of retirement. This lesson covers trusted family
some important aspects of what are known as the members and
slow-go years. outside advisors
long before
JOHN AND CAROL you need them.
Discuss your
● John owned an auto dealership, which he sold concerns openly.
when he was in his mid-60s. He invested the And consult with
money that he made from the sale and retired. an attorney to get
Carol and John owned a home in a beautiful your legal affairs
location, with no mortgage debt. They lived in order.
off of monthly Social Security payments and
monthly withdrawals from their investments. Finally, before
● John and Carol enjoyed their go-go years. adding anyone—
But unfortunately, Carol was diagnosed with even a beloved
cancer in her early 70s and passed away. family member—to
your financial
● Over time, John decided that the large home accounts, deeds,
he had owned with Carol was too much for and other assets,
just him. He said he wanted to sell the house make sure that
and buy a condo. He wanted to buy the condo you understand
first (he was looking at a price point of about the potential
$300,000) and then list the house so that he consequences.
didn’t get stuck renting during the transition. And if a family
member asks you
● John had plenty of investments that he could to sign anything,
liquidate to pay cash for the condo. And he consider reviewing
estimated that he would make more than the document with
$500,000 on the house itself when it sold. an attorney.
But because his investments had done quite

83
 well over the years—essentially Aging research has found
doubling—liquidating $300,000 that we experience a 2%
of the portfolio would realize decline in financial literacy
$150,000 in capital gains. That each year after age 60.
meant incurring $30,000 in But our confidence in our
extra taxes. financial decision-making
does not decline. This puts
● Another option was to take out us at risk of making poor
a home-equity line of credit on financial decisions later in
his existing house and use that to life. You can help guard
make a substantial down payment against this by assembling a
on the condo. He’d easily qualify group of people you trust as
for a small mortgage to cover the you head into retirement.
rest of the condo’s cost. And when
John’s home sold, he could use the
proceeds to retire the home-equity line and pay off the small mortgage on
the new condo. After comparing interest rates and fees on his options, John
determined that this was the easiest and most economical option.

● Years later, when John reached his late 80s, he wanted to move into a
retirement community. His health was fine, but he wanted to feel secure in
knowing that if something happened to him, he would be in a place where
care was readily available.

● John was looking at a type of retirement setting called a continuing care

retirement community (CCRC).1 He found one that required a $295,000
down payment, and he was charged $3,000 in monthly dues. Cleaning and
most meals were included, and the community offered social and learning
opportunities. It was equipped to handle all levels of continuing care, so if
John developed medical needs, he would not have to move.

● Just as he had done before, John worked through the best way to finance
the transition. He wasn’t able to take out a mortgage to cover the buy-in
to the CCRC, but he was able to use a home-equity line of credit on his

1 There are different price points and payment plans for CCRCs. If you’re reviewing a CCRC
agreement, you might want to ask an attorney to review it, too.

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 Lesson 10 Financial Strategies for the Slow-Go Years

existing residence—along with a pledged asset line of credit. John bought

into the CCRC and moved in. Then, he listed his condo for sale. When
the condo sold, he paid off the lines of credit.

● But why would John opt to borrow against his portfolio instead of cashing
in some investments?

● Since some of John’s investments had doubled in value, he would have to

pay substantial taxes on the gains if he sold them. But if he passed those
same investments onto his heirs, his children would benefit from a step-
up in the cost basis. The term cost basis usually refers to the cost of an
investment, but when passed along as an inheritance, the tax basis becomes
the investments’ market value at the time ownership transfers. So the near-
term taxes on those gains could be avoided by passing them along.

● Because John was in his late 80s, he realized that borrowing to finance his
move was probably a more economic move for him and his heirs. And the
borrowing would be temporary. If he’d had to carry the mortgage for a
longer time frame, then liquidating investments might have been a better
option, because he was paying interest on the loan. But things worked out
for him.

TITLING ACCOUNTS AND DESIGNATING BENEFICIARIES

● Most people think of wills, trusts, powers of attorney, and health-care
directives as among the most important documents in estate planning.
But two other considerations can be of great significance when passing
along property to heirs: getting the titling of your accounts and property in
order; and properly setting up beneficiary designations on your retirement
accounts, any life insurance, and any other investment accounts.

