September 2022 – Your Financial Pharmacist

YFP 275: How to Build a Retirement Paycheck (Retirement Planning)

Posted on September 29, 2022March 14, 2023 by yfpadmin

How to Build a Retirement Paycheck (Retirement Planning)

In the fourth episode of the four-part series on retirement planning, Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, discuss how to build a retirement paycheck.

Episode Summary

In this week’s episode, Your Financial Pharmacist Co-founders Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, wrap up our four-part retirement planning series by discussing how to build a retirement paycheck. Highlights from the show include a discussion on retirement income planning and how social security claiming strategies fit into retirement income planning. Three critical issues addressed include how to replace your paycheck with your retirement income that meets your retirement expense needs, how to plan for large one-time expenditures in retirement, and how to mitigate the risks one faces in retirement. Tim Baker shares three approaches to building a retirement paycheck, The Flooring Strategy, The Bucket Strategy, and The Systematic Withdrawal Strategy. Tim dives into the theory behind each and how to put them to use in your retirement planning. When it comes to retirement, the value of a financial planner throughout the timeline of your life is tremendous, not just in the accumulation phase of your retirement planning. It is valuable to take stock of where you are now regarding the social security statement, cash flow, budget, and net worth, in addition to plans for retirement. Tim Baker explains how life planning plays an integral role in retirement planning, often ahead of financial planning to build the retirement lifestyle you envision with a paycheck to match.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRO]

[00:00:00] TU: Hey, everybody. Tim Ulbrich here, and thank you for listening to the YFP Podcast, where each week we strive to inspire and encourage you on your path towards achieving financial freedom.

On this week’s episode, Tim Baker and I wrap up our four-part retirement planning series by discussing how to build a retirement paycheck. Highlights from the show include discussing what retirement income planning is, three key issues when determining a retirement income plan, how Social Security fits into retirement income planning, and three different approaches to use or consider using when building a retirement paycheck.

Before we jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does in working one-on-one with more than 250 households in 40-plus states. YFP Planning offers fee-only high-touch financial planning that is customized to the pharmacy professional. If you’re interested in learning more about how working one-on-one with a certified financial planner may help you achieve your financial goals, you can book a free discovery call by visiting yfpplanning.com. Whether or not YFP Planning’s financial planning services are a good fit for you, know that we appreciate your support of this podcast and our mission to help pharmacists achieve financial freedom.

Okay, let’s jump into my conversation with certified financial planner, Tim Baker.

[INTERVIEW]

[00:01:17] TU: Hey, everyone. Welcome to this week’s episode of the YFP Podcast. We are on our fourth and final part of our series on retirement planning. On episode 272, we talked about determining how much is enough, building that nest egg. Episode 273, we discussed the alphabet soup of retirement accounts. What are the different options or at least the tax favored accounts that we’ll focus on potentially? Then last week on episode 274, we talked about risk tolerance versus risk capacity and determining or beginning to determine our asset allocation plan.

So this week, we’re going to talk about how to build a retirement paycheck. Ultimately, we’re at the point where we’ve accrued that nest egg we established at the very beginning, and the question is now what, right? How are we going to distribute those funds and ultimately replace what was our W2 income and be able to replace that with the various investments and buckets of savings that we’ve accrued over the years?

So Tim, this feels like an overlooked topic and one that is not often discussed. You recently shared with me that, really, up until more recently, it has not even been foundational in the Certified Financial Planner training. So why is that the case with what appears to be such an important topic?

[00:02:28] TB: I think it’s kind of rooted in for a long time, the predominant advisor that was out there was – I’m not going to say an advisor was a broker. So when you work with a financial advisor back in the day, it was kind of more to transact investment trades. So it was you calling your broker and saying like, “Hey, I like this stock,” or, “I like this mutual fund,” or whatever. Like, “What do you think?” Then that would be the exchange. Really, it was more about placing the orders than kind of looking at something more comprehensively.

The problem, though, is that even like in the CFP’s like curriculum, I feel like most of it is really geared around the accumulation stage of like gathering assets, and this is how to understand modern portfolio theory in investment, all that kind of stuff. But it’s kind of like when you get to the end, it’s like, “Okay, now what?” Like, “What do you –” We have these buckets of money that are separated between a Roth IRA a 401(k). You might have money in a pension.

What we’re really trying to figure out is like, okay, how do we convert these pools of money into a steady, sustainable retirement paycheck that’s going to last the rest of your life? It’s really hard to do. It’s really hard to do. Again, like, I’ve worked with firms where the conversation is, “Hey, Tim. You’re the client. We’re going into 2023. What do you need next year?” I think that like if you’re in that relationship of like you’re kind of just advising on stocks or investments, maybe that holds up.

But I think like what we’re seeing, like if I’m the client, the first question I would ask to that question was like, “Well, what can I take?” Like, “What can I take, so I don’t run out of money,” advice. Or like –

[00:04:19] TU: Shift of conversations. Yup.

[00:04:20] TB: Yeah. Tell me that like. It’s nice that – That’s kind of like what we talked about in previous episode is like investments are really important. But I think if you’re working with someone comprehensively, it shifts more to like, okay, what are the investments and less about the tactical and more about the strategic approach of like, “Okay, now that we’ve accumulated all these assets, like how can we do this with the mountain risks that we face?”

Because one of the really hard parts about this, Tim, is like you could live to your 72 or you can live to your 102. We have no idea.

[00:04:54] TU: That’s right. Yeah.

[00:04:55] TB: Without that major variable of like the duration of the plan, which is connected to your life, super hard, right? So I think the industry is changing, where it’s trying to equip advisors with more tools and more education around this shift from the accumulation phase to withdrawal phase and really have meaningful conversations with clients because this is only going to get more important, right? The data says that roughly 10,000, baby boomers turn age 65 every day, and half of them have never really calculated where they’re at with what they need to maintain their lifestyle.

So it is kind of a little bit of like flying by the seat of your pants. Like I said, it’s just a complex thing. If you’re looking at how do we convert assets to income streams while keeping the tax man in mind, and those income streams could be Social Security. It could be working part-time in retirement. How does that affect your Social Security paycheck? It could be distributed money from a 401(k) or a taxable account or a Roth IRA. There’s very strict ways you should do that to maximize your taxes or minimize your taxes, I should say.

It could be a pension or like you convert part of that bucket of money into an annuity, along with – We’ll talk about that more with the flooring strategy. How does your home play a part in this? A lot of people kind of discount the home, even when that’s going to be the biggest expense of any retiree is your home. That’s typically at any phase of retirement, except for maybe like old old, where it might be more of a health – Those people that are kind of 90s plus is more medical expensive.

So it is a complex thing to basically tackle, and you wouldn’t think it would be that hard because a lot of people are like, “Oh, $1,000,000. Four percent, $40,000. We’re good.” Kind of wipe your hands of it, and you’re good to go. But it’s a lot more complicated than that.

[00:06:59] TU: Yeah. I think it’s a good reminder, and I’m glad we’re digging into this topic, really, for the first time in detail. I think we’ve certainly spent a lot of time on the show talking about the accumulation phase. But to your point, we very much tend to oversimplify this, right? You need 3.2 in a nest egg. Or you need – Based on the four percent rule, you can draw so much per year.

Well, what about all the various asset pools that are out there, right? What about your home, whether you’re going to work at all during retirement? How does that impact how and when you withdraw? What about all the tax strategies? What about taxable accounts versus tax-deferred accounts? I mean, just so many different layers to consider here. Then, obviously, Social Security is another one to put on top of that as well.

So important that we’re thinking not only about the accumulation but also what’s the strategy and the optimization. I think this is another great example where like, in my opinion, obviously, bias, like the value of a financial planner is a lifelong journey. So early on, we’re working on accumulation, getting started, really understanding our options and our vehicles, doing it at a tax-efficient way.

Here, we’re talking about a whole another host of things that when you look at advisor fees and other things that are involved, like if done well, the return on investment there is very strong, not only numerically in terms of tax saving optimization, but also in terms of having that third party, having somebody affirming and making sure that you’re feeling comfortable and confident in the distribution of all the hard work you’ve done to accumulate along the way.

[00:08:30] TB: Yeah. I think the big thing that I would say along those lines is that I think the difference between advisors today and then advisors of your, like it’s more of a collaborative process. Before, it might be like, “Hey, what do you need?” Or this is like what you get type of thing. Whereas more it’s coming from like a place of like what’s going on and like what are the things that are going on in your life and then basically constructing that from that approach.

I think it is more of a collaborative approach versus like us saying this is what it is or waving our finger or whatever. So like I think that’s a big distinction to make too.

[00:09:12] TU: Tim, what are some of the key issues? So here we’re talking about retirement income planning. Ultimately, we’re discussing how to build this retirement paycheck. What are some of the key issues that folks need to be thinking about when it comes to building this retirement income and planning for this?

[00:09:29] TB: Yeah. So the three big things that are out there are how do you replace a paycheck with kind of a stable source of income to meet your basic retirement expenses, which, again, can be a tough thing to figure out because you snap your fingers, Tim, and like you’re not going to work. So like how are you spending your day?

For some people, it might be you’re just sitting in a room because your spouse is still working. For other people, it’s like your guys are both retired. So it’s like, “Hey, school’s out.” You’re kind of throwing your books in the air. You’re traveling. You’re dining out. You’re doing all those things that you didn’t do. So like maybe your expenses go up.

So I think sitting down and looking at like what does retirement look like for you and trying to sketch out. We talked about budgets with clients, younger clients, and like they don’t go away like because like a big part of this equation is like how much you’re going to spend. So how do we give you a paycheck that’s going to meet your basic retirement expenses, number one?

The second thing is how do you plan for those one time, large, large expenditures that are planned? So that might be like a car purchase, like big vacations. It could be –

[00:10:42] TU: Second properties, right?

[00:10:43] TB: Second property. It could be paying for a son or a daughter’s wedding. Like those types of things are big. Then the last part is like how do we start to not inoculate but mitigate the risks that you face in retirement. The risks are many. There’s lots of potential potholes that are out there that can trip you up. One is like life expectancy. We don’t know how long you’re going to live. So a lot of people, they base their Social Security decision making on, “Well, my uncle died at this age, and my dad died at this age, and I’m just going to take it,” which is typically not –

Sometimes, it’s advisable. But sometimes, it’s not because the other thing that we have to remember is that in Social Security, your spouse gets the larger of the benefit that you’re collecting. So if I claim early because my life expectancy in my mind is lower, my benefit is going to be reduced. But it still might be better for me to wait and defer, so that benefit grows. So then like maybe I collected for four or five years, but then Shea would get that when I kick the bucket.

So those are things that people just don’t think about. So life expectancy, big risk. Inflation. So sources of retirement income need to increase at the same rate as the cost of goods and services, which right now is tough, right? Because we were seeing a spike in inflation. So how do we combat that, the inflation, and how do we how do we make sure that the – So that’s another reason that Social Security is great because it gets cost of living adjustments every year, most years, that keeps pace with inflation. Most products out there do not. Even if you buy an annuity on the street, Social Security is going to beat that every single time.

The other one is a death of a spouse. So income needs don’t necessarily go in half when your spouse dies. So how do we – Is that looking at things like insurance or second to die policies? The things like that to make sure that you are okay that you had two Social Security income streams, and now you only have one. It’s the greater one. But like how do we plan for that?

Health care. So we know that’s increasing exponentially. How do we plan for that long-term care? So this is the possibility of needing care for those everyday activities like eating and bathing and using the bathroom, those types of things. I think the majority of people, they use family members. But do you buy a policy to help with that?

Investment returns. We talked about, Tim, the stock market is volatile. Fixed income portfolios, which are often retirement portfolios because we want more of that safety in principle, like those things changes over time. So right now, it’s probably good to look at things that have something with inflation tied into that.

Then probably the last one, which I think is the most dangerous one, is the sequence of returns risk. So this is the risk of receiving a lower or negative returns early in your retirement when withdrawals are made. That’s what I talked about last episode. If your portfolio goes from a $1 million to $600,000, and then you’re taking 40,000 or 50,000 dollars a year out of that, it’s almost impossible to overcome both of those.

So that’s where it goes back to like is your asset allocation right when you get into that eye of the storm before retirement. If it isn’t, maybe the hardest conversation that we have to have is like we have to wait for the market to recover because, ultimately, you might have to go back to work anyway if you go out and then you have to go back because we just don’t have enough money to sustain you for the rest of your life.

So those are probably not all of the risks that are out there, Tim, but a good amount of the risk that you’re facing as you’re kind of saying, “Okay, how do I take this pot of money that I have and make it last for the next 30 years or so?”

[00:14:40] TU: Yeah. The example of that last one, Tim, the sequence of returns, I think about folks that have retired in the last, what, 12 to 24 months, right? If there wasn’t kind of a change of asset allocation in the eye of the storm, as you talk about. Some folks might be feeling that in the moment, right? I saw the portfolio drop significantly, and maybe that did or did not change. If they had more than enough saved, maybe that didn’t matter as much. But maybe that means going back to work for a little bit of time or elongating the timeline to retirement.

Again, so important that we’re really planning this from beginning, all the way through the actual withdrawal phases.

[00:15:15] TB: Yeah. One thing to note is that sometimes this is out of your control, like when you’re going to retire. Sometimes, it’s like –

[00:15:22] TU: That’s right.

[00:15:23] TB: When there is a downturn in the market, it’s also because the economy is bad. So companies could be looking to either get you out the door or force retirement, and that can be really, really bad for your – I talk to my dad a lot. Like his company was bought by another company, and he was kind of winding down. But he was not ready to retire yet. But he was kind of duplicitous. They’re like, “Hey, you’re kind of on the chopping block here.”

So that is the other thing is like sometimes we assume. Just like what I was talking about, some people assume they’re going to die early, so they take – Most of the time, they like outlive what they think. But the other part of that is we assume that like when I asked you the question, “Hey, Tim, like when do you want to retire,” and you say, “Hey, I will retire at full retirement age.” For us, it’s 67. That that’s actually going to be an option.

[00:16:12] TU: In our decision, right? Yup.

[00:16:14] TB: Yeah. Sometimes, it’s either because of job, or it’s because of the health of yourself or a family member that causes you to retire earlier than you expected. Something like 40% of people kind of fall into that bucket.

[00:16:29] TU: That’s a good point and a good reminder. Before we get too deep into talking a little bit more about Social Security and then specifically three different approaches and strategies to build your retirement paycheck, I want to reference folks to a resource that they can use to download, follow along with some of the discussion, as well as provide some other information. That resource is What Should I Consider Before I Retire. It talks about some of the considerations around cash flow, assets and debt, health care and insurance, tax planning, long-term planning, and other topics as well. You can download that at yourfinancialpharmacist.com/retire. Again, yourfinancialpharmacist.com/retire.

Tim, we can’t go too far into this topic without talking about Social Security. You’ve dabbled in it a little bit already. We talked about it in episode 242, which was Social Security 101, history, how it works, why it matters. One of the most common questions for good reasons is when. When should I begin to withdraw or begin to have access to Social Security? We all know. We’ve heard it before that the difference is significant between if we take it early at 62 or we wait until the age of 70.

So give us some more information here on why this is such an important topic, what the differences can be in those numbers, and obviously the role that Social Security can play and will play likely in building retirement paycheck.

[00:17:47] TB: Yeah. I would even back up before we even talk about that, Tim, because I think it’s going to play into this. I think it’s kind of like people want to talk about like, “Oh, what do you think about this like stock or this investment or whatever?” I’m like, “I don’t know. Where are you at? Where are you going?”

So I think the first thing, even before we talk about Social Security, is to take stock of those two things. Where are we at, and where are we going? So like, to me, I think the two biggest things to look at, and Social Security is part of this, is look at your Social Security statement. I’ve done this recently. You can go on to socialsecurity.gov and put in your Social Security number and create an account. It’ll basically pull up your benefits estimate. So like it’ll say – Like for me, if I retire early, like this is the benefit that I get, 2,200 bucks. If I retire at full retirement age, for me, it’s 67, my benefit’s 3,300 bucks. Then if I wait till 70, which you get deferral credits, 4,220.