● First, let’s address how accounts and property can be titled. John had sold
his auto dealership and invested the money in an account jointly titled in
his name and Carol’s. When Carol passed away, the account reverted solely
to John, and this occurred seamlessly.

85
● If John were to pass away, that account would pass according to what was
in his will—if he’d prepared one. But since the account was titled only in
John’s name at that point, the account would have to go through a judicial
review known as probate: the legal process of proving the will is valid and
that assets are distributed appropriately.

● But there were other options. One was to name a designated beneficiary
on John’s investment account.1 John had four children, and he could name
them all as beneficiaries, so—with this type of designation—when John
passed, the account would be divided equally among all four children.
There’d be no need for probate; the assets would pass directly to his
beneficiaries.

● A similar designation can be made for real estate. It’s called a beneficiary
deed. In most places, you can set up your home so that you own it—and
control it—while alive. But it passes directly to a named beneficiary, or
multiple beneficiaries, at the time of your death.

● John discussed this prospect with his estate-planning attorney. The

downside to adding a designated beneficiary is that if John were to become
incapacitated, it would be difficult for one of his children to step in and
make decisions on his behalf.

● So, John asked about a power-of-attorney document, which is where you

specify who can step in and handle your financial and legal affairs if you
can’t. It’s a good idea to get this document in place. But they don’t always
function well in real life. The problem is that many financial institutions
make it difficult for you to use a power of attorney, and the process can be
tedious and frustrating.

● To avoid this hassle, John’s attorney recommended that John set up a

trust—which is a legal document that spells out how assets titled in the
trust are to be passed along. Or, if it is a piece of property, you file a deed
to make the trust the owner of the property. If you don’t do this, expect
delays and additional paperwork and costs.

1 At some financial institutions, this is called a payable-on-death registration or a transfer-on-

death registration.

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 Lesson 10 Financial Strategies for the Slow-Go Years

● John’s attorney explained that if John were to become incapacitated, the

trust would name a successor trustee who could step in and continue to
manage John’s financial affairs.

● The great thing about titling assets in a trust is that they are prepped for
an easy transition at death, and also in cases where an elder might be ill
and unable to manage his or her financial affairs. But it’s not enough to
just have a trust. You have to title things in the name of the trust.

● It’s important to check how your accounts are titled. And if the account
has a beneficiary designation, make sure it’s current.

● If you title your accounts to pass directly to someone, that overrides the
will and trust in most cases. Regardless of what your will or trust says,
a financial institution must pass the funds along according to how the
account is titled or according to the latest beneficiary designation on file.

● You might have heard of cases where a 401(k) or life insurance policy was
passed along to an ex-spouse. This is because the financial institution had
to follow the beneficiary designation on file. It’s an area where mistakes
can easily happen.

● One situation that sometimes arises is a parent adds an adult child to a

bank account as a joint account holder to help pay bills and take over in
the event something happens. In some instances, there can be quite a bit of
money in the bank account. And when the parent passes, the account now
belongs entirely to that child. If there are other siblings, that can—and
does—cause problems.

● Another pitfall to watch out for is how you title your home. Some parents
think that adding an adult child to the title is a good thing. Often, it isn’t.
Any of your child’s creditors can then go after your home. You might also
trigger some unintended tax consequences.

● Normally, if someone inherits your home, that person gets a step-up in the
cost basis when you die. For example, assume you purchased your home
for $200,000 and it’s worth $400,000 when you die. Now your heirs will
pay taxes only on any gains in excess of $400,000.

87
 ● But if you’d added your heirs to the title of the home when you were
alive, half of the property’s ownership could be considered theirs prior to
your death. In that event, your heirs might have to claim half the gains as
income on their tax return.

HEALTH-CARE EXPENSES
● There are two main categories of health-care expenses in retirement:
routine costs, such as doctor’s visits and prescriptions; and long-term care
costs, which typically begin at the point when you need help with everyday
activities, such as bathing, getting dressed, and eating.

● Medicare and Medicare Supplement

Insurance do not cover most long-term “It’s paradoxical that
care expenses. So, if you must plan for the idea of living a
these as out-of-pocket expenditures, long life appeals to
how much will they cost? everyone but the idea
of getting old doesn’t
● The big mutual fund investment
appeal to anyone.”
management company Vanguard
—Andy Rooney
worked with the benefits firm Mercer
on a report that helps us estimate
long-term care costs. Their research
showed that almost half—48%
of retirees—will encounter no
long-term care expenses. These are
people who live a healthy retirement and pass suddenly.

● At the other end of the spectrum, more than one-third, or about 37%, of
all retirees can expect to pay anywhere from a few thousand dollars up to
$249,000 in long-term care costs. And 15% of retirees can expect to pay
more than $250,000.

● You might need to pay someone to come to your home to help with the
cooking and cleaning. Many retirees can pay for this cost out of pocket.
But if you have to pay for extended medical care, you can expect your costs
to be on the high end. You’ll need to either have enough assets to cover the

88
 Lesson 10 Financial Strategies for the Slow-Go Years

expense or have good insurance in place. Or, if you plan to spend down
your assets and apply for state-level Medicaid, you’ll find that each state
has its own rules and you’ll have to check to see how to become eligible.

READING
Finke, Howe, and Huston, “Old Age and the Decline in Financial Literacy.”

Vanguard Research, “Planning for Health Care Costs in Retirement.”

89
11
SOCIAL SECURIT Y,
MEDICARE, AND
TA X STRATEGY
 Lesson 11 Social Security, Medicare, and Tax Strategy

F ew things are more complex than the US tax code—except maybe Social
Security regulations or the US health-care system. And in retirement,
you get to navigate your way through all three. But the reward for doing so
can be worth thousands, or even hundreds of thousands, of dollars. In other
words, getting it right can be one of the best investments you make.

SOCIAL SECURITY
● In the early 1980s, projections indicated that the Social Security Trust
Fund faced a serious short-term financing crisis. President Reagan set up a
National Commission on Social Security Reform, and as a result, a set of
amendments was enacted in 1983 to bring the system into balance for both
the near term and well into the next century.

● As it stands today, the Social Security system should be OK until about 2033
or 2034, or about 50 years from when the 1983 amendments were made. If
no additional changes are enacted before that time frame, then benefits will
need to be cut to about 70% to 80% of their current projected payout.

● Could another 50-year fix be put in place? Yes. Small changes in tax rates
or adjustments to the Social Security eligibility age could bring the system
into balance. Such changes were made in the 1980s, making the system
solvent without major impacts on
any one person, on average.
If you are of the
● But will the government again mind-set that
wait until only a few months out only 70% to 80%
to make changes? We don’t know. of benefits will be
Based on what has happened in paid to you, then
the past, the necessary changes start planning
to the Social Security system will today as if you
likely be made—we just don’t will get less.
know when.

91
 ● Benefit amounts aside, how do you plan for changes to the rules? Again,
the past provides a guide. In November 2015, congressional lawmakers
eliminated a strategy for claiming spousal benefits for people born after
January 2, 1954. For some dual-income couples, the impact was that they
would receive $40,000 to $60,000 less in lifetime benefits.

● Most of the online calculators programmed the new rules into their
software quickly. And it was easy to run the new numbers and make the
needed changes to your plan. If rules change again, be prepared to update
your projections and to again figure out how to adjust.

● Your Social Security benefit amount is based on four criteria: how long you
work, how much you make each year, consumer inflation, and at what age
you begin to take benefits.

● The 35 years of work history during which time you made the most money
is what’s used to calculate your Social Security benefit. Those 35 years are
indexed to inflation so that earnings from a long time ago are updated to
reflect what they would be worth in current dollars.

● This adjusted earnings history is used to calculate your primary insurance

amount, which is the amount of money you’re eligible to receive at your
statutory full retirement age, which is 67 for those born after January
2, 1960.1

● If you claim benefits before your statutory retirement age, you’ll get a
reduced benefit amount. If you wait and claim benefits later, you’ll get a
larger amount.

● You qualify for a maximum Social Security benefit at age 70, and there is
no additional financial advantage to waiting past 70 to collect.

● After you begin to take Social Security, the benefit amount will be subject
to an inflationary adjustment on an annual basis.

1 If you were born prior to this date, you have to look up your statutory full retirement age, as
it’s based on your month and year of birth.

92
 Lesson 11 Social Security, Medicare, and Tax Strategy

● If you’re thinking about starting benefits before your statutory full

retirement age, be sure to check the current Social Security earnings limit
at [Link]. If you keep working while taking Social Security—and
earn more than the allowable limit—then your current Social Security
benefit might be reduced.