[00:18:54] TU: Wow, big difference.

[00:18:55] TB: Yeah. Socialsecurity.gov is actually pretty – They have some good calculators and like – So it’s pretty decent. So I would say like take stock of where you’re at, which means looking at the Social Security statement, looking at your cash flow statement, i.e. budget, like what’s that look like? Then the big one is the net worth statement. So what are the assets? What are the liabilities?

From there, I think we have a conversation of like where are we going. I think that’s like when do you want to retire. Some people might be like, “I want to work forever.” Some people are – They’re like, “Now. I want to retire now. I’m 45. I want to retire now.” So I think going through some of those exercises, like I’m a huge proponent of life planning. It’s like changed my life. But actually sitting down – I think so much of the emphasis on retirement is kind of this oasis of like, “I’ve made it. I have some type of financial independence. My calendar is back, and it’s like this destination.” But it’s really more of an ongoing journey of, okay, so you wake up. The retirement party’s over. You just got back from your Hawaii trip to celebrate your retirement. What are you doing? Are you by yourself? Is your spouse still working? Like how are you spending your day?

So actually write down like what is an ideal schedule. What are the things that are still on your – Things that if you were to die today or tomorrow that you have left undone. What are the things that you’re passionate about? So sometimes, unfortunately, our passions might not necessarily align with like our ability to earn and make money. So sometimes, those things are left for retirement to say, “Hey, I always want to volunteer to do this,” or, “I always wanted to help kids here,” or whatever.

So I think really having a plan for that. Because to be honest, like the finances are almost – They’re not almost. They are. The finances are secondary. The financial plan in retirement is secondary to like the life plan in retirement because so much of our identity is tied up in our job as director of pharmacy here or pharmacy manager or whatever it is. That it’s hard for us to like wake up one day and be like, “Okay, I’m not that person anymore.” Well, you are that person. You’re just not working in that job anymore.

But it’s even hard for spouses too because so much of your time is at work, right? So kind of to relearn and do – That’s a real thing. A lot of retirees struggle with addiction, with depression, with kind of like a loss of sense of self and things like that, that I think needs to be addressed. More and more people are talking about this, which is good. So I think like once you get an idea of like, “Hey, where are we at numbers wise and like where are we going life planning-wise,” then I think it’s really important to start getting to things like Social Security and claiming strategies and things like that.

So to answer your question, Tim, I think that it is one of the most important, if not the most important, decision that you make in building out your retirement plan. Actually, Morningstar did a study that said that – So I think it was based on working with an advisor. It helps you with better decision making can increase your retirement income by 37%. Nine percent of that, which is the highest one, was the Social Security claiming strategy. Of the 37%, 9% of that was that alone.

You could see, when I rattled off my numbers, 2,200, 3,300, 4,200, that’s a huge difference. For so many people, for a long time, they’ve looked at it as like a breakeven. So they say like, “Okay. If I take 2,200 versus the 3,300, then I have to live to this age to breakeven on what I would be given up.” The problem with that is that the biggest risk that Social Security combats is longevity, meaning that your money doesn’t run out. So if a good chunk of your income is coming from Social Security, which gets cost of living adjustments and never runs out because it’s backed by the full faith and credit of the US government, like that’s huge.

It really doesn’t matter if you leave some money on the table. But even in most cases, that calculation is typically early 80s for a lot of people. So unless you are thinking that you’re going to live less than that, and you don’t have a spouse because we talked about the spouse gets the higher benefit, then maybe you look at that. But it really needs to be looked at from I think more of an insurance. Like a safety perspective is when you’re looking at that.

As we said, 78% is basically the amount of your Social Security benefit increases each year from age 62 to 70. So what that means is that every year you defer, you get a 7% increase, a raise in your retirement paycheck. So if you think about that as a working person, if I can lock in seven or eight percent as a raise for eight years, like that’s huge. But for whatever reason, we look at this as like, “If I don’t take this as soon as possible, I’m going to lose out. I’m not going to get the money back.” I think it’s a framing of the decision that we have to relook at.

So I think the big thing here is like it’s kind of getting away from the water cooler. I think a lot of people claim benefits as soon as possible. I think it’s sometimes greatly influenced by family members, coworkers. It’s the same thing we say with like student loans, where people are like, “Oh, my classmates are doing this.” I’m like, “You’re not your classmates. You have your own financial plan. You do you type of thing.”

Sources of income in your retirement paycheck do not have an inflation protection as Social Security does. So that’s also hugely important, especially in the times that we’re living in right now. So I think the steps to optimize your claiming strategies, one is to educate yourself. Determine what your benefit is and the implications of claiming at different ages, which means pulling your statement.

I think that before you even get there, Tim, this is kind of in the get organized of like where are we at. One of the things that you’ll see on your statement is like all of your years. So it looks at 30 years, 35 years, I should know this, of earnings. You can actually say like, “Okay, this is right or this is wrong.” So if you have a beef with what they’re reporting, then you can basically say, “Hey, let me pull my 2008 return.” I can say I actually didn’t make 100,000. I made 150,000, and that will change your benefit. So that’s also a big thing.

Then take the steps to figure out what is the best solution for you in terms of claiming, and that’s going to be so huge with kind of a jumping off point of how you’re going to build your retirement paycheck.

[00:25:34] TU: Tim, can you read your numbers again? I think those were really powerful. So you gave the early full retirement. I’m looking at mine as well, but they’re skewed a little bit because I worked at universities for a while, where I wasn’t contributing to Social Security, so much lower. But you gave your early number, your full 60 to 67. Then you’re delayed. What were those numbers?

[00:25:52] TB: So my early at 62 is $2,211. If I were to wait until my full retirement age, which for me is 67. Anybody that’s born after 1960, I think, the benefit goes to $3,325.

[00:26:15] TU: So almost a little over 1,000 more. Okay. Then what about 70?

[00:26:18] TB: Then at age 70, the benefit goes to $4,220, and there’s no benefit to defer past that. That’s the range, so again – It’s getting better. People are most – You can see like people are delaying claiming now, which I think it means more people are educated about this. But I think for a majority of the people that are out there – Even if I don’t work, my plan is to not to claim Social Security until and unless barring some unforeseen things, is I’m going to be claiming that 70, and I’m going to collect – Again, this will change between now and then because my earnings will change.

[00:26:58] TU: Numbers will change. Yup.

[00:27:00] TB: But you can see the impact is huge. Again, the other thing to remind ourselves is that this is inflation-protected. So at the end of this year, retirees are going to get a major bump in their retirement paychecks because of how inflation has been this year. Whereas if you buy a commercial annuity on the street, so you say, “Hey, I’m going to take $200,000, and it’s going to be paying me a paycheck,” you might get some type of like 2% or 3%, which you’re going to pay a lot of money for.

[00:27:30] TU: I get 9%, though, when inflation’s up.

[00:27:32] TB: No, new. So that is off. That’s another thing. Again, it doesn’t really hit home for a lot of pre-retirees or even before that because like the world is your oyster, right? Like when you’re accumulating, you can always earn more money. But like for retirees, especially if they can’t work, which it’s a fixed income, so if you can make a greater percentage of your retirement check Social Security that is inflation-protected, it’s just going to greatly improve your longevity. To mitigate longevity risks in the money running out.

[00:28:12] TU: So in your example, there’s round numbers, about $2,000 difference between your early and your delayed, 62 and 70. So just some rough math. So $2,000 a year, I’m looking at eight years difference between 62 and 70. So basically, if you were to take it at 62, by the time you got to 70, there’d be a little over 16,000, 17,000 dollars that you wouldn’t have otherwise had if you delayed, right?

Now, if you wait and delay till 70 and it’s 2,000 extra per month, you can kind of see the math there of how many years it’ll take to essentially breakeven, right? Now, what we’re not including there is, obviously, the inflation component. Someone could argue, “Hey. Well, there’s an opportunity cost. If you pull money earlier, you could do other things with those.” But again, it goes to really show the difference and how if we’re planning early on, as we’re working on our nest egg kind of coming full circle where you started the series, if we’re planning for a delayed withdrawal from Social Security, well, then we’re going to be able to mitigate that feeling or need at 62 of, “Hey, I’ve got –” Or whatever the age would be for individuals that I got to have this money at this point in time.

[00:29:21] TB: Wade Pfau, who is the professor of retirement income at the American College of Financial Services, one of the things he stated, because I’m going through a certification for retirement income certified professional, his quote is, “Deferring Social Security is the cheapest annuity money can buy.” So he’s done that study, where from 62 to 70, and then if you take that money and you were buying annuity, like it’s not even close. So you could do it like, hey, if you were to invest this for eight years, but it’s not even close like to basically do a one for one if you were to buy like an annuity on the street.

That’s the big thing here because, again, if you put the money in the market, if you’re putting into an S&P 500, you’re risking that money, and it goes back to the sequence of returns. If you’re eight years and you needed that money, it’s going to be very, very conservative. You’re not going to be able to get the return. So you’re talking about a seven to eight percent raise for yourself year over year, and that is also inflation-protected, which is huge.

Again, like one of the things that we should address is that if you’re a 30-year-old or even a 40-year-old, a 20-year-old, and you’re saying, “Social Security, I get it,” it’s going to be there. Social Security, I think, is one of those things, and I hate to say this, but it’s too big to – It’s not going to fail because so many people rely on that as their every day. So there’s a lot of things that says like the trust will be depleted. But you’ll still be able to sustain payouts at a reduced benefit.

I think that’s what’s going to happen. I think people – I think the Congress is going to be forced to raise like payroll taxes to fund the trust. But I think that we’re also going to either see a step back in benefits in some way or

[00:31:00] TU: Yeah, combination. Yeah.

[00:31:02] TB: But at the end of the day, even a reduced version of Social Security is still going to be your best. I’m still going to encourage to – If your retirement paycheck is 1,000 bucks theoretically, I still wanted that to be – If we can get that to be $400, $500, $600, the most of that paycheck needs to come from Social Security because of its safety and the inflation protection.

[00:31:27] TU: Yeah. Again, when you’re working with someone who kind of is helping you build the next egg, you can run it with it. You can run it without it. You can run it in a middle ground, to your point. So maybe it’s not the full benefit or numbers we’re seeing there, but we think it’s a reduced amount and kind of see how you feel with what shakes out in terms of whether you’re on track or not and what you need to do.

[00:31:47] TB: Well, one last point to make about Social Security is really looking at this as an insurance decision versus like an investment decision. So typically, like wealthier people or people that don’t necessarily look at or need Social Security, they look at it more as like, “Okay, how do I get the most out of my money?” Most of the times, they’re going to defer. But for a lot of people that are really relying on this to make sure that their retirement paycheck is sustained for at least 30 years or their lifetime, it needs to be looked at as an insurance decision.

If you look at the different risks like longevity risk, which is the risk of your money running out, the larger – This is a larger stream of lifetime inflation-protected risk. Like that’s important. Long-term care risk, so you have like more resources later than life. So if you’re getting a bigger paycheck, so if I’m getting 4,200 at 70, versus if I would have taken the 2,200 at 62, that means I have to deplete my portfolio more later. Inflation. We talked about the larger percentage that’s protected by inflation.

The other big thing is reality risk. Like as you get older, if a majority of your paycheck is just coming straight from the government, it simplifies decision making. You’re also less at risk for like elder financial risk, which is you want to have a greater stream of income. It’s more about income streams versus assets. You have less opportunity for people to defraud you. Unfortunately, like financial advisors are top. They’re not top of the list. Actually, family members are at the top of the list for that.

But the big thing is like excess withdrawals. So like if your greater paycheck is coming from Social Security, you don’t necessarily are going to deplete your assets faster. Eliminate some market risk because, again, you’re not relying on your assets as much. Then that whole risk of like early loss of spouse, deferring that larger benefit that then your survivor would get.

So in the case of like, Shea, let’s say Shea has a benefit that’s $2,800, and I claim it 2,200 because I feel like I’m going to, I’m going to pass away early, that’s a big mistake because she is stuck with her $2,800 because my 2,200 is less, whereas if I were to defer and say, “At 70, I’m collecting 4,200.” Then even if I die at 78, she gets the 4,200, and then 2,800 goes away. Those are some of the things that we’re talking about in practice. It just makes sense to really look at this closely before kind of just doing whatever your coworker is doing.

[00:34:14] TU: Great stuff, Tim. We’re going to come back to this topic more. We’ve touched on it here. We talked about it previously in episode 242. But, man, there’s so many layers of Social Security to consider, and I think regardless of where someone is at in their career journey, an important topic and part of the financial planning that probably doesn’t get enough attention. Or it maybe just prematurely gets kind of ruled out, especially for folks that are early on in their journey.

Let’s wrap up this series and this episode by talking about at a high level the three approaches to building your retirement paycheck. I love when you talk on this topic because I think we’re starting to get a little bit more granular on how are we actually going to build this retirement paycheck. How are we going to produce this income? We all are familiar with the W2 income, the paycheck we get it once or twice a month. Now, we’ve got to find a way to build that same type of paycheck in retirement.

So Tim, walk us through three approaches, certainly not the only ones that are out there, but three approaches to building the retirement paycheck.

[00:35:11] TB: Yeah. So the three are going to be the flooring strategy, the bucket strategy, and the systemic withdrawal strategy. So to start with the flooring strategy, so it’s probably going to be the most conservative approach of the three. Critics of this approach will say like, “I don’t want to survive. I want to thrive.” But what the flooring strategy does is it builds an income floor to meet essential expenses with things like Social Security or like an annuity. So the essential expenses might be housing, food, gas, utilities, medical expenses, insurance, maybe debt.

So that is basically – If we determine that those expenses are, say, $5,500 a month, and we know that Social Security is going to pay us, say, 3,500, then we need to buy, essentially, like an annuity. So think of an annuity as like a private Social Security. So you give an insurance company a sum of money, and then they’re going to pay that back. Usually, it can be for a term certain, but it’s usually for the rest of your life. So you would buy a stream of income to make up the rest of that floor. So that if something were to happen, you always have the essentials met.

Then the discretionary expenses, there are things like travel and gifts and dining out and entertainment and hobbies, are then basically funded by the portfolio. So you have $2,000 a month of discretionary. Then that money would basically come from the portfolio or could come from like part-time work or something like that. So the flooring strategy is for those that are very conservative, and they want to ensure that for as long as they are alive, they have money to basically keep the lights on and feed themselves. What that typically takes, which is hard for a lot of people, is parting with potentially a good chunk of your income.

If we use this example, and I don’t know what it would take to get $2,000 worth of income, but say you have a million-dollar portfolio, and you get $2,000 worth of income based on your age, your gender, maybe to part ways with $300,000 or let’s say $300,000 that all of a sudden, you wake up one day, and you have the income stream. But your million-dollar portfolio is now $700,000 that you’re now drawn on for those discretionary expenses. Now –

[00:37:28] TU: You’re trading some of that nest egg for an income stream. Yeah.

[00:37:32] TB: Exactly. Now, psychologically, they say that that’s tough to get over that hump. But it’s a lot better to do that, versus someone who is in a systematic withdrawal strategy. We will talk about it. That’s drawn down every year. Their portfolio is going down and down and down most years. So just to have that paycheck coming in is from a mental perspective good.

Now, the bucket strategy is essentially where you set up separate pools of investments with the lowest risk investments in the near term time horizon or segment. Then you have like a middle bucket and then a longer term horizon bucket. The idea is that you would say, okay, bucket one is going to be funded with X amount of dollars, and it will say it’s like five years of spending. So it might have $250,000 in there that is going to be super conservative, and that’s going to be with cash, things like tips, which are inflation-protected bonds, a bond ladder, whichever year creates some type of income for you.

Then the medium term bucket is going to be more moderate. So that might be for like a 6 to 15-year time horizon, and that could be in like income stocks or like utility stocks and maybe some bonds. Then you have a 15-plus year bucket. That might be the balance of your portfolio that’s more aggressive. So that’s going to be more growth stocks and things like that. The idea is that once the first segment is depleted, so that zero to five-year bucket, that $250 is spent over five years, then the bucket two kind of replenishes bucket one, and then bucket three kind of replenishes bucket two. There’s lots of different rules that you can put into place of how you do that.

From a conceptual perspective, one of the advantages of this is that clients are like, “Okay, I get this,” and like, “All I’m really worried about is like do I have enough money in bucket one,” and knowing that, although like the market can be crazy, and bucket three is not good right now, I’m not going to touch that for another 15 years. So it’s a way to kind of bucket or segment different money for different purposes. This is one that a lot of advisors use.

Probably the predominant one is the last one, is systemic withdrawal strategy. So this is based on essentially the work of William Bengen, who researched the all 30-year time periods, and he gets the 4% rule. So the idea here is that you look at your portfolio balance. You look at like what the market – How the portfolio performed and then inflation. Then you essentially – Like if you start the first year and you say, “Okay, it’s a million dollars,” and you get $40,000. Then that year, the market returns 6%, and inflation was 2.9%. Based on those inputs, you then adjust the paycheck, the $40,000 for the next year.

So you might say when the market is up and inflation is moderate, then you basically give yourself a raise with maybe some caps. If the market is down and inflation is such, maybe you freeze it. Or maybe you actually reduce spending. So it’s a very rule-based way to kind of use the 4% rule as a guide. But to work dynamically year to year with the portfolio and with the market factors that are inflation and those types of things, to make sure that year to year, you’re given the client a paycheck that is sustainable for the longevity of the retirement period.

Again, there’s a million different ways to kind of skin this as well. But the idea is that you’re working more dynamically with market forces, and it’s based loosely on the 4%. Now, a lot of researchers have said that like the 4% rule won’t necessarily hold up in the future because of when that was done, you have low inflation and really high equity valuations. So that’s important to take note of. Although he did his research, it’s not necessarily indicative of what’s going to happen in the future.

So you have the flooring strategy, you have the bucket strategy, and then you have the systemic withdrawal strategy, are kind of different approaches on how to build out their retirement paycheck on a year-to-year basis.

[00:41:35] TU: Tim, great stuff. I’m just reflecting on the journey we’ve come over the last four episodes, and we’re going to dive into all of these topics in further detail on future shows. We’re going to be doing webinars. We’re going to have blog posts. Make sure to check out information at yourfinancialpharmacist.com.

We understand the needs that are out there around retirement planning, wherever someone is at on their financial journey, a new practitioner midcareer, pre-retiree, or those that are even in retirement. So whether you have yet to work with a planner, and this is an opportunity to do so or perhaps you’re working with a planter but are wondering what might else be out there and interested in a second opinion, we’d love to have an opportunity to talk with you in terms of learning more about the one-on-one comprehensive financial planning services that are offered by the team at YFP Planning.

We’ve got five certified financial planners and in-house tax team. That includes a CPA and an IRS enrolled agent, soon to be two IRS enrolled agents. So we’d love an opportunity to learn more about your financial goals, learn more about your situation, and determine whether or not those planning services are a good fit for you.

You can learn more and book a free discovery call at yfpplanning.com. Again, that’s yfpplanning.com. Thanks so much for listening to this series, and we hope you have a great rest of your day.

[END OF INTERVIEW]

[00:42:47] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Furthermore, the information contained in our archived newsletters, blog posts, and podcasts is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analyses expressed herein are solely those of Your Financial Pharmacist, unless otherwise noted, and constitute judgments as of the dates published. Such information may contain forward-looking statements that are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer.

Thank you, again, for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 274: Risk Tolerance vs Risk Capacity (Retirement Planning)

Posted on September 22, 2022March 30, 2023 by yfpadmin

Risk Tolerance vs Risk Capacity (Retirement Planning)

In part three of the four-part series on retirement planning, Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, explain why it’s critical to evaluate how much risk you are able to stomach versus how much risk you should take to achieve your long-term savings goal and considerations for setting asset allocation in alignment with your risk capacity.

Episode Summary

YFP Co-founders Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, explain the difference between risk tolerance and risk capacity in this episode, the third part of the four-part series on retirement planning. Tim and Tim explain why it’s critical to evaluate how much risk you can stomach versus how much risk you should take to achieve your long-term savings goal, and considerations for setting asset allocation in alignment with your risk capacity. Tim and Tim break down some strategies to employ when your risk tolerance and capacity are not in alignment. They connect the topic of the retirement nest egg to asset allocation. What we determine we need for the nest egg, combined with risk tolerance or risk capacity, will guide asset allocation. Tim Baker shares the value of a financial planner as an objective third-party in making retirement planning decisions, explains how preconceived notions about money impact the financial plan, and mentions early and ongoing financial literacy to increase risk tolerance. The five to ten years leading up to retirement can be a period of uncertainty, and Tim and Tim explain the sequence of returns risk during that time frame. They close with a reminder to revisit asset allocation percentages over time to maintain the amount of risk initially planned.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

[00:00:00] TU: Hey everybody, Tim Ulbrich here and thank you for listening to The YFP Podcast, where each week, we strive to inspire and encourage you on your path towards achieving financial freedom.

On this week’s episode, Tim Baker and I continue our four-part retirement planning series by discussing the difference between risk tolerance and risk capacity, and how this impacts your asset allocation plan. Highlights from the show include why it’s critical to evaluate how much risk you’re able to stomach, versus how much risk you should take to achieve your long-term goals. discussing strategies to employ when your risk tolerance and your risk capacity don’t jive and some considerations when setting your asset allocation plan to be in alignment with your risk capacity.

Before we jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does in working one on one with more than 270 households in 40 plus states. YFP planning offers fee only, high-touch financial planning that is customized to the pharmacy professional.

If you’re interested in learning more about how working one on one with a certified financial planner, may help you achieve your financial goals, you can book a free discovery call by visiting yfpplanning.com. Whether or not YFP Planning’s financial planning services are a good fit for you, know that we appreciate your support of this podcast and our mission on how pharmacists achieve financial freedom.

Okay, let’s jump into my conversation with certified financial planner, Tim Baker.

[INTEVIEW]

[00:01:25] TU: Welcome everyone to this week’s episode of the YFP, podcast excited to have Tim Baker alongside me again as we continue our four-part series on retirement planning. On Episode 272, just two weeks ago, we talked about determining how much is enough when you’re saving for retirement. Last week, episode 273, we talked about the alphabet soup of retirement accounts with a focus on those tax advantaged accounts. In this episode, we’re going to focus and dive into further on how to differentiate risk tolerance versus risk capacity, which ultimately leads to how the funds are going to be allocated within your various accounts as you’re putting together your savings strategy, also known as asset allocation.

So, Tim Baker, let’s start with why this topic matters and the connection to the nest egg ultimately, that folks may need to take just about the risks they think two or perhaps even more or less.

[00:02:18] TB: Yeah, I think this is one of the probably the most important concepts to understand. Because I think once you understand it, it’s kind of the easiest thing to adapt to better improve your financial situation, especially for like long term investment for the sake of retirement. So, I think a lot of people leave a lot of meat on the bone with regard to opportunity to improve their financial planning, because they either lack the experience or they don’t understand it, or it’s scary. But I think understanding this concept between what your risk tolerance is and what your risk capacity is, and then adapting that to your portfolio is huge. Again, we’ll kind of talk about conservative Jane versus aggressive Jane and really, all of the factors that are involved in that. One of the easiest ones to kind of change your dial up has to do with risk and ultimately, your asset allocation, which we’ll get into today.

[00:03:08] TU: Yeah, and I think this is a topic, Tim, where like, just being honest with yourself and having some self-awareness on how do I feel about the risk that I’m taking. Obviously, we’re going to talk about the importance of putting that alongside of your goals, do those jive, do they not jive. And I think this is really where the value of a third party can come in as well, when you’re looking at whether it’s one individuals, two individuals doing the financial plan, but often we might need to be both pushed and or held accountable. Obviously, an objective third party can play a really valuable role there.

So, I think we’ve all been told before, at some point or another that, hey, we’ve got to take some risk, if we’re willing to achieve, those big lofty, long term goals that we have. We talked about in episode 272, we need this big number 2, 3, 4 or $5 million, that seems way off into the distance, or perhaps for folks that are a little bit closer to that, not so far off in the distance. But regardless, it can feel overwhelming. And so, we’ve got to take some risk to get to that goal. But I don’t think we often differentiate this concept of risk tolerance versus risk capacity. So, Tim, let’s start there, break these two down in terms of definition of tolerance versus capacity.

[00:04:16] TB: Yeah, the tolerance is what we’ll start with, and this is typically the one that most people understand and know about. When I think of risk tolerance, I think of like the questionnaire. So, probably a buyer’s perspective, one of the things that we need to do to make sure that we’re doing our due diligence with a client is to ask them some questions about their experience, their outlook on the market, their understanding of how stocks and bonds work. If x loss, how they would feel about x loss or x gain and what their actions would be.

So, it’s really based on a questionnaire. From the advisor perspective, it’s really based on what we think the client can handle in a down-market. So, we’re trying to build out the best, and again, what we’re trying to do here, ultimately, is to get the best possible return for the least amount of risk, and that’s what asset allocation is. So, from the investor’s perspective, or in our case, the advisor or the client’s perspective, it’s the amount of risk that you want to take. It’s more of an emotional thing.

To me, that is basically the starting point for the conversation at least. And there are a lot of ways to get about, like what your risk tolerance are. So, one of them is kind of the rule of thumb, and I think I misspoke on a couple episodes back when we talked about this, because I think they’ve actually adapted it, the general rule of thumb. So, the general rule of thumb is that, to get your risk tolerance, you take 110, and then you subtract out your age, and then that gives you the amount of stocks or equities that should be in your portfolio.

So, if you’re 30 years old, 110 minus 30, you should have an 80% of your portfolio in stocks, or equities, and then the remaining 20% in fixed income or bonds. I think that that is a terrible rule of thumb myself. I think that’s a rule of thumb that doesn’t like necessarily hold up. But it’s what a lot of people use to kind of get started. The other way is to kind of go actually go through like a risk questionnaire, and I know Vanguard is one that – you can do that for free, go to their website and basically answer a few questions and it says, “Voila, you are 60/40, or you’re 70/30”, whatever that is. And I would actually start there before using any rule of thumb.

So again, the risk tolerance team is basically what we think you can handle on a down-market, or what you think as a client, you want to take. It’s more of an emotional thing.

If we shift over to risk capacity, this, from an advisor perspective is based on what you can actually handle on a down-market. So, this is actually using some numbers and looking at time horizon, and things like that. So, from your perspective or the investor’s perspective, it’s how much risk you should take. It’s more objective, and factors, and savings rate, goals, time horizons, think things like that. Again, it goes back to that amount of the risk that you can handle.

To give you an example of a risk capacity, versus risk tolerance, say we’re both 40-year-old pharmacists, and me close closer to you, and I’m not a pharmacist. Say, we’re just –

[00:07:23] TU: Coming up. It’s coming up.

[00:07:24] TB: So, if we both take a questionnaire, you could take that questionnaire and be a very savvy investor, have read up on the topic, and you can come back with a very, say, aggressive allocation for where you need to be. And I could do the same thing and come back very, very conservative. So, I could be a 50/50, you could be a 90/10. That’s risk tolerance, is basically based on our inputs in a questionnaire. For risk capacity, it does have to do with the individual itself, but it’s really about, I think, kind of where you’re at in life as well. So, in the same breath, if we’re both 40 years old, and we have 25 years left in the workforce, and we both kind of have the similar amount saved or earning potential, our risk capacity is so much higher than, say, my risk tolerance because I’m scared of the market, because I just have a longer time horizon.

So, where risk capacity is typically the lowest is right at the point of retirement. Because that is typically your longest time horizon, where you have a fixed dollar amount, i.e. your nest egg to work with. So, you just don’t have a lot of room capacity to take a lot of risk. You have to be somewhat conservative. Whereas if you have a longer time horizon, you have good earnings, a good savings, your capacity is a lot, a lot more. Maybe a convoluted way to say it, but to recap, tolerance is kind of like what you feel or like what you want to take. Risk capacity is what you can or what you should take. One of the things that often happens in this, is that those two things are not often equal. So, what we do as a third party is kind of have a conversation about this, and educate a client and sometimes that is over years, because sometimes they’ll say like, “Hey, Tim, I understand what you’re saying, but I just want to be safer.” I’ll say, “Okay, I’m going to bug you about this again.” The next time it’s like, “All right, well, my head didn’t fall off when the market went down 20%. It’s doing what it’s doing. Maybe I’ll be a little bit more aggressive.” And I think that is all the difference when it comes to long-term investing, is making sure that you are – again, you keep expenses low. We’ve talked about that numerous times with regard to your investment portfolio, but your asset allocation, which is based on your risk tolerance, and your risk capacity is set where it needs to be and then the big proponent of that.

[00:10:00] TU: Yeah, this is Tim, where I think the rubber meets the road of what we started this series on, with the nest egg calculation and looking at how much is enough, right? Because you and I could punch numbers in a calculator, or like, “Great, we need 4.2 million 3.7”, whatever the number is, but then we start to get a layer deeper. We talked about the tax advantaged accounts of how we might get there. But the next layer of which we’re getting into today is really that how are we going to invest within these types of accounts, which is the asset allocation. Which, as you just mentioned, comes down to, ultimately our risk capacity and the potential friction that may or may not be there with the risk tolerance.

So, I think that my question here, let’s lean into that situation where there’s a disconnect, where there’s a rub, where I understand what you’re saying, risk tolerance is what I’m able to stomach, risk capacity is maybe what I need to be able to do to get to that nest egg number. So, let’s say I punch in my numbers in the nest egg, they come out at $4.2 million, but then I realized, like, based on the rate of return and the level of aggressiveness that, those numbers are determined upon. I’m not comfortable with that. So, play that out. Is that a scenario where, as you just mentioned, we’re kind of working towards this and getting more comfortable in the long run? Is it adjusting down that nest egg goal? How do you begin to work through this with a client?

[00:11:20] TB: Yeah. The nest egg is a multivariate problem. So, the two defaults that I would always go to is like, if you’re not comfortable with taking more risk, and again, I would say, investing is definitely risky. Of course, it is. But what I would say over a 20 plus year time horizon is actually fairly predictable. We have enough data points that says that the US market, and again, there’s not necessarily any – it’s not past performances are indicative of future performance. But I think we’re not gambling here, we’re not speculating.

So, we’re not taking a bet all on like one stock. But I think if you’re uncomfortable with that, I think, the second thing I would say, is you have to save more though, you have to invest more. When we talked about conservative Jane versus aggressive Jane, and we kind of said, “Hey, conservative Jane, she makes $120,000. She gets 3% cost of Living raises, she saves 10%. She has a 30-year career. And then this is her nest egg.” What’s your income? What’s your cost to live? What do you actually save? And then the time horizon, 30 years. So, the other thing that you could say is like, “Okay, well, maybe we’re not retiring at 65 in 30 years. Maybe we’re retiring at 70.” So, it’s a 35-year career. And that’s the thing is like, you can always work longer.

One of these things have to give, and that’s why I say like, the easiest thing for me, is to say like, “Look, if you’re 30, 35, 40, even 45, and you have 20 years, left until retirement, who gives a crap if the market goes down in 2022?” But, we as humans, we feel that loss, we’re like, “Man, my portfolio was $200,000 or $20,000, and now it’s $140,000 or $14,000.” You feel those losses. But again, this goes back to like what I was saying, it’s hard for us to conceptualize time, and when the market went down during the pandemic, I don’t even think about that and a lot of people freak out about that. But we know that the market is going to do this, and this is like on a podcast, I’m just waving my hand up and down like a roller coaster. But typically, it’s going in a positive trajectory. You’re just going to have some of those ups and downs.