● The earnings limit no longer applies once you reach your statutory full
retirement age. At that point, you can earn as much as you like with no
reduction in Social Security benefit.

● There’s also a formula that determines how your Social Security benefits
are taxed. Anywhere from 0% up to 85% of your Social Security benefit
might be considered taxable income. The exact amount depends on how
much taxable income you have from other sources.

● For married couples, there are also spousal benefits and survivor benefits
to consider. You might even be able to claim benefits based on an ex-
spouse’s earnings record—if you were married to that person for more
than 10 years, are currently unmarried, and meet a few other eligibility
requirements that you can find on the Social Security website.

● Calculating benefit options is complex, particularly for married couples.

However, online calculators quickly crunch the numbers and spit out
mathematically sound analyses.

● There are two giant mistakes people make when trying to evaluate the
optimal time to take Social Security benefits:

• People try to do the math on their own. Doing so means they might
miss some important factors. For example, many people look at the
numbers on their Social Security statement and use those to project
outcomes. But the Social Security statement doesn’t include the cost-
of-living adjustments you are likely to receive. In that case, you will be
underestimating the value of your benefit.

• If you’re married and doing the math yourself, then you might miss the
value of potential survivor- and spousal-claiming options.

93
 ● For these reasons and more, you should use an online calculator. There are
free ones, such as Open Social Security, and others you pay a fee for, such
as Maximize My Social Security.

● Keep in mind that you’re talking about a future cash flow that will
be worth $500,000 for many people, and perhaps $1 million if you’re
married. So, it pays to do your research, see what current software vendors
are available, and do the math.

TAXES
● It’s not easy to project accurate tax obligations in future retirement years.
Many retirement calculators and financial-planning software programs use
an assumed tax rate that is grossly incorrect. This is because it’s hard to
code correctly.

● Each source of income may be taxed differently. And these income sources
interact with one another. For example, if you withdraw more money from
your IRA one year, that can mean more of your Social Security is taxable and
that you end up paying a higher rate on certain types of investment income.

● Over the years, there have been numerous changes to tax schedules and
deductibility, and there will be more. However, one thing that hasn’t
happened is a reduction in complexity. And there are always opportunities
for tax arbitrage—which is the ability to use the tax code to your advantage.

● Tax arbitrage is the income earner’s goal whenever you make a contribution
to your IRA or 401(k) retirement savings plan. In your primary earning
years, when your tax rate is highest, you can put money into these plans on
a pre-tax basis, bringing down your immediate taxable income.

● Then, in retirement, when you’re likely to be in a lower tax bracket,

since you’re no longer drawing a salary, you can withdraw previously
earned income at the lower rate. If your tax bracket for your earning
years was 35% and you retire in the 25% bracket, you’ve just saved 10%
in potential tax liabilities. And your retirement investments grew in the
intervening years.

94
 Lesson 11 Social Security, Medicare, and Tax Strategy

● On paper, this form of tax deferral is a great deal. However, tax rates aren’t
the only factor. Several complex formulas apply in retirement, including
one that determines how much of your Social Security might be taxable,
another that determines the tax rate that is used for various types of
investment income, and another that determines how much you will pay
for certain parts of Medicare.1

● And for those who retire before reaching Medicare age, yet another
formula determines if you qualify for a health-care tax credit to help
subsidize the cost of health-care premiums.

● When you factor in the impact of all these formulas, your tax rate might
not always be lower during retirement. And the conventional wisdom of
letting your tax-deferred retirement money grow as long as possible may
not be the right answer.

● With tax-deferred retirement savings accounts, IRS regulations state

that soon after age 72, you must begin taking your required minimum
distributions. An IRS formula determines the amount you must withdraw
each year.

● Most people will retire earlier than age 72. If you retire at 60, you’ll have
12 years before distributions are required. This presents an opportunity—
potentially 12 years where you can choose how and when to withdraw in a
tax-smart way.

● The first step is to project your tax rate each year. The tax-planning
opportunities that open up depend on your situation, but here are five
things to consider:

• If you have savings in many different types of accounts, look at

withdrawal order. What accounts should you take out of and when?

• Calculate the impact of starting Social Security later. Can you create
additional tax-planning opportunities and preserve more wealth by
starting Social Security at 70?