What I would say is that, if you can stomach those ups and downs and lean more towards equities, you’re going to be better off. I think what people do is they put more bonds or fixed income in their portfolio, to smooth out those rides, even those rides are still the same. But what they do is they make themselves feel better in the near term, at the behest of like long-term performance.

So, on the other side of this, Tim, is like, if we’re talking to the pre-retiree, the person that’s going to retire in the next five years, sometimes you look at that portfolio, and it’s looking at him like, “Whoa, we’re taking way too much risk.” Because if the market does go down 40%, then we don’t have enough time to recover from that. So, it’s really indicative to like, say, “Hey, I’m glad you took risks throughout your working career. But now we got to start protecting the principal.” And this is where you probably want to be the most conservative with your portfolios is kind of that right in the eye of the storm, which is 5 to 10 years plus or minus, your retirement date. And people get that wrong, too. That’s where you almost – you’re at risk for like sequence of return risk, which means that if the market is down, say 20%, 30%, 40%, and then you’re taking 40 or 50 grand out of your portfolio to live on, the failure rate, meaning you’re going to run out of money is so much higher than anything that you could be doing leading up to that.

So, it’s really, really important to know where you are in space and time, and ensure that your portfolio is positioned in a way that’s going to, one, get the best returns, but also protect you. For a lot of us, it’s kind of not knowing. And I would say it’s one of the major missteps that I see, looking at people’s portfolios is a misalignment of that.

[00:15:31] TU: Yeah. Tim, one of the things I’m sensing, at least anecdotally, and talking with pharmacists, about this in various settings, is that the mid-career pharmacist, so I’m thinking about the group that is maybe 10 to 25 years into their career, they’re not yet feeling the retirement date right around the corner, but they’re certainly past kind of the early part of their career. I think there’s a real risk here, as you highlighted. Some of the limitations of the rule of thumb, to get too conservative too early. And I think, in this moment, we’re in a period of volatility right now in the markets. And depending on when people graduated and started investing, this might be the real first significant downturn that they’re feeling in the market, right? You look at even some of the start of the pandemic. That was very short lived. It was significant, to drop. But it was pretty abrupt and recovered quickly.

So, I think this is really – I graduated in 2008. I’ve talked about this on the show before. This is the real first test for me in my portfolio to say, “All right, am I really adhering to my asset allocation plan and what I need to be doing, and the rub potentially the tolerance capacity.” And I think it’s different than a new practitioner, because you have worked hard for 10 or 15 years, you have built up several $100,000 or more of savings, and you’re looking at this saying, “Man, this hurts in the moment.” But if we’re looking 20, 30 years into the future, as you said, over and over again on the show, the worst thing we can do is buy high and sell low. So, the third party here, I think, it’d be really helpful making sure we have a plan to kind of weather the storms. But I specifically am thinking about that mid-career group right now, in this period we’re in of volatility, and they’ve done hard work, they’ve built up some savings, and this might be the first test, of that happening.

[00:17:12] TB: Yeah, I mean, and when those numbers get bigger, you feel that even more, right? I’m human. When I do catch a glance at my portfolio, I’m like, “Oh, is this really?” But I had to step back and look at the long term. I almost have to like detach myself emotionally from it. Because what happens, and I say this all the time is like, when the market just does this, and it’s just a downward plunge, your first reaction is you want to take your investment ball and go home. You don’t want to play anymore. Oftentimes I say, is like, you want to do the exact opposite of how you feel. So, that’s when I reassure myself and I say, “Hey, Tim, you know what, you are putting in x amount of dollars into your 401(k) at every pay period. And now, what you’re buying with those dollars is going. It sets the dollar cost averaging.” So, when it’s up, I’m not buying as many shares, but I’m still like, patting myself on the back, because I’m like, “Yeah, my portfolio is up.” But when it’s down, I have to basically say, “Look, if I’m putting money into my portfolio systematically, on a recurrent basis, which is typically what people do in their 401(k), your dollars are just going farther.” So, then when it does rebound, you’re going to see that impact even more.

So, it is one of those things where it’s, again, it’s not getting caught up in the moment, and it is really looking at the long term. But when you hear the news, or you hear other people talking and there are things that – it gives you pause, and you start to doubt yourself. But I think at the end of the day, what I always say to myself is like I trust the market. I trust what the data has showed. Again, maybe it’s not always going to be 10% when you just sit down for inflation, it’s 6.87%. But always not be that. And sometimes people go to the catastrophic thing. I’m like, “Then we have other problems to worry about, if that’s the case.”

I really believe that, if you look at all this all the things, whether it’s you can make more money, and then potentially save more or you can work longer. To me, the easiest thing to do is to kind of like surrender yourself to the market and say, “Look” – to your point, Tim, like the rule of thumb, it’s this gradual, and I have – I’ll share the camera here, which I’ll be on the video, but this is like a really terrible sketch. Because I was trying to like sketch this out conceptually, because I’ve never showed this. I’m a visual learner. In the rule of thumb, it has you go in and say like, “Okay, if you’re 30, then how do you start in 80% equities?” And then when you go to 40, you’re at 70%. In my mind, I’m like, “No.” Hell to the no. Because it’s just so much lost opportunity.

Whereas mine is more like, my belief and this is more of a capacity thing, is more of a cliff. So, you should be very much mostly equities, and there’s a lot of criticism against an equity portfolio. And again, this is not investment advice. This is not investment advice. But it should be typically closer to the equity or equity portfolio. And then when you get close to that eye of the storm, that’s when you start to basically divest out of equities, and go more to the fixed income, the bonds, and then you go through that eye of the storm where you’re here, and then you start to gradually, as you get to 75, 80, and you’re really looking for combating its longevity risk, which is the fear of the money running out. You need that to last into your 90s, 100, that type of thing. So, you’re going to take more risks on the back end, but typically, you have a more of a handle on spending, and things like that, post eye of the storm time.

So yeah, I mean, no matter where you’re at in life, this is an important conversation to have. And there is no right answer. But I would say that there are wrong answers in my estimation. But I also think it’s important to say that, at the end of the day, we say this about student loans, but at the end of the day, if you’re like waking up and you’re like sweating bullets, because you’re worried about how your investments are faring, especially in a volatile market, then we talk about this with the emergency fund, it’s just not worth that.

[00:21:20] TU: But, something’s got to give.

[00:21:21] TB: Something’s got to give. That means you either have to save more or work longer, and there’s a lot of –

[00:21:27] TU: Spend less.

[00:21:28] TB: Spend less, yeah, which, which is really hard. That’s the one I didn’t mention, because that’s really, really hard to do, for most people. And I think I said on a previous episode, some people look at a 60% to 80% of their income, and that’s basically what they need is. Some advisors just look at what the tax return says, and if you’ve earned $180,000, leading up to retirement, that’s what they plan for, because that’s basically the money that’s flowing through. So, there’s lots of different ways to kind of look at that as well.

[00:21:59] TU: Tim, I think one of the interesting things here is for folks, again, I mentioned the self-awareness thing. I think they really dig deeper about like, where might these beliefs come from. Wherever you are, on kind of the risk tolerance, what you’re able to stomach scale. You mentioned earlier in the show, some folks might be like, “Hey, I’m scared of market. I’ve heard that multiple times. I have no interest kind of investing in the market. Don’t trust it. Not comfortable with the risk, whatever the case may be.” And then there’s obviously the other end of the spectrum, which is like, I’m all in on whatever investment strategy could be equities, could be cryptocurrency, could be real estate, could be a combination of things. I don’t even feel the risk. It’s like, “Man, you could have two people at the same point in their journey, and are just dichotomously in very, very different directions.”

I’m just curious from your life experiences working with clients, is that coming from some of the money scripts and things that were growing up in? Is that coming from experiences like, “Hey, I lived through the 2008 recession. I saw my parents lose a significant amount of their nest egg or grandparent”, whatever be the case. Obviously, the pandemic could have an impact. Where does that come from?

[00:23:13] TB: I think it’s a combination of all those things. I mean, you even look at it, the Great Depression, that generation didn’t put money in banks, because they just didn’t trust banks, and then that can kind of filter through later generations. I think it’s a combination of, kind of your – I think your upbringing, like I would – I talked to my parents, and they’re older now, but even when younger, I think, my mom opened up a Roth IRA for me when I was really, really young, but I think it was like, mainly in cash, or like, very, very conservative bonds, or something like that, that we actually invested in which , again, doesn’t really make any sense if it’s going to be used for 14-year-old in retirement, 50 years later or 60 years later.

So, I think it is a lack of understanding and kind of, I think, a lack of education, or financial literacy around investments is part of it. That’s not anyone’s fault. I just think it should be more part of the curriculum and the things that we talk about as students in grade school, in high school. And again, we kind of talked about you can take out hundreds of thousands of loans, but not really not understand like the financial implications of that. So, I think we need to do a better job of that. I think, again, to go back to my own experience, Tim, we didn’t talk about money growing up. It was very much a taboo thing. So, it was kind of just something that was hands off, which I think kind of does lead to stunted growth in that regard. I think that a more openness to kind of talk through some of these things, and some of like the head trash, I think, a lot of it goes – it does come from your experience. I think there is a curiosity for a lot of people and we see it, where we kind of talked about maybe some missed prioritization of like, you’re invested in penny stocks or individual stocks, but you’re not necessarily taking your match for 401(k) or you have zero emergency fund.

I don’t hate on that too much, because I think it’s someone’s willingness to kind of learn and understand, like how markets work, right? I’ve been in that boat. But I think over time is like, the market is very, very humbling, where you – it’s almost like going to the casino. No one ever says, like, “Oh, man, I lost all this money.” It was like, “I had a great” – those things get lost in the fold. I think that over time, I think people’s experience with the market is, even professional. I just read a headline somewhere that Warren Buffett says, like a monkey could pick stocks better than most financial advisors, which I would agree with. Because there is a lot of randomness with that. So, it’s, again, buy the market, don’t try to beat the market.

I think it’s a little bit of that. It’s experience, it’s education. So, people that are nerds about this, that read up, I think kind of understand what to do. But I think a lot of it is the fingerprints of what our families put on us, and sometimes those things are overcomeable, and we are aware of those things, and sometimes they’re not. Sometimes it takes someone to say, “Maybe we need to look at this a different way.” Because if you want to get to where you need to go, and for a lot of pharmacists, especially if they’re a lot of pharmacists out there, they might be the first person in their family to have graduated from college. They might be the first person that make a six-figure income.

So, with that, comes, I think, a different set of issues and things to think about as you’re – because, again, typically, the higher you are on the income scale, we look at like Social Security, less of your retirement paycheck is coming for security. The lower you are on the income, the majority of your paycheck is going to come from security. So, you just have a different set of issues and things to think about, as you make more money and have that paycheck. So, I think it’s all of those things that can shape your money script, the things that you’re saying to yourself, but I think it also is even deeper than that. It’s kind of the caveman, cavewoman approaches like you don’t want losses, right? So, you want to protect yourself in any way that you can to shield yourself from those losses. So, we do sometimes irrational things just to protect that pain. I think that’s just in our DNA. We’re here today because our ancestors have survived, some didn’t. But as the evolution of sorts is that you are programmed to do things that maybe don’t necessarily make sense in here now.

[00:27:45] TU: Tim, that’s so true. I think it’s human behaviors, you mentioned. But as you’re talking, I can and always will, I think vividly remember the significant losses in my portfolio. You feel more in the moment, but I don’t remember the significant gains in my portfolio. The long-term trend is up in a positive direction, and the significant ups have been bigger than or equal to some of the significant downs. But I don’t remember those. Like I do the losses.

Let’s wrap up this third part of our retirement planning series by connecting all of this to the asset allocation plan. So, what we determined we need is the nest egg. We talked about that in the first episode. What our risk tolerance or capacity is, those two things combined is going to then help us inform what our asset allocation plan is. So, how we actually are going to distribute these dollars within the accounts, the various alphabet soup of accounts we talked about in the last episode. So, what is asset allocation, Tim? Just to find that a little bit further, and then what are the main variables. We’ve obviously talked about one in terms of the risk, but other variables that can impact our asset allocation plan?

[00:28:51] TB: Yeah, so the asset allocation is basically the art, or you can say, even the science of construction of portfolio with a mix of stocks and bonds to achieve the most amount of return for the least amount of risk. That’s what you’re really trying to do. So, at a very strategic level, there’s basically two buckets or two asset classes. There are stocks, which are basically where you own an equity share and a company, and you’re afforded things like dividends and capital appreciation. These are the things that we need to outpace things like the inflation monster, the tax man, et cetera. And then the second part of the portfolio are bonds or fixed incomes, and these are typically IOUs or notes that say, “Hey, government, I’m going to lend you the money.” Or, “Hey, corporation, I’m going to lend you my money. Give it back to me sometime in the future, but give me an interest payment as we go.”

Between the two, typically, bonds are more like a linear growth. Stocks are more exponential growth, but there’s typically more risk with stocks and less versus with bonds. That’s asset allocation in a nutshell. And then what you could do is, you can kind of go more granular in terms of like, “Okay, well, if I have this” – if 80% of my portfolio is going to equities or stocks, you can divide that up between things like large cap, mid cap, small cap, international, emerging market, real estate, that type of thing. And then same thing with bonds, if 20% of your portfolio is going to bonds, you can divide that up between junk bonds or international bonds or short duration bonds, long duration bonds, government bonds, that type of thing.

So, it is more granular. But at a very high level, to tie risk to asset allocation is, either using the rule of thumb, or using some type of risk tolerance, gauge or questionnaire, you can say, “Okay, I’m going to answer these questions. It’s going to say I’m an 80/20 portfolio, maybe a more balanced 60/40 portfolio.” And with that, if you have kind of an unexamined, approach, meaning like, most of the time, I think a lot of people will take that, and that’s how they invest. And I think, what we, as an advisor would do is say, let’s say, “I’m you’re 35, I know what saying you’re at an 80/20. But here are some numbers to show you that you should probably should be more aggressive.” We’re not going to spend this portfolio for another 30 years. Who cares what it does for the next 20, for the next 10, whatever that is. But let’s take a little bit more aggressive.

So, that’s where you kind of get that talk about risk capacity. And then what you do is say you say, “Okay, we’ll compromise. We’re going to like a 90/10.” Then essentially, if you have $100,000, we’ll just say you’re a government employee with a TSP, if you have 100,000, know that 90,000 is going to go into some type of equity portfolio. So, the big one in TSP would be the C fund, which mimics the S&P 500. And then 10%, would go into the bond fund. That’s basically it. That’s where you connect the risk of where you’re at which again, is partly derived from the things that we just talked about, your upbringing, the head trash that you have, your experience. If you’ve experienced any pain, et cetera. And then, it should be then examined from where you’re at in terms of your time horizon, what you have saved. You’re working with an advisor, obviously. If you don’t have experience, you have a little bit more cred there to come up with, you know, what your final number is for your asset allocation. And then you put that into practice.

And then the idea is that over the course of a year, five years, 10 years, that portfolio is going to drift. So, say you are at 90/10, it could drift to a 95/5. It could drift down to an 80/20 or an 85/15, and you really want to make sure that you rebalance that over time. Because if you don’t, then if you’re an 80/20 portfolio, and you drift to something like a 90/10, if the market was then to go into a spiral, you’re taking more risk than what you signed up initially. So, sometimes when I say to rebalance, it just means to basically lock your percentages back to what you originally had agreed upon with your advisor or with yourself. That’s the big thing. So, you are kind of just resetting the percentages.

[00:33:12] TU: Again, this is a really important connection, as we bring this all together and talk about the value of a third party and the value of a planner that can really help your –it’s not – the value is not coming from picking stocks or picking investments that are going to beat the market. We’ve established that, what you’re describing is more passive investing strategy and here, we’re just talking about investing, which again, is just one part of the financial plan. The value really comes from okay, what is the game plan? What is the life plan? What is a wealthy life look like now? What is retirement life look like? What’s the number for us to get there? What does that mean today? How much do we need to be saving today to get there? We talked about that, in the first part of the series. What accounts are we going to leverage? How do we optimize this tax strategy? And within there, how do we begin to pick the investments, rebalance those portfolios over time.

Again, just such an important reminder, there are a lot of nuances in there alone, but investing is one part of the financial plan. So, we need to take that step back out of this silo that we’re in retirement planning and say, “Okay, what else is going on? What are all the other aspects of the financial plan that are happening? And does that impact or does that change potentially how we’re going to approach our investing plan?” I think, sometimes, we can hear this and hear the passive investing strategy. We can hear the nest egg calculators and think like, I can do that, I’ll just rebalance every once in a while. And you certainly can do it yourself. But let’s not lose sight of what can happen when you bring a third party into the equation, and we also have some value in zooming out and making sure this is fitting in correctly with the rest of the financial plan and the other puzzle pieces that are involved.

[00:34:56] TB: Yeah, the act of investment is a necessary, I don’t want to say evil, but it’s a necessary thing that we need to do to, again, get in front of things like inflation and taxes. A lot of advisors make that the central part of their practice and it is important. I don’t want to say it’s not important. But it typically takes a backseat to a lot of the other things that are going on in life, whether that is, “Hey, I need to pull money out of this investment, because we have to put an additional on our house, because I’m taking care of an aging parent.” Or, “Hey, we have a kid that’s going to college. So, we need to, again, change some things around.” Or, “Hey, I lost my job, so I’m not going to be able to invest like I was.”

The thing with a financial plan is that, the value is more in planning, not the plan. And the investment piece is very important, and it can be as complicated as you want to make it. But even in the simplest version, it can be complicated, because again, if we’re talking about an asset allocation, the example that I gave is in a TSP, but if you’re trying to do that across a brokerage account, an IRA, a Roth IRA, some of the task, it can very quickly, when you add layers, get more and more complicated. But I think that the – yeah, the value, I think, with working and this is at any part of the financial plan, not just the investments. It’s almost like an am I crazy type of – am I crazy to be doing this? Should I give myself permission to do this? And sometimes, because of the environment or the way that we live today with social media, like there’s so much gaslighting. You can almost start to doubt your own judgment. So, it’s sometimes good to have a rock or a steady influence, and this is at, really, any part of your life, but I think finance is what we’re talking about here to just say like, “Hey, am I crazy? Or what do we do here? Or this is a variable or this is a bump in the road? Or this is an opportunity, like what’s the best way to proceed?” Again, super biased. But I think that’s really the value. It’s not necessarily saying like, “Hey, we’re going to beat the market and all that nonsense. It’s like, life has happening, and are we living a wealthy life or not?

[00:37:20] TU: Yeah. And so, to that point, whether you are a new practitioner listening, early on in this journey of saving for the future, mid-career pharmacists wondering, “Hey, am I on track? Are there other things I should be thinking about? How does this fit in with other goals that I’m working towards? Or, pre-retiree, retiree thinking about more the distribution stage and building that retirement paycheck, which we’re going to talk about on our fourth and final part of the series. Regardless of where you’re at in the financial journey, our fee only financial planning team of five certified financial planners, in-house tax team that includes a CPA and an IRS enrolled agent. They’re ready to work with you to build your retirement plan, among work with you on your other financial goals.

So, you can book a free discovery call, learn more about our one on one financial planning services that is customized for the pharmacy professional. You can book that call at yfpplanning.com. Again, that’s yfpplanning.com. Thanks for listening and have a great rest of the week.

[OUTRO]

[00:38:09] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and it is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Furthermore, the information contained in our archived newsletters, blog post and podcast is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analysis expressed herein are solely those of your financial pharmacist unless otherwise noted and constitute judgments as of the dates published. Such information may contain forward looking statements, which are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer.

Thank you again for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 273: Alphabet Soup of Retirement Accounts (Retirement Planning)

Posted on September 15, 2022November 2, 2022 by yfpadmin

Alphabet Soup of Retirement Accounts (Retirement Planning)

On this episode, sponsored by Insuring Income, Tim Ulbrich, PharmD, sits down with Tim Baker, CFP®, RLP®, for the second part of the four-part series on retirement planning. Together they discuss the alphabet soup of retirement accounts including commonly used vehicles for accruing a nest egg.

Episode Summary

YFP Co-founders Tim Ulbrich, PharmD, and Tim Baker, CFP®, RLP®, discuss the alphabet soup of retirement accounts in this episode, the second part of the four-part series on retirement planning. Tim and Tim know that planning for retirement and building a nest egg can be overwhelming with so much to consider. In this episode, they break down common vehicles for building a nest egg into two main buckets. Tim Baker differentiates between tax-advantaged accounts administered by the employer and those administered by the individual. Tim and Tim spend time discussing how each tax-advantaged account works, including the contribution limits, catch-up provisions, and phase-outs where applicable. They get specific on how not all “buckets” are equal in terms of what you, as the investor or retiree, will receive. Due to the nature of retirement accounts and their relationship to the financial and tax plans, Tim and Tim share the importance of marrying the retirement plan to tax planning for the most benefit to the investor. Lastly, Tim and Tim explain that there are many factors to consider when determining the priority of saving among different tax-advantaged accounts, reference resources for listeners on prioritizing investments, and mention the services provided by YFP Planning and the YFP Tax team for pharmacists.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

[00:00:00] TU: Hey everybody, Tim Ulbrich here. Thank you for listening to the YFP Podcast, where each week we strive to inspire and encourage you on your path towards achieving financial freedom.

On this week’s episode, Tim Baker and I continue with the second of our four-part series on retirement planning. Last week on Episode 272, we discuss, determining how much is enough for retirement. This week, we take a step forward by talking about the alphabet soup of retirement accounts including commonly used vehicles when occurring a nest egg. Highlights from the show include differentiating tax advantaged accounts into those that are administered by the employer, and those that are administered by you the individual, how each tax advantaged account works, including contribution limits and ketchup provisions, and why not all buckets are created equal, and factors to consider when determining the priority of saving among different tax advantaged retirement accounts.

Now before we jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does in working one-on-one with more than 270 households in 40 plus states. YFP Planning offers fi only, high-touch financial planning that is customized to the pharmacy professional. If you’re interested in learning more about how working one-on-one with a certified financial planner may help you achieve your financial goals, you can book a free discovery call at yfplanning.com. Whether or not YFP Planning, financial planning services are a good fit for you, know that we appreciate your support of this podcast and our mission to help pharmacists achieve financial freedom.

Okay, let’s hear from today’s sponsor, and then a jump into my conversation with certified financial planner, Tim Baker.

[SPONSOR MESSAGE]

[00:01:39] TU: This week’s podcast episode is brought to you by Insuring Income. Insuring Income is your source for all things term, life insurance and own occupation, disability Insurance. Insuring Income has a relationship with America’s top rated term Life Insurance and Disability Insurance Company, so pharmacists like you, can easily find the best solutions for your personal situation. To better serve you, Insuring Income reviews all applicable carriers in the marketplace for your desired coverage. Supports clients in all 50 states and make sure all of your questions get answered.

To get quotes and apply for term life or disability insurance, see sample contracts from disability carriers or learn more about these topics. Visit insuringincome.com/yourfinancialpharmacist. Again that’s insuringincome.com/yourfinancialpharmacist.

[INTERVIEW]

[00:02:31] TU: Tim Baker, welcome back.

[00:02:33] TB: Yeah, good to be back, Tim. Looking forward to part two of this series.

[00:02:37] TU: Yes, this is our second part of the four part series we’re doing on retirement planning. Last week, we talked about, How to Determine How Much is Enough? We ran through some mistakes scenarios and calculations to determine that number. This week, we’re going to start to get into more of the X’s and O’s on how to get there. As I mentioned, as we wrapped up last week’s episode, often when we begin to wrap our mind around, okay, this 3 million, this 4 million, this 5 million number and we begin to accept what that is and what we need to be saving each month to get there.

The next natural question is, all right, where do I actually invest the money? What are the vehicles and options that are available? That’s what we’re going to talk about this week, some of the variety of investment vehicles and we’re primarily going to focus on tax advantaged retirement accounts, but certainly acknowledge that there are a variety of ways to build a nest egg outside of just the accounts that we’re going to talk about. So that could be real estate, that could be digital currency and assets, business ownership collectibles, and knowing many individuals are building a base that comes from, maybe not exclusively includes, but comes from traditional retirement accounts. We’re going to focus our time there.

Another important distinction I want to make is that for our small business owners that are listening, we know there are several you out there. We will cover not in detail on this episode, but certainly there are other options from a business standpoint, SEP IRA, simple IRA, solo 401K. We’re not going to focus on those in this episode, but certainly, those are a valuable option to get us to our goal, as well.

Tim, we throw these terms around all the time in pharmacy as notorious for throwing around acronyms. We put together pharmacy and financial planning. I feel like it gets worse. So we throw around term 401K, 457, TSPs, traditional IRAs, Roth IRAs, HSAs. This is often when we’re speaking with a group of pharmacists where we start to see the eyes gloss over. Okay, I understand there’s options I need to take advantage of, especially from a tax standpoint, but there’s a lot to consider, this can be overwhelming. We’re going to break this down into two buckets to give ourselves a framework.

Those tax advantage accounts that are administered by the employer. Then the second bucket is those tax advantage accounts that are administered by you as the individual. So this distinction I think will help us begin to organize and have a framework for how we can think about different options that we have to save. Tim, let’s start with the accounts that are administered by the employer. Give us a rundown of the accounts that are available here and some of the distinctions between them.

[00:05:10] TB: The ones that are typically administered by the employer are going to be the 401K, the 403B, the TSP, those are the three primary ones. Then sometimes you run into things like the 457 plan, which is typically a bonus plan. Sometimes you see 401As, which are like 401Ks, except the participants aren’t making contributions to them. The one that we’ll talk about, synonymous with all the other ones is a 401K. The 401K, is the most popular profit sharing plan. Essentially, how it works is when you are hired by an employer. They’re going to say, “Hey, welcome to the team. As part of a benefit to working on our team, we have this 401K that we’ve set up through fidelity or whatever, whoever the custodian is. These basically are funded through salary deferrals from your paycheck.”

Back in the day, you had to basically make that election yourself, but the Obama administration, I think, smartly made it, so you have to opt out. A lot of these plans, now you’re auto enrolled at a certain percentage into the plan, I think, based on your age into a target date fund. The backdrop of this, Tim is back in the day, when our dads were starting the career, the most prevalent retirement plan was a defined benefit plan, a pension. What happened over really started in the 80s and 90s, employers were starting to see how big of a burden that was on their own balance sheets, because they were basically carrying the lion’s share of saving for the employees retirement. The 401k was introduced, which is a defined contribution plan and that means that that risk of having enough save for retirement has shifted from the employer to the employee.

Now it is up to the employee to figure out how much they need to be different from their paycheck, where to invest it, and then how to distribute it tax efficiently in retirement. The problem is that we just aren’t necessarily good at that. The 401K has really taken off and now defined contributions will outpace pensions, as many of us know that do not have pensions. Participants make elective salary deferrals and for anything that doesn’t have Roth in front of it, contributions are not tax until they’re withdrawn. What this means is that, I’m a pharmacist, and I’m making $120,000 a year, and I put 20,000, just for round numbers, the maximum you can put in is 20,500, but let’s say, I put $20,000 into my 401K. The IRS taxes me as if I made $100,000. It goes in pre-tax.

Now the money is actually, it’s only going to be taxed either going in or going out. That traditional 401K, that $100,000 is going to grow and grow and grow. Then when we pour it out in retirement, that’s when it’s going to be taxed. If we think about this, say I’m going to 25% tax bracket at age, we’ll say 40, it’s not taxed at 25%. It goes in tax free. Now let’s say I’m at age 65, I’m retiring. I’m at a 25% tax bracket. If that $100,000, let’s say, it grows, but that’s going to be taxed at 25%. Your benefit, there’s really no benefit either way. The benefit comes if your tax bracket is actually lower. If you’re at a 20% tax bracket, that’s when you see some of the statements. That’s for the traditional. Now if you are age 50 and older, Tim you can make a $6,500 catch up.

Now all of these things are the same for a 403B, which is typically 401K you typically see for profit 403B, you typically see for a non-profit or hospital that type of thing. The 403B has an additional catch up and it says typically if you are a certain age and you have a certain years of service, you can put in as typically 15 years you can put an additional $3,000. So you get your 20,500 Plus the 6,500 regular catch up plus another 3000. So that’s just a funky thing with 403Bs. TSPs are very similar to all of them they have the catch-up, not like a 403B, but a regular catch-up. Their matches the same across, so TSPs is the Thrift Savings Plan, typically for military government workers, their match is 5%. The big benefit for the TSP is that they’re in basically five funds that are super low costs, which is not necessarily the case with the 401K or the 403B.

The appropriate use for these, Tim are typically when If the employer wants to provide a quality retirement benefit, without being required to make ongoing employee contributions. So you can have, you can have an employer that offers a 401K, but doesn’t put any match or anything into it, that’s up to the employer to do that. A lot of employers are doing this to incentivize their employees to save, but also as a retention, because you can have vesting schedules attached to it, which means if you leave after a certain amount of time, you don’t get that match. It’s a great vehicle if you have a young workforce, because you can accumulate savings over a long period of time. But the basically the risk is on the employee to do what they need to do to get to have an adequate retirement.

A lot of 401Ks allow for insert with withdrawals for hardships, you can take loans against it. Most 401K’s these days, same thing with the TSP and the and the 403B have a Roth component. The big disadvantage here, Tim, is that oftentimes a 401K can be expensive. So typically, the rule of thumb is, the smaller the employer, the more expensive the 401K is to that individual participant. I’ve seen it, where all in cost on a 401K is almost 2%. So think of that, I have $100,000 in a 401K, $2,000 per years coming out either to pay an advisor expense ratio or things like that. Whereas something a TSP, it’s like, three basis points, which is $30, compared to 2000.

Then the other disadvantage is that, it’s not going to guarantee an adequate retirement benefit as a pension would. Oftentimes, again, smaller 401K is the investment selection won’t be great. That’s the main one. Again, all of those, the TSP, the 403B are going to be very, very similar to that without with some minor nuance. The 457 plan, which some people will see is a non-qualified tax advantage, deferred compensation retirement plan. This is typically for people who work in state government, local government, even some nonprofits. This is often another bucket that you can put up to $20,500 into. It’s the same thing they’re typically not taxed until it was withdrawn, but often those are available to the creditors of that. If you work for a local government that goes bankrupt, then you could potentially lose that money, which is problematic. That’s a big thing that some people will see as a 457. So typically, work on the 401K, the 403B first and look at a 457 after you’re maxing that out already.

[00:12:37] TU: Tim, correct me if I’m wrong. When I was at one university, we had the 457 available with a 403B and a 401A, but the 457 amounts was on top of in addition to –

[00:12:49] TB: Correct. Completely separate bucket, yeah. Sometimes we get that – we’re going to talk about those administered at individual levels, some people say, “Well, if I put 20,500 into my 401K, can I also put money into an IRA?” So they’re separate buckets, just like the 457 is a separate bucket that’s available to you.

[00:13:07] TU: Great synopsis. That was covering our first bucket, which is those that are administered by the employer, as Tim articulated, really looking at those interchangeable 401K, 403B, TSP, typically for profit, not for profit, those that work for a federal government agency organization. He talked about the contribution limits per years, some of the catch-up provisions after the age of 50. Then the additional one for the 403B. Then making sure we’re not confusing, a Roth 401K, Roth 403B with a Roth IRA, which we’ll talk about here in a moment. I think as we see the Roth employer sponsored accounts grow in popularity, there’s some confusion among okay, I’m contributing to a Roth 401K, can I also contribute to a Roth IRA?