1 You pay a monthly premium for Parts B and D, and if your income exceeds certain threshold
amounts, you will pay more. The trigger for such additional costs might be because you took
extra money out of your IRA that year.

95
 • If you have nonretirement brokerage account investments, make sure
they are structured tax-efficiently. You can take advantage of the lower
tax rates that apply to qualified dividends and long-term capital gains.
And there are years when it might make sense for you to realize capital
losses, if an investment is down; and years when it may make sense to
realize capital gains, if that gain will be taxed at the 0% rate.

• If you are retiring before you’re eligible for Medicare, see if you can
structure retirement cash flow in a way that allows you to qualify for a
health-care tax credit.

• Another planning opportunity is the formula used to determine your

Medicare Part B and Part D premiums. The higher your adjusted gross
income as reported for tax purposes, the higher the premium you’ll pay.
If you can structure things to keep your reported income lower, you
might be able to pay less.

HEALTH CARE
● In the United States, most people who worked 40 calendar quarters are
eligible to receive free Medicare insurance coverage beginning at age 65.

● Medicare has multiple parts, Parts A, B, C, and D. Medicare Part A,

which covers most hospital stays, is considered the foundation of Medicare.
Medicare Part B covers additional services, some medical supplies, and
some preventative services. Part D refers to prescription drug coverage.

● If you add up what is covered in Parts A, B, and D, you’ll find there are
gaps in coverage. On average, Medicare covers about 50% of your total
health-care costs. To cover the gaps, most people purchase a Medigap, or
Medicare Supplement Insurance plan. The most popular plan for higher-
income retirees is Plan G, as it offers the most coverage.

● There’s another option, too: a Medicare Advantage Plan, sometimes called

Medicare Part C. It’s private insurance, and it provides coverage in a single
plan that also includes Parts A and B. Some Advantage plans additionally
include Part D prescription coverage and extra services, such as vision care,
dental, and hearing.

96
 Lesson 11 Social Security, Medicare, and Tax Strategy

● You must choose between original Medicare with the optional

supplemental plan or a Medicare Advantage plan.1

● It’s tedious to compare plans, but it’s recommended that you evaluate your
choices every year. Doing so can save you money and help protect you
from gaps in coverage.

● Medicare has an open enrollment period each fall, when you have the
option to change plans. You can use the online Medicare Plan Finder
tool to compare plans. Another resource is the State Health Insurance
Assistance Program, which is a volunteer-staffed organization that provides
objective counseling to Medicare-eligible individuals in all US states.

Overall, how much you can expect to pay for all health-care
costs in retirement, including insurance premiums and out-of-
pocket expenses, depends partially on your health.

● The investment management firm Vanguard engaged the consulting firm

Mercer to categorize retirees as low, medium, or high risk and identified 12
conditions that put you in a higher risk category, including hypertension,
rheumatoid arthritis or osteoarthritis, heart disease, diabetes, chronic
kidney disease, cancer, and asthma.

● As of 2020, if you were a healthy 65-year-old woman with none of those

conditions and you purchased a quality Medicare supplement plan, you
might pay only $3,800 a year for almost all of your health-care costs.2
A medium-risk person could expect to pay $5,200 a year, including
premiums and out-of-pocket expenses, and a high-risk person could expect
to pay as much as $10,900.

1 The Medicare Advantage plans might have only limited coverage when you’re traveling outside
your local area, so most retirees who travel choose the original Medicare plan along with a
supplemental policy.
2 Costs are expected to increase about 5% a year, so current numbers may be higher.

97
 ● These estimates do not include chiropractic care, nor some other
alternatives, though they do cover dental and vision care. They also do
not include long-term care costs, which typically begin when you need
assistance with activities of daily living, such as bathing, getting dressed,
cooking, and cleaning.

● Medicare does not cover most long-term care costs. You can purchase
insurance to cover these costs, although it can be expensive. Nevertheless,
you should research this. Another option to consider is community living.

● For those who have no long-term care insurance or other resources, state
Medicaid insurance coverage fills in. Each state has its own limits on what it
takes to be eligible for Medicaid, so check your state’s regulations for details.

READING
Social Security Administration, “Retirement Benefits: Benefits for Your
Family.”

———, “Social Security History.”