The answer to that is yes, there are some considerations there, but totally separate. One administer by the employer when administered by the individual. Let’s shift gears, Tim to that second bucket. Those administered by the individual. Two, subcategories here that I want to talk about would be the IRA accounts, both the traditional and the Roth IRA. Then the second would be an individual that wants to invest in a brokerage accounts. Let’s start with the IRAs differentiate the traditional IRA, the Roth IRA, some of the income limits and considerations for pharmacists that would contribute here.

[00:14:22] TB: Yeah. So same thing, when you see traditional or no precursor at all just IRA, you’re going to think pre-tax, when you see something Roth, you’re going to think after tax. The traditional IRA is a retirement account. It’s the traditional individual retirement account. It is an account that you either set up yourself so you go to something like Fidelity, a Vanguard, TD Ameritrade, a Betterment and you basically open it up or you can work with an advisor and they’ll basically open one up to advise for your benefit.

The traditional IRA is funded with pre-taxed dollars. Again, this is a separate bucket away from the 401KL, the TSP, etc. you can contribute up to $6,000 per year, plus $1,000 per year catch up if you’re age 50 or older. Now, anybody essentially with earned income can contribute to a traditional IRA. It’s subject to phase out deductions. So what does that mean? If you are a single individual, and you make anywhere from 68,000, to $78,000 like AGI Adjusted Gross Income, then once you get to $78,001, you can no longer take a deduction for your IRA. I’ll give you example on the other side, so if you make less than $68,000, so $67,999, you can deduct 100% of your say $6,000 deduction or contribution. It phases out, which means that once you get to that midpoint, so 68,000, to 78,000 the midpoint is 73,000.

If you put $6,000 in you can deduct 3000, but then you can’t, which is half of it and you can’t deduct the other 3000. This is really good for people that are listening to the podcasts that might be fellows or residents or maybe they’re in school, and they’re working and they’re trying to save some for retirement, typically, pharmacists are not going to be allowed to make a deductible contribution. So just to give you an example, if I’m out there, and I make $60,000, which is below that, and I’m single, and I make below that threshold, and I put $6,000 into my traditional IRA. The government, the IRS looks at me as if I made 54,000. So similar example, as I used before.

Now, the difference between the IRA and the 401K is the 401K is coming out of your paycheck. It’s not basically hitting your bank account. This is typically funded where it hits your bank account and you’re technically contributed into that with after tax dollars, but you’re just deducting it on your 1040 when you go to file. That’s a little bit of the nuance. The phase out, if you’re married filing jointly is 109 to 129, which again, typically for a lot of pharmacists if they’re dual income, they’re going to be above that that threshold. The same thing as, so that $6,000 goes in pre-tax, it gets invested, it grows tax free. Then when we pour that out in retirement, when we withdraw it in retirement, that’s when it’s taxed. Again, it’s either tax going in or going out.

The Roth is the one that’s tax going in. The Roth IRA is an account that’s fun it with after tax dollars and it stays after taxes. You’re not going to take a deduction. So basically, it’s the same thing, you can contribute up to $6,000 plus $1,000 after age 50. Now, and this is an aggregate, if you were to contribute $4,000 a year to your traditional you can only contribute $2,000 to your your Roth IRA. This is subjected to phase outs to actually contribute. So what that means is that once you make as a single person, once you make the phase out is 129 to 144,000. Tim, once you make $144,001 the door slams shut, and you can no longer make a contribution to the Roth IRA. For married filing jointly that ranges 204,000 to 214,000. So if you’re a couple and you make more than 214,000, you can’t directly put money into the Roth IRA, which then gets into that, you fund a traditional IRA, you got to go through all those rules that we talked about and then you can do a backdoor Roth IRA, again easier to explain, harder in actual concept.

To just reiterate, if I make, we’ll use the same example. Let’s say I make $60,000. I put $6,000 into a Roth IRA. Now, the government looks at me as if I made $60,000 that $6,000 that goes in, it grows tax free. Then when I pour it out in retirement, because it’s already been taxed, that $6,000 is all mine, or whatever it grows to. That’s the big thing that we often talk about is like, if you have a million dollars in your traditional IRA at the end of the rainbow, when you’re going to retire, you don’t have a million dollars. If you’re in a 25% tax bracket, you actually have $750,000 and the government has 250,000. If there’s a million dollars in a Roth IRA or Roth TSP or a Roth 401K, that money is yours. That’s super important to remember. I think I hit everything with Roth.

[00:19:34] TU: Yeah. Then again, Tim, just to zoom out for a moment so in the first segment, we talked about the big security number, what do we need at the end of the rainbow at the nest like three, $4 million. We back that into, okay, what do we need to be saving per month based on a set of assumptions, asset allocation, risk tolerance, all those things? Maybe that number is 800 1200, 1500, whatever it is per month. Now we’re talking about where does that go, right? So we started with employer counts. Is that a 401K, for profit 403, not for profit TSP federal government? Or and or are there individual options, traditional, perhaps maybe not a deductible option there for many pharmacists based on income or a direct Roth or backdoor Roth, depending on income limits for pharmacists.

If you put these two together, and where we see many pharmacists beginning to build their foundation, again, not the only place that we’re going to be investing 20,500, certainly more than that, for those that are listening, that are in that catch up age, older than 50. Then on the individual side $6,000 per year, so 26,500 per year between the two of those and that 20,500, Tim is not including any employer match as well, right? That’s employee –

[00:20:46] TB: Yeah. If you include the employer match, and anything else they give you, I think the number can go all the way up to 61,000. As long as the employee and the employer match doesn’t exceed, 61,000 you’re good to go, which that’d be nice if you got that much in a match.

[00:21:02] TU: We put the two of these together. Again, not investment advice, but we put the two of these together, and we’re now north of $2,000 per month towards our savings goal. Is this the only way we can invest? Absolutely not, but these two tax advantage accounts, and there’s a lot of strategy and consideration here. Tim, you mentioned it a few moments ago, tax bracket today, tax brackets in the future, what else is going on in terms of the tax situation, another great example where we need to marry the tax plan with the financial plan, but a really good place to begin to think about the foundation for our investing.

[00:21:33] TB: Yeah. That’s a common question that we have, is like, should we put in Roth, we put it in traditional, should we be putting it in taxable, which we haven’t talked about, the brokerage account, which we can talk about here in a sec. The answer is yes, all of them. Because what we do when we try to build a retirement paycheck, we’re trying to get that money out of those tax advantaged accounts at the lowest tax rate possible. The other thing at the sprinkle in is oftentimes what use the brokerage account for, so often you use a brokerage account for an early retirement or to delay claiming Social Security as long as possible. So you increase that percentage of a known income stream from the government that’s inflation protected, and that is a bigger part of your percentage of income, that’s huge and a lot of people will not do that correctly.

Before we get to the Brokerage account, the last thing I’ll say about all these accounts that we talked about, so far, the 401K, TSP 403B, Roth traditional IRA, the other one that’s often synonymous with a traditional IRA is a rollover IRA, that’s typically, when you’ll see that’s also pre-tax. Worth mentioning for all of these accounts is that if you take non-qualified withdrawals, which that’s typically when you take money out before you’re 59 and a half years old, you’re subject to a 10% penalty along with paying the tax. That’s basically discouraging you to rob that account for a car, or a home downpayment or things like that. There’s exceptions to that rule, but that 10% penalty it’s a good way for you to keep that money in there.

Again, we talked about gratification, sometimes it’s really hard for us to lock that money away and not use it until the future. So the brokerage account, Tim, is the last account that we can talk about, and the brokerage account is, it’s a taxable account. It’s an account that you can set up through any of those custodians that I mentioned. It’s funded using after tax dollars. This can either be set up as an individual account, so in your name, just like all your retirement accounts or a joint account with a spouse or a partner. The contributions to this are unlimited. With all these other accounts, we’re saying, “Oh, you can only put $20,000, 500 or $6,000.” Here’s have at it, if you if you get an inheritance, or you’re maxing everything out, and you can put five grand a month or whatever into an account, you can do that.

You typically use this when you’ve exhausted your retirement contributions previously mentioned. The other one that we of course, always mentioned is the HSA, it’s another bucket, that’s good. You typically use this account when you’ve exhausted those things or if you’re doing something else like, we often use this account for a tax bomb for a non-PSLF strategy. It could be for something that –

[00:24:23] TU: Early retirement.

[00:24:24] TB: Yeah. It could be something that’s an early retirement. So if I’m going to retire at age 55 and I’m not going to be, I can’t collect on my other accounts until I’m age 59 and a half, you would use it for that or if you’re saying okay, I’m going to retire it 62 or 65. I’m going to delay to claim Social Security to age 70. I’ll use that account from that as well. Those are typically or the last one, which is not necessarily retirement related. You might say, “Hey, Tim, I want to basically buy a piece of real estate investment in 10 years.” I’m like, “Well, that’s probably long enough time horizon where we probably should do something other than a CD or high yield savings account.” So let’s build a balanced portfolio or something along those lines that we can get a little bit more return for a little bit more risk.

The advantage to the brokerage account is the greatest flexibility, there’s no penalty to withdraw, as I mentioned from the other accounts do, you can recognize losses to offset gains, that’s called tax loss harvesting. That’s one of the big disadvantages that when you put in will use the $6,000. Tim, I put $6,000 into my Roth account or my traditional. When we say it grows tax free, what that means is when you buy mutual fund ABC at $100 per share, when you sell it and withdraw the account and say it’s $300 per share in the future, there is a gain of $200 for that investment.

Inside of a Roth inside of a Roth IRA, a 401K, a traditional IRA, you don’t have to pay tax on that $200 per share gain, in a taxable or a brokerage account you do so what that means is that you’ve contributed after tax dollars, you made the investment, you have a 200 per share gain, you have to pay either long term capital gains on that, which is typically 0%, 15%, or 20%, most pharmacists are probably going to be in the 15% bracket, or short term capital gains tax, which means you’ve held it for a year or less, that’s typically ordinary income, which is 24% tax bracket plus whatever, in your state. So that’s the big disadvantage that you’re taxed multiple times on that investment, but it allows you flexibility to do what you need, move money in and out. The investment selection is yours and there’s typically less fees, because you don’t have that big administrator typically hanging over it like you do in a 401k or even an IRA.

We often see these, Tim with employee stock purchase programs, so if you’re in an ESPP with your employee, employer, they’ll put those dollars in a taxable account, typically RSUs are granted and they’ll put those dollars or shares and investment accounts, ISOs, that type of thing, as well. There are specific scenarios where you’ll use this, but the brokerage account, again, is often one that we don’t talk about enough for retirement purposes. Sometimes I don’t like to use it especially the further away you are for retirement, because you could say, “Hey, Tim, this is for retirement.” But it’s like, just kidding. Five years later we’re going to use it for something else.

Now that $50,000 that I accounted for in your nest egg calculation is gone, right? That can be problematic. That 10% penalty, although it stinks, it can be a good firewall for you not to take that money out, but this is another important account to utilize as we’re growing our assets to then disperse in retirement, and we want to make sure that we pick efficiently from a tax perspective from each of these buckets year over year.

[00:28:00] TU: Tim, when you teach this topic, and I think you teach it so effectively, you mentioned earlier that not all buckets are created equal, right? If you have a million dollars in a Roth, a million dollars in a traditional, a million dollars in an HAS, a million in a 401K, a million in a brokerage account, you don’t really have $5 million. I mean, I guess you do on paper, but there’s going to be tax implications that are different. The visual you give for the brokerage is it’s got holes in the bucket, right, because we’re putting money in after tax, and then we’re going to incur either short or long term capital gains doesn’t mean it doesn’t have value, you gave several examples where it could in terms of bridging to delay Social Security, it could be a short or mid-term type of purchase five, 10 years if you want to get some growth momentum for the market, don’t want that sitting in our checking account. So there’s value there, but we also want to make sure we’re looking at the right priority of how we’re investing.

I think one of the common mistakes that we are seeing, I think in part, just because of the availability in marketing around brokerage accounts is, are we putting money in a brokerage account and perhaps not taking advantage of some of the tax favored accounts we talked about. Is that intentionally the choice we’re making or are we not considering the tax implications by doing that?

[00:29:09] TB: Yeah. That’s one thing we talked about, it’s a prioritization. We see pharmacists that come in, they have 1000s of dollars in a brokerage account, but they’re not really taking full advantage of match or, and I get it, Tim. I’m not a hater. I get it, because a lot of times we’re marketed to by said company that says “Hey, buy this and invest and you’ll get free bitcoin or ETFs or stock.” I understand the want to scratch the itch and get in and try to make money and invest, but if you think about it, and again, it’s not a bad thing, because you can offset losses, but if I’m being taxed already on if I’m in a 24% tax bracket for that money goes in, and then I’m taxed another 10 or 15% when it from capital gains, but then you can defer that tax or in a pre-tax account or pay it after it comes out. I think that there’s a lot of meat on the bone with regard to efficiency, right? That’s one of the things we preach is just being efficient.

[00:30:14] TU: Yeah.

[00:30:14] TB: All of these have a place, particularly when talking about the in this retirement series, and there should be attention paid in a strategy and an allocation for each, just asking these questions if you’re listening to this, look at your balance sheet. Always comes back to the balance sheet and the goals. Look at the balance sheet, how much do you have in an after tax? How much do you have in taxable? How much you haven’t pre-tax? And take stock of where you’re at.

Once you know where you’re at, then you can outline where you want to go. Yeah, I think, it’s really important to look at the priority. Again, I don’t hate on anyone in that, who is doing that. It’s just a matter of focusing and say, “Okay, what is important, what’s not important? Sometimes if we want to do some stock picking and things like that in a brokerage account, let’s just keep it minimum 5% of the overall portfolio, and then we can go from there. I’m a big believer in keep it simple and keep fees low and set the right asset allocation, and then go from there.

[00:31:11] TU: While we’re talking about priority, we’re not going to dig in depth on this episode, because we’ve done it on many others, ruling to 165 is one example, but we can’t omit the HSA when we’re talking about priority of investing. Back to my visual of your brokerage account with the holes in it, the HSA is the bulletproof account, right? Depending on how we’re using that account, we have an opportunity to avoid taxes throughout. Obviously, if we have healthcare expenses that we need to fund, we can, of course, use it for that and have some tax advantages.

Got to be working for an employer, we have a high deductible health plan that dollars aren’t as big in terms of contributions that we’re going to see in a 401K or 403B, so 3650 for an individual 7300 for family in 2022. Some catch up provisions are again, but another tax optimization strategy that want to be considering. I hope we’re hitting that point home, intentionally is that I think one of the things our planning team does so well and a shout out to the integration between the planning and the tax team is, are those two things in sync? Are we are we planning with a tax mindset? Are we also thinking about the tax implications, but also building the financial plan around that as well?

Tim, I probably should have mentioned this earlier, but we’ve thrown around a ton of numbers in terms of contribution amounts, we’ve talked about phase outs and AGI limits, and maybe some folks are trying to scratch those down. Hopefully they weren’t doing that when they’re driving, but we have all these numbers available for use, you don’t need to memorize any of those. We’ve got a sheet that has 2022 important numbers, even beyond just what we’re talking about here and investing savings, you can go to yourfinancialpharmacist.com/2022numbers, again, yourfinancialpharmacist.com/2022numbers and get that information.

Again, this is our second part in a four part series on retirement planning. Next week, we’re going to come back to risk tolerance versus risk capacity, a very important distinction between those and how we begin to determine within these accounts we talked about in this episode, where we actually start to invest the money. Then finally, we’ll wrap up in our fourth part about how to build the retirement paycheck. The team at YFP Planning is ready, whether you’re new practitioner, mid-career pharmacist, someone who is approaching retirement, our fee only financial planning team of five certified financial planners and an in-house tax team, including a CPA and an IRS Enrolled Agent, ready to work with you to help build your retirement plan among your other financial goals as well.