98
 12
10 QUESTIONS TO
ANSWER BEFORE
YOU RETIRE
I n retirement planning, small changes eventually have big impacts.
Everything is connected. Your investment choices affect your tax return.
Your pension choices affect how much wealth your heirs might inherit. And
all decisions affect your level of financial security in later years.

IDENTIFYING YOUR RETIREMENT-PLANNING QUESTIONS

● Decisions you make without analysis can
produce unanticipated outcomes later in
life. To make sure you objectively look The key to
at all relevant factors in your retirement planning the
planning, start with a list. You’re more perfect retirement
likely to achieve a goal if you write it is flexibility and
down, and you’re more likely to calmly a willingness to
evaluate your options when you see make adjustments.
them on paper.

● Start with the following 10 questions

and then add onto them:

1 When should you retire, or at what age?

2 When should you opt to start taking monthly Social Security payments?

3 What will your budget be? How much do you estimate you will spend
each month or year once retired?

4 If you have a 401(k) retirement savings plan, should you roll it over into
an individual retirement account (IRA) that you can manage yourself
in retirement?

5 How much money should you budget for health care?

6 If you have a spouse, do you plan to retire at the same time or at

different times?

7 What financial assets should you draw on first during retirement?

100
 Lesson 12 10 Questions to Answer Before You Retire

8 Do you want to guarantee some of your retirement income by

converting some of your savings to an annuity?1

9 How and when do you want to adjust your investment portfolio as you
approach retirement?

10 What formula or retirement strategy should you use to make sure that
you don’t run out of money during retirement?

● Once you have your questions, start working out the answers.

● Many people mistakenly compress the first two questions into one
decision. People often think of retirement as synonymous with claiming
Social Security. But there are important factors to be aware of in claiming
Social Security benefits, and they may have a direct impact on your
financial bottom line.

● So, if you retire at 62 and take your Social Security benefits right away—
because that’s what you think you’re supposed to do—you might be
making a seemingly simple decision that could work against you or a loved
one later in life.

● Taking benefits at a later age might provide you—and your spouse—with

more income later, when security becomes critically important. It’s in your
interest to identify and compare these choices to see what serves you best
over the long term.

● What about the third question: How much money are you likely to spend
during retirement? Don’t ballpark this. When upcoming retirees guess
at how much they should budget, their estimates often leave out future
auto purchases, dental expenses, major home improvements, and health
insurance premiums, and they often underestimate taxes.

● A few years into retirement, they might realize that they are spending far
more than they had projected. It’s better to estimate your future expenses
on the high side and possibly work a few years longer to save more if you
need to than it is to come up short once you’re retired.

1 an insurance contract that provides fixed-income payments

101
 ● Consider the fourth question: Upon retirement, should you leave your
401(k) with the investment company of your employer’s plan or roll it
over into an IRA? It’s easy to leave it where it is, but there are potential
drawbacks to doing so.

● Your 401(k) plan might be transferred to a new service provider. When

a plan transfers, it goes through a blackout period, when no transactions
are allowed—not even withdrawals. So, if you’re retired and rely on this
account as your primary source of cash flow, this could be a problem.

● As you compile your list of retirement questions, don’t try to solve them
all at once. The goal is to identify the important ones first. Then begin
gathering information to help you address them.

● When you’ve compiled your list, you’ll start seeing relevant information
everywhere, and you’ll participate in conversations in a new way. Your
brain will subconsciously be on the lookout for books, articles, and
podcasts that help address the very questions you want to answer. It’s just
the way human brains work.

EXAMINING HOW THE VARIABLES INTERACT

● After identifying your retirement-planning questions, examine how the
variables interact. You can build a spreadsheet from scratch or use the
help of online retirement calculators. Or you can subscribe to professional
software that financial advisors use or hire a financial advisor to help
design a custom analysis for you.

● You will want to come up with thoughtful assumptions for each data point
in your planning model, including investment rates of return, inflation,
and spending estimates.

● Small changes in assumptions can have large effects on the results. Take
inflation as an example. Assume that you have $1 million and will average
a 5% annual rate of return. You plan on withdrawing $40,000 a year and
increasing your withdrawal by 3% a year to account for inflation. After 30
years, you’ll still have about $500,000.

102
 Lesson 12 10 Questions to Answer Before You Retire

● If you adjust your inflation estimate down to 2% from 3%, now you
can plan on having nearly $1 million remaining after 30 years instead
of $500,000. Notice how this fairly small difference in your inflation
assumption signals a $500,000 difference.