If you want to learn more about the one-on-one fee only comprehensive financial planning services that are offered by YFP Planning, you can visit yfpplanning.com to book a free discovery call. Thanks for listening. We’ll see you next week as we continue the series on retirement planning.

[SPONSOR MESSAGE]

[00:33:50] TU: Before we wrap up today’s show, let’s hear an important message from our sponsor Insuring Income. If you are in the market to add own occupation, disability insurance, term life insurance, or both, Insuring Income would love to be a resource. Insuring Income has relationships with all of the high quality disability insurance and life insurance carriers you should be considering and can help you design coverage to best protect you and your family.

Head over to insuringincome.com/yourfinancialpharmacist or click on the link in the show notes to request quotes, ask a question or start down your own path of learning more about this necessary protection.

[OUTRO]

[00:34:27] TU: As we conclude this week’s podcast, an important reminder that the content on the show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Furthermore, the information contained in our archived newsletters, blog posts and podcasts is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analyses expressed herein are solely those of your financial pharmacists unless otherwise noted and constitute judgments as of the date publish. Such information may contain forward-looking statements which are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer. Thank you again for your support of the Your Financial Pharmacists podcast. Have a great rest of your week.

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Special Update: Student Loan Announcements from the Biden Administration

Posted on September 12, 2022 by yfpadmin

Special Update: Student Loan Announcements from the Biden Administration

This is a special update with more information about the student loan announcement that was announced on August 24, 2022, from the Biden Administration. We know this update is top-of-mind for many pharmacists in the Your Financial Pharmacist (YFP) community and will update this post as we know more.

Check out this special update YFP podcast episode to learn more.

Let’s jump in with the updates:

1. Another Extension of Administrative Forbearance

It’s been almost three years since student loan payments were put on hold, and borrowers now have another extension that pauses both payments and interest.

The extension of the administrative forbearance will continue through December 31, 2022, with payments expected to begin starting January 1, 2023.

Although the forbearance has been extended in the past, we do think this is the last extension.

As before, all $0 payments will continue to count towards PSLF (Public Service Loan Forgiveness).

Announcements from student loan servicers should come out sometime between now and the end of October 2022. This communication should include payment amounts, employment certification requests if needed, and other information.

For pharmacists that graduated in the last 3 years, this will be the first time student loan payments will be made. Those pharmacists that were already making payments and had a pause in doing so will have to start making them again.

Student loans are a big part of the financial plan for the YFP community so payments restarting will impact other aspects of it.

2. Providing Targeted Debt Relief to Low- and Middle-Income Families with Debt Cancellation

Debt cancellation has been a hot topic since the presidential election. President Biden discussed canceling $10,000 of student loan debt, however, borrowers weren’t sure if this would happen.

On August 24, the Biden Administration announced that $10,000 of student loan debt would be canceled for those that have less than $125,000 (single) in Adjusted Gross Income (AGI) or $250,000 AGI (couples/households).

Borrowers that have Pell Grants can receive an additional $10,000 of student loan debt canceled.

For good reason, many questions have been raised with this part of the announcement:

How do I receive the debt cancellation?

How do I know if I’m eligible for it?

What’s the process to get student loan debt canceled?

What year will AGI be taken from?

From the latest information the YFP Planning team has seen, there will be an application that needs to be submitted for debt cancellation. The form should be available by October and submissions are encouraged by mid-November. AGI will come from your 2020 or 2021 tax return.

It’s likely that there will be a 4- to 6-week processing time for applications and applications should be available for one year.

The application is valid for undergraduate or graduate loans and Parent Plus loans, Direct loans, and some FFEL loans will qualify (note that not every FFEL is under a federal loan servicer and private servicer loans are not an automatic qualification). Clarification is needed here.

3. New and Improved Income-Driven Repayment Plan

A new and improved income-driven repayment plan hasn’t formally been announced, however, we do know that the biggest benefit is that it’s going to decrease the overall amount of required minimum payments for those that choose this plan.

Here’s how the income-driven repayment plan currently works:

Payments are based on a percentage of your discretionary income. From the federal government’s perspective, your discretionary income comes down to two things: your adjusted gross income and the U.S. poverty guidelines for your family size. For the current Income-Drive Repayment plan, discretionary income is your adjusted gross income minus 150% of the poverty guidelines. From there, your payment under this repayment plan is 10% of your discretionary income.

With the updated plan, your discretionary income will be calculated this way: adjusted gross income minus 225% of the poverty guidelines. With this updated plan, your payment is decreased to 5% of your discretionary income.

If you have graduate loans or a combination of undergraduate and graduate loans, a weighted average will be taken.

Calculators will be made available before payments start in January so that you can estimate your payments.

We should expect to hear something about this new plan and when to apply for it in the coming announcements.

It’s important to remember that while this may benefit many, it doesn’t mean that choosing this plan is the best for your personal financial situation as you would need to recertify your income based on your 2021 taxes if you haven’t recertified in a long time.

So what should you do while we wait for more information to be announced?

Get prepared to start making payments in January and estimate what that payment amount will be
Find out if you have a Pell Grant by visiting studentaid.gov
Make sure you can log into your loan servicer, especially if you are pursuing PSLF
Once you submit an application for cancellation when the time comes, be sure to check your balances to ensure that it happens
The temporary waiver for PSLF is scheduled to be in effect until October. Make sure to recertify your employment if you haven’t already so that it picks up all possible payments that you could be eligible for.

Still have questions? We can help.

We know that navigating student loan repayment with or without changes to the income-driven repayment plan and the announcement for debt cancellation is overwhelming.

Now is the perfect time to get a handle on your student loans and determine the best strategy to tackle your loans.

Your Financial Pharmacist offers a Student Loan Analysis with one of YFP Planning’s Lead Planners, Kelly Reddy-Heffner, CFP®, CSLP®, CDFA® or Robert Lopez, CFP®. During this analysis, they’ll evaluate all of your options and decide on the best repayment plan and strategy for your personal situation.

Get all the details and purchase your student loan analysis with Kelly or Robert here.

Have additional questions? Email [email protected] and join the YFP Facebook group.

Current Student Loan Refinance Offers

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YFP 272: How Much Is Enough? (Retirement Planning)

Posted on September 8, 2022November 2, 2022 by yfpadmin

How Much Is Enough? (Retirement Planning)

On today’s episode, sponsored by APhA, Tim Ulbrich, PharmD, sits down with Tim Baker, CFP®, RLP®, to discuss how much you need for retirement in part one of the four-part series focused on retirement planning.

Episode Summary

Tim Ulbrich, PharmD, sits down with Tim Baker, CFP®, RLP®, to discuss how much is enough when it comes to retirement planning in part one of the four-part series focused on retirement planning. In this discussion, Tim and Tim cover finding a balance between saving for the future and living a rich life along the way, factors to consider including determining how much is needed when building a nest egg, what the 4% rule is and why it is commonly used as a safe withdrawal rate during retirement, and why time in the market and savings rate matter more than the rate of return on investments. Tim Baker shares his opinion on financial planning as an exercise in goal setting for the long term while balancing experiencing life in the present and how financial planning and even minor changes in your investment portfolio can have a significant impact on your total retirement amount. They dive into what many folks consider a safe savings rate and considerations for increasing that savings rate dependent on numerous factors in the financial plan. Tim and Tim explain the rule of 25, which is popularly used in the FIRE (Financial Independence Retire Early) community as a guideline for retirement savings, how it works, and how it compares to the 4% rule. They close with general calculations and formulas for determining the nest egg for retirement and tease next week’s episode on the “alphabet soup” of retirement accounts.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

On this week’s episode, Tim Baker and I kick off a four-part retirement planning series by discussing how to determine how much is enough when it comes to saving for retirement. Highlights from the show include finding a balance of saving for the future, while also living a rich life along the way, as Tim Baker says, “It can’t be just about the ones and zeros in the bank account.” Factors to consider when building a nest egg and determining how much is needed. What the 4% rule is and why it is commonly used as a safe withdrawal rate during retirement. And why time in the market and savings rate matters more than rate of return. Before we jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does, and working one on one with more than 270 households in 40 Plus states.

YFP Planning offers fee only, high-touch financial planning that is customized to the pharmacy professional. If you’re interested in learning more about how working one on one with a certified financial planner, who may help you achieve your financial goals, you can book a free discovery call at yfpplanning.com. Whether or not YFP Planning financial planning services are a good fit for, know that we appreciate your support of this podcast and our mission pharmacists achieve financial freedom.

Okay, let’s hear from today’s sponsor, and then jump into my conversation with certified financial planner, Tim Baker.

[SPONSOR MESSAGE]

[00:01:33] TU: Today’s episode Your Financial Pharmacist Podcast is brought to you by The American Pharmacists Association. APhA has partnered with Your Financial Pharmacist to deliver personalized financial education benefits for APHA members. Throughout the year, APhA will be hosting a number of exclusive webinars covering topics like student loan debt, payoff strategies, home buying, investing, insurance needs, and much more. Join APhA now to gain premier access to these educational resources and to receive discounts on YFP products and services. You can join APhA at a 25% discount by visiting pharmacist.com/join, and using the coupon code YFP. Again, that’s pharmacist.com/join, and using the coupon code, YFP.

[INTERVIEW]

[00:02:19] TU: Tim Baker, welcome back on the show.

[00:02:21] TB: Thanks, Tim. Yeah, good to be back.

[00:02:23] TU: It’s been a while. I mean, you’ve done some case studies with the planning team, which have been awesome. But we haven’t been back on the show together in some time, so I’m looking forward to this series that we’re going to be doing on retirement planning. We’ve got a four-part series plan, all about retirement planning, starting with determining how much is enough, what do we need as we look at preparing towards retirement, and ending with strategies and considerations for actually building that retirement paycheck. And a topic that’s often overlooked, we’ll talk about that in detail when we get to that fourth and final part.

I believe we’ve constructed this, Tim, in a way that whether it’s a new practitioner who’s just getting started wondering what’s this big scary number for off in the future, or someone who’s mid-career checking in to see if they’re on track, or pre-retiree thinking about, “Hey, this is coming up, and are there some tweaks that I need to make, or adjustments or perhaps confirmation that I’m on track.” I think this topic is relevant, regardless of where someone is at, at their career.

So, we’re going to get into the dollars and cents. We’re going to nerd out on the nest egg and some of the X’s and O’s. But first, I think it’s valuable that we consider what is the purpose, what’s the vision for what we’re trying to do before we start thinking about, is it 3 million? Is it 4 million? Is it 5 million? So, Tim, talk to us about number one, why is this so important before we actually determine how much is enough, and then how are we going to get there? And how do we practically begin to accomplish defining the vision that we have when we think about retirement, and what that life will look like?

[00:03:57] TB: Yeah, so comprehensive financial planning, to me, it really boils down to the idea of how do I best go about living a wealthy life today, say in my 20s, 30s, 40s, 50s, and a wealthy life tomorrow. We typically think of tomorrow, more in terms of like the long-term horizon of in my, 60s, 70s, 80s, 90s through retirement. It can be really difficult for us, Tim, to kind of conceptualize time, or like, feel time. So, the further, when we kind of talked to clients, and we say like, what does success look like a year out, two years out, three years out, five years out, those conversations are a lot easier to have. But as that time horizon becomes more and more, we kind of lose sight of how to even like think in decades.

So, to me, that’s what comprehensive financial planning, is about is kind of coming up with solutions where you feel good about what you’re doing today and then what you’re planning for the long tomorrow. And I think what often happens is that individuals, kind of swing one way or the other. So, like in our household, I’m thinking about, “Oh, man, are we saving enough for retirement? Are we doing everything from the long term?” Whereas my wife is like, “Bro, we have two young kids, we need to make sure that we’re doing things with them while they’re young, and they’re still under our roof and all that kind of stuff.”

I actually think some people think that that’s like not a good thing, if you have two partners that are kind of diametrically opposed. I think it’s good, because I think it leads to balance and leads to address some of those conversations. So, if you’re all one way, then sometimes it’s really hard. If you’re like, save, save, save, it’s really hard for you to open up your hand and spend. But the other thing, sometimes people are afraid to talk about a planner is like, “I’m very spendthrifty. I’m not saving enough for the future, because I can’t see two feet in front of my face”, or just, “I grew up in an environment where we didn’t really save. We just kind of live for today and hope for the best.”

So, to me, this whole thing of like, how much is enough? It’s kind of an exercise in that and projecting out, okay, what is a reasonable number that we should be shooting for? And are we doing what we need to do to get there? I think the disconnect with this is, oftentimes, you’ll get a statement, Tim, or you’ll talk to a financial planner, and it’s like, “Oh, you need $4 million to retire.” It’s like, that’s such a big number and I look at what’s in my account, and I’m like, “Yeah, right.” It doesn’t even calculate or compute. So then, it’s almost like you give up, right?

But the problem is, is that the number for a lot of our listeners, it’s going to be multi millions that they’re not going to need to save more than likely. And we’ll get into things like, where does security play a role? And if that’ll be there, and all that kind of stuff? But to me, that’s really the exercise. Are we doing what we need to do today? And then are we doing what we need to do to ensure that we’re good to go for tomorrow. I think it’s about as simple as that, and I think when you talk about retirement planning, you’re looking at the full breadth of the timeline, and making sure that – because it just gets – the longer that you wait, I kind of look at it as, if you started in your 20s, you’re climbing like a steady grade. If you start in your 60s, its Mount Everest, because you literally can’t save enough to kind of overcome that, and the alternative is just a huge cut in your lifestyle, and what you’re going to be able to afford when you do turn off that W-2 or income that’s coming in every two weeks.

[00:07:47] TU: Yeah, and I think so many people, as you mentioned, feel defeated by and we’ll talk about the nest egg numbers and kind of how we get there. I think for many folks, maybe there’s confirmation of, “Hey, I am on track.” And for others, they’re like, they hit the stop button, because they’re like, “No way this is going to happen for me in the future.” Because of, it’s hard to really believe in trust the process and time value of money and compound interest and growth, and that’s a future thing. That’s a tomorrow thing. And as you mentioned, it’s hard to see and imagine our future selves, especially when we’ve got things right in front of us today. And so, this is where the balance comes in. We’re going to go through this exercise of how much is enough. But as we talked about over and over and over again on the show, like an investing retirement plan is another great example of that, we can’t look at any one of these in a silo because for many, if not everyone listening, this is not the only thing they’re worried about, right?

[00:08:39] TB: Yeah. And just to go back to that, like in terms of the numbers, basically, I was doing some research for the case study that we recently recorded with Kelly and Robert, and I was trying to construct, what was the reasonable purchase price for a home in Portland, Oregon. The average, I think, was something like $88,000, or something like that in the late ‘80s. So, think about that, like those numbers. And again, when I typically talk about investments, and I talk about the secret ninja, the termite that is inflation, I always say that, what is it, that $4 latte at Starbucks in 30 years is going to cost north of 10. Or my dad will say, “A nickel would buy the whole candy store.” Now, a nickel doesn’t buy anything. When he’s grown up, he’s growing up in the ‘40s and ‘50s.

So, yeah, and to your point like, it is one – the investment and the retirement piece is one of many, many things that you have to consider. Just the overall risk to your wealth and planning for a catastrophic event is huge. Things like taxes, which are so overlooked, and how to pay your fair share, but then mitigate how much your – there’s so many things that kind of go into this, and a lot of it, we will talk about today, it’s not even about the rate of return or anything like that. It’s just about putting money in bucket.

[00:10:00] TU: Time and money.

[00:10:01] TB: Yeah, and it’s more about the savings rate, then the rate of return. So, even those mechanics and like the behavioral finance, that kind of bleeds into everything, it’s just so imperative that we’re looking at this and examining it. And unfortunately, because either it’s a boring topic, or it’s a painful topic, or we have head trash related to it with our upbringing, or name a number of reasons why we don’t necessarily want to look at this or work on it, it just becomes harder and harder as we go.

To give you some numbers, Tim. So, if you look at a pharmacist with medium pay, and they’re saving about 15% of income with an average annual rate of 6%, which is about what the market returns. So, that’s a fairly aggressive portfolio. If you started at age 25, by the time that you reach age 60, you have a portfolio of $2.6 million. Now, if you’re at age 25, and you’re saving 15%, and you’re an aggressive, that’s pretty good. The fact of the matter is, is that you’re probably not doing – a lot of people are not saving 15%, right off the bat.

At 30, when you get to – so you have 30 years now of accumulation, it goes to 1.8 million. So, a pretty big drop. At 35, just five years later, so 35 to 60, 1.2. If you start to the ripe age of 40, turning 40 this year, Tim, to age 60, so just 20 years, now, you’re not even crossing that million dollars. You’re at 822,000. So, a lot of this is just the mechanics of it’s better than what it was in the past. In the past, if you had a 401(k), you actually had to like sign up. Now, a lot of them will auto enroll you, so you are getting out of the way. But what I would encourage people if they’re not thinking about this, is add that 1% or that 2% every year, so you can get to that 15% or 16%.

During one of my recent courses, they were looking at what is the – everyone talks about the safe withdrawal rate. We’ll talk about that, the 4%. But what’s the safe savings rate? And the number that I remember is about 16%. So, if you are enrolled in your 401(k) and auto enrolled you at five, you are ways away. So, then the flip side of that is for you to make up, you’re going to have to be saving 20%, 25%, 30% later in your career to kind of make up for that. So, these are all things to kind of be mindful of as you’re navigating this minefield, so to speak.

[00:12:24] TU: Yeah. I think we’ve all had a parent, grandparent, friend, mentor, colleague. Somebody has told us, you got to start saving as early as you possibly can. And the numbers you just gave highlight that. If you start at 25, instead of 30, you’re adding about a million dollars. If you started 25 instead of 35, 1.5 extra, and that’s just simple math savings calculator, time value of money. And those numbers are hard to believe. But it becomes at a point where you see the exponential growth of those funds, but it feels like a grind for that first 10, 12 years, and you start to see the time value of money work, it’s magic. It really is 76ers style, trust the process long-term.

[00:13:03] TB: Trust the process, Jojo.

[00:13:04] TU: It’s hard, though, right? Because what did we talk about in this show? Homebuying with student loans, all these competing priorities. We got to have an emergency fund, we’ve got to be – we know folks are working hard to save for kid’s college while they’re also caring for elderly parents. We want to travel. I mean, all of these competing priorities, and pharmacists make a great income. But at the end of the day, there’s only so much to go around. And so, we’re not suggesting that this is an easy drop in the bucket, but something that we need to be intentional and consider with the rest of the plan.

[00:13:34] TB: I’ll say like, in our household, I’m always like, “Hey, can we increase your 401(k)?” “No.” It’s a battle in my household. And I’m like, “I do this for a living. Trust me.” But it’s that pool again. So, I’m like, “Okay. But if that’s taken away from what’s actually in our bank account, and then funding some of these other goals.” So, it’s a struggle. I mean, it’s a struggle in our household. And again, I probably am too diligent on the future, and not so much on the present, although I think some of the things that we’ve done in our financial plan is kind of said otherwise. But this is – it’s such a human thing, right? Because it’s that delayed gratification. But it is one of those things that if you can understand how to tweak it now, potentially early in your career, or even to say, even later in your career, knowing what to do for the final 5 to 10 years of your career can make all the difference.

The other side of that is, things like, what is your asset allocation when you’re in your 50s, if you’re trying to retire at 60? What do you what are you doing from a Social Security claiming strategy? Is there a way to lock an income through like an – there’s a ton of things that you can do to shore up your prospects, that just like what we see with student loans is kind of, sometimes you just follow the crowd. “Oh, my co-worker is doing this, so I’m doing that.” That never go goes away. “My brother in law is doing this, so I’m going to claim here.”

So, to me, it’s what I often say is like, you don’t have the same goals or the same balance sheet as whoever that is. But it’s hard to basically discern, “Hey, this is my situation. This is what I’m trying to do.” And wave through all of the stuff that’s out there to say, “Okay, this is the right – this is a clear path.” It’s just tough, and there’s so many variables that go into it.

[00:15:27] TU: Tim, one thing I want to share, and you’ve done a good job of opening my eyes to this, and we see this with clients over and over again, before we get into the numbers in the weeds is that we often talk about saving for retirement from a scarcity standpoint, as a, “Hey, I might not have enough, or are we going to fall short.” But we see many instances where you could argue like, is someone saving too much? And I think the value of this exercise, as you mentioned, is we have to find this balance between taking care of our future self and living a rich life today.

So, if we have a quick start in our retirement, we run the nest egg, and we see we’re not running a monthly deficit, perhaps there’s a surplus there, that begs the question of like, are we living the rich life today? So, just like an opportunity cost, of having too much in the emergency fund, there could be an opportunity cost of too much in a retirement account. Maybe a good problem to have, but it’s a problem, nonetheless. So, we’re going to talk about the balance of that, and I think that side gets overlooked often when we talk about retirement planning.

[00:16:24] TB: Yeah, I mean, we’ve definitely had clients that come in, where we actually do the analysis and it’s like, “You’re going to be fine.” So, we can afford to dial this back. And it’s not just retirement accounts, it’s education, especially if we kind of reframe what is the goal around education? What is the goal around retirement? A lot of the times, Tim, especially if you’re on the younger end of things, we’re planning as if so security’s not going to be there. So, you’re shouldering this all yourself. But the fact is, is that there’s a stat that says today, about 50% of people have Social Security makes up 40% of their income, or it’s flipped, the other way around. So, that’s not going to zero. It might be 25, it might be 30, and we can talk about Social Security more in detail. But if you think about that, and we say, okay, for every $10 that you’re going to spend on Social Security, or every $10 in your paycheck, $4 of that is going to come from Social Security. And if you claim right, that number gets bigger and bigger. If you kind of go through a proper claiming strategy, that’s huge.

So, we kind of plan as if like the worst-case scenario, that’s not going to be there. But if we can kind of back some of those numbers. If we use today’s averages, or maybe even like, on the low end, it really lends itself to saying, “Hey, this is not so bad. Again, if you have a lot of time.” Now, if you’re up against it, there’s a lot less wiggle room. It’s almost like you’re trying to steer the Titanic away from the iceberg. The closer that you are, the harder it is just to get around it. If you have miles, like a lot of younger pharmacists do, a few tweaks here and there just makes all the difference. And that could just be from again, the contribution rate, the allocation, or even just doing it and saying like, where am I tracking to like where we’re currently contributing, and then maybe back that off to then enjoy more today. Which I think is something that’s very unusual, because I feel like most financial planners will say, as much as you can, save. Because the more money you have, the more options you have.

But my view is, you can do that, and I kind of look at it as you can stick your head and run through the rose bushes to get your soccer ball. But you’re not really enjoying yourself on the way through. So, I think that’s where that balance comes through. I remember having conversations with clients about this very early when we were going through this of like, we back this off, we buy the home sooner, maybe we start our family sooner because of what this analysis shows us.

[00:19:03] TU: Start the business.

[00:19:05] TB: Yeah, exactly. Exactly, right. And to me, that is power. That’s options, right? So, that’s why I’m just a big believer in a plan and planning. It’s a dynamic thing.

[00:19:15] TU: Yeah. And I bring that up, because again, I think we don’t talk about much of that side of it, and it is more from that scarcity mindset. But I just heard from a client yesterday, it said, one of the greatest values I’ve gotten from the planning team is the permission to spend in an area that they have determined as richest in their own lives. And that was around hosting and welcoming people into their home. And obviously, there’s costs that come with hosting. But at the end of the day, if you’ve got 3.2 versus 4.1, but you’re going to look back on all those memories of friends and people in your home. What are you going to remember, right? I mean, it’s an obvious – so yeah, we got to take care of the future self, but also are we making sure that we’re living a rich life today.

Let’s talk dollars and cents. How much is needed? How much is enough? And there’s different ways of doing this. I want to start him kind of back of napkin math. Disclaimer here is that, this is certainly not the advice of, “Hey, I run some numbers. I punch some things in a calculator, and I know exactly what I need for retirement.” So, we’re going to plant some seeds. But there’s obviously a lot of in-depth analysis that goes into this. But I want to start with the rule of 25, which is a common quick math that’s used in the Financial Independence Retire Early Community, the FIRE Community, which says take 25 times your annual expenses, and that’s roughly the estimated amount that you’ll need to achieve financial independence.

So, let’s say someone’s listening and they look at okay, if I had about $100,000 per year of annual expenses, 25 times 100,000, I need about $2.5 million to get to the point of financial independence. And what that is really referring to, is the amount that you would need to have invested in a conventional stock and bond portfolio. We’ll talk a little bit more about that throughout this series, to probably, keyword “probably”, consider yourself financially independent, that you could not depend upon work income and be able to draw from that portfolio without concern that you’re going to be running out of money sooner than would be desired. And that comes from, Tim, and I want you to break this down a little bit further. That rule of 25, the inverse of that comes from the 4% rule, which as you mentioned just a few moments ago is about this concept of safe withdrawal rate.

So, break that down a little bit more for us. We’ll talk about this in depth when we get to the retirement paycheck piece. But what is the 4% rule? And I know this has been debated, but why might this be a good starting point for us to think about what’s needed in a portfolio?

[00:21:38] TB: Yeah, so the safe withdrawal rate is based on the work by William Bengen. And what he did was he looked at all of the historical rates of return for a portfolio and I think he did like a 60/40, portfolio 60% in equities, 40% in bonds, and he used a time horizon of 30 years. Basically, what he was trying to figure out is, what is the amount of money that can draw from the worst 30-year period where at the end of that 30-year period, there would still be money left over? So, the money would not run out.

He did the analysis and basically came out with – and I forget what the year. I think it was like 1961 to 1991? Or maybe it was like –

[00:22:31] TU: Yeah, it sounds right.

[00:22:32] TB: Yeah, right around, I think it was like ‘60s and ;90s and 4% — so what that presumes is that all of the other roll on your peers, you could actually take out more, and still be okay. But the worst period in, I think, he did it since like the 1920s all the way up until I think 2012. The worst period of that 30-year period was from the ‘60s to the ‘90s, and the safe withdrawal rate where their money was not going to run out was 4%. Now, there’s been a ton of debate of whether that is. It disregards things like taxes, it disregards things like fees associated, so whether you’re working with other fees, it disregards, kind of adjusting portfolio as you go through those 30 years.

And then the other thing is that, one of the observations of late is that for a lot of retirees in this low interest rate environment, obviously, it’s ticked up here this year, and equities performing what they’re performing, maybe 4% is not necessarily a good role going forward. So, there’s a lot of debate about that, and can you set it for 4% and be good to go? Maybe. But that’s basically what it’s based on. It’s like, okay, what is the worst, and when they’ve tested it in other, say, like, Italy, it failed, where this basically was successful 100% of the time, in that same period, it failed 80% of the time in Italy. Not to say that we would have, but they were dealing with a lot of inflation and things like that.

So, that’s basically it. So, the inverse to your point is 25 times your annual expenses. The problem with the annual expenses, Tim, is that if you ask somebody like what’s your annual expenses, unless they’re a FIRE nerd, they’re not going to know. And even that, when you’re trying to back into building a retirement paycheck, I know some financial planners, they don’t even ask the client for their annual expenses. They just assume that everything on their W-2 is basically they’re going to spend.

[00:24:29] TU: Their income, yeah.

[00:24:29] TB: And there’s other ways that you can discount and things like that. But that’s kind of where you get to it. I wouldn’t say that rule, I like rules of thumbs because they’re easy to remember, right? We talk about rules of thumb and other parts of the financial plan. So, if it’s $100,000, 2.5 million, I don’t think that that’s necessarily something that is not a bad thing to at least have in your back of your mind to shoot for. But there’s a lot of gray and again, a lot of gray with the accumulation but then also the kind of withdrawal phase of like, “Okay, I have this pot of money where there’s 2.5 or 4 million. How do I actually turn that into a paycheck that’s going to sustain me for the rest of my life?” And that’s a difficult kind of thing to tackle.

[00:25:09] TU: Yeah, and we’re going to cover that in more depth in the retirement paycheck part of the series. And obviously, we’ll dig into that after that as well. But just to bring my example back here. So, 2.5 was the number that we determined. Again, 4%, inverse of the rule 25. So, 2.5, 4% of 2.5 would be $100,000. So, that would be the idea, and correct me if I’m wrong, Tim. But I think the 4% rule also suggests that you’re essentially bumping that up 3% per year for inflation. So, the 100 would become 103, and then you would continue that on into the future.

So, there are a lot of nuances in there. You mentioned tax is one. Obviously, what types of accounts do you have saved up. We’re in a time period like we’re in right now, where inflation is obviously a lot higher than 3%. That can have an impact. So, if folks want to just back up napkin, okay, maybe three, three and a half, well, three would be 33 times annual expenses, you can run some of these numbers and kind of see what they would shake out to be.

Tim, let’s get a layer deeper then, which is the nest egg calculation, something that our planning team and works with our clients a lot on, which is we’re trying to get more specific about the individual circumstances for that client, what they currently have, say, projected age of retirement, how long they might live, how does Social Security factor in. And then ultimately, I think one of the great outcomes of a nest egg calculation is getting out of this monopoly money state of mind of 3, 4, $5 million into the future that I can’t relate to, to what I actually need next month, and the month after, and making this tangible as a part of the monthly planning.

So, tell us a little bit, high level, about the nest egg calculation and what are some of the factors we’re considering to ultimately get to that? Are we on track? Or are we not on track for what it’s enough?

[00:26:58] TB: Yeah, so I feel like very early in my financial planning career, I looked at the different approaches to this particular question of like, do we have enough? There are other things like Monte Carlo analysis, which we can talk about, or bootstrapping, which we can talk about briefly after this. But I found that doing the nest egg calculation was really important. But when I did it in my last firm, we would basically stop at, “Hey, you need 3 million, Tim.” And then we would move on to, “This is what you need to do for insurance or your state plan or whatever.” It was, like you said, it was like monopoly money. Nothing about that connect it to the client, especially if the further away they were. I went out to reference that. If it’s like you have a million dollars and need 1.5, and you’re four or five or six years away, then that obviously connects.

So, what I basically did was, I was like, okay, I asked the question, how can we make this more digestible? I’ll walk through kind of high level of the nest egg, and then I kind of see how we pivot from there. What we do is we take a client, we take their current age, we take what their target retirement age, which for a lot of people, it’s like, I don’t know, 65, or maybe it’s full retirement age for a lot of – 67. And that gives us the work life expectancy. That’s basically the amount of time left that you have to work for the man. That’s your timeline, your career timeline.

And then we look at what their life expectancy is, which you can go on to socialsecurity.gov, right now, put in your birth date, your gender, and it’ll spit out the year and the month you’re going to die. So, for me, it’s like 86.8 years old. Now, what most financial planners will do is they’ll go a little bit beyond that. So, 90 to 100. A lot of like financial planning software will go to age 100. You just kind of pick what is a good timeline for you. If you take the number that you’re going to retire at 67, for an example, and then say, we’re going to die at 95, then you have 28 years of basically, retirement, senior unemployment. And that’s what makes us really hard, Tim, is that we’re trying to solve an equation without all the variables, right? We don’t know when we’re going to pass away. So, we just make some assumptions. And then we look at what do we currently have in retirement savings, so that’s all the 401(k)’s, IRA’s, all the alphabet soup that we’ll talk about in the series.

And then what is your current income? Now, we use current income because we use a discounted amount called your wage replacement ratio, to kind of figure out what the need is in retirement. So, a lot of planners will use 60% to