● In the 1990s, a 3.5% to 4.5% inflation-rate assumption was typically used.

The economy has evolved since, and so have financial markets. After years
of lower inflation rates in the United States, long-term assumptions have
also trended down.

● In 2020, some financial planning models were applying the following

assumptions: Start with a 3% annual inflation-rate assumption for
households planning to spend $50,000 a year or less, 2.5% for those
spending in the $50,000 to $100,000 range, and 2% for families who
spend more than $100,000 a year.

● You can also adjust your assumptions—and will want to—based on

different phases of your retirement. During the first 10 years of retirement,
you will tend to spend more on travel and entertainment. During these
years, you might want to budget more for these items and then taper them
off beginning in your early 70s.

● Expectations for investment returns have also evolved. In the 1990s, many
financial planners assumed that a client’s investments would average
10% annual rates of return, and that is what they used in their financial
planning projections. That proved to be too high over the longer term.

● Based on additional market history and research, beginning in the early

2000s, many reputable financial planners lowered their estimated annual
returns to 7%—and by 2010 to 5%.

● You’ll need to figure out if you are comfortable doing the research and
making the right assumptions for your projections. If you love numbers,
math, and spreadsheets, you might have the perfect skill set to model your
retirement. But if that isn’t your skill set, be careful.

103
 PROFESSIONAL FINANCIAL PLANNING
● Michael Piper, a CPA who writes the Oblivious Investor blog, states in his
book Can I Retire? that most investors do not need a financial advisor if
they’re willing to take the time to learn all the ins and outs. However, he
goes on to say that “as an investor gets closer to retirement, the usefulness
of an advisor increases dramatically.”

● Professional planning can help you minimize mistakes and seek to

maximize the options that are best for you. But you will want to be
cautious and do your own research, just as you do in selecting a doctor,
lawyer, or general contractor.

● You can interview advisors as part of your learning process. And if you
are looking for an advisor, come up with a screening process, including
credentials, compensation, and competency.

● When it comes to credentials, at a minimum, look for someone who

has earned a Certified Financial Planner designation. To acquire this
designation, a candidate must meet extensive training and experience
requirements, pass a comprehensive exam, and commit to a set of ethical
standards that requires them to put their clients’ interests first.

● Next, keep in mind that what you need as you are nearing retirement is
someone who is well versed in topics such as Social Security, taxes, and
putting together income-distribution models.

● Designations that signify a specialization in retirement planning include

the Retirement Income Certified Professional (RICP); the Certified
Retirement Counselor (CRC); and the Retirement Management
Advisor (RMA).
● The second thing to think about is compensation. Some financial advisors
primarily sell products and are paid via commissions on what they sell,
while others focus on giving advice and are compensated via fees, such as
an hourly rate, a quarterly retainer, or a percentage of the investments that
they manage on your behalf.

104
 Lesson 12 10 Questions to Answer Before You Retire

● What you want to consider is how a financial planner’s compensation

structure might impact the advice or recommendations they provide
to you.

● Research by digital wealth manager Personal Capital found that nearly half
of Americans falsely believe that all advisors are legally required to always
act in their clients’ best interests. Some advisors do have a fiduciary duty to
you—which means legally they must provide advice in your best interest.
However, typically commission-based advisors are not held to a fiduciary
legal standard.

● All compensation structures can create some type of conflict of interest.

Make sure to ask that any conflicts are disclosed and look for advisors who
are open to discussing compensation in a forthright manner.

● The final thing to look for is competency. Does the advisor or firm have
the expertise you need? To answer this question, start by asking if the
advisor works with other people like you and how long they’ve been in the
business with that particular specialty.

● Come up with a few questions that pertain to your specific situation.

Listen for whether their answers make sense to someone who fits your
profile and if they communicate in a way that works for you. Steer clear of
people who try to impress you with fancy jargon or with past investment
returns. That often isn’t a good sign.

READING
Personal Capital, “Too Many Americans Are Still in the Dark about Getting
Financial Advice.”

105
 Quiz

1 Which of the following is worth more?

a $1 million today
b a penny doubled every day for 30 days

2 Will your tax rate be lower in retirement?

a Yes, of course.
b It depends. The taxes you pay vary based on your tax rate, filing
status, and underlying sources of income. Different tax rates can
apply to different types of income, and while some retirees have
a lower tax rate in retirement, others end up in a higher tax rate
than they had while working.
c No, taxes will increase.

3 What are the two key phases of retirement planning?

a accumulation and decumulation

b acceleration and deceleration
c growth and safety
d growth and income

4 What can you use to help you determine specifically how much
you’ll need to retire?
a a personal financial model that uses an income, expense, and
gap timeline to illustrate your withdrawal needs year by year
b a budget that shows how much you’ll spend each month
and year
c both of the above
d none of the above

106
 Quiz

5 It makes the most sense to contribute to Roth IRAs and Roth 401(k)s
when your tax rate is which of the following?

a highest
b lowest

6 If you don’t want to track spending by detailed category, then you’ll

want to use which type of budgeting?

a top-down
b bottom-up

7 Your contributions to a Health Savings Account are tax-deductible.

a true
b false

8 What is the biggest mistake people make when they have access to a
company-sponsored retirement plan?

a not participating
b choosing poor investments
c not staying at the company long enough to get vested

9 What is a bond?

a a loan to a company or government entity

b an equity investment in a company
c an account that pays interest

107
 10 An S&P 500 stock index fund has more risk than an
individual stock.

a true
b false

11 What are annuities?

a guaranteed investments issued by banks

b contracts issued by insurance companies
c growth investments issued by private companies

12 When are the retirement red zone years?

a 10 years after your retirement

b 10 years before and 5 years after your retirement
c 5 years before and 5 years after your retirement

13 When money transfers from an employer retirement plan to an IRA,

it is which of the following?

a a rollover (and when done properly, it is not a taxable

transaction)
b a withdrawal (and it is subject to taxes)

14 When you use a total return with systematic withdrawal approach

to generating retirement cash flow, you typically withdraw what
starting percentage of your portfolio?

a 3%
b 4%
c 5%

108
 Quiz

15 With an asset-liability matching investment approach, you do which

of the following?

a buy dividend-paying stocks and borrow against the portfolio to

buy more stocks
b put investments in buckets that are earmarked for use at specific
points in time
c withdraw the same percentage of your portfolio each year

16 Medicare, the federal health insurance program that begins at age

65 for those who have worked in the US long enough to qualify, is
estimated to cover which of the following?

a all of your health-care costs

b about 75% of your health-care costs
c about 50% or less of your health-care costs

17 When does the Social Security earnings limit apply?

a when you collect Social Security before your full retirement age
and continue to work
b when you collect Social Security and continue to work,
regardless of your age
c when you collect Social Security at age 70 and continue to work

18 Spending in retirement is typically lowest in which phase?

a the go-go years

b the slow-go years
c the no-go years

109
 19 Which of the following statements best represents how your Social
Security benefits are taxed?

a Social Security benefits are tax-free in retirement.

b Anywhere from 0% to 85% of your benefits may be included
as taxable income on your tax return, depending on your other
sources of income.
c Social Security benefits are 100% taxable in retirement.

20 If you have an updated will and trust, you do not have to worry
about updating your account titles, registrations, or beneficiary
designations.

a true
b false

21 With the debt snowball approach to paying down debt, you do

which of the following?

a pay down high-interest-rate debt first

b pay off smaller balances first

22 Once retired, you can assume that your income and expenses will do
which of the following?

a be about the same from year to year

b still vary quite a bit from year to year

23 Required minimum distribution rules begin at which age?

a 70
b 70 ½
c 72
d 75

110
 Quiz

24 Which of the following is not a retirement risk to be worried about?

a longevity risk
b sequence risk
c inheritance risk
d inflation risk

25 Which of the following statements is true about a reverse mortgage?

a The amount a homeowner owes goes up, not down, over time.
b You accelerate the payoff of your mortgage.
c Your interest rate goes down, not up, over time.

Quiz Answers

1. b; 2. b; 3. a; 4. c; 5. b; 6. a; 7. a; 8. a; 9. a; 10. b; 11. b; 12. c; 13. a; 14. b;

15. b; 16. c; 17. a; 18. b; 19. b; 20. b; 21. b; 22. b; 23. c; 24. c; 25. a

111
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20. shapecharge/E+/Getty Images; 29. Rawpixel/iStock/Getty Images Plus;
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Getty Images.

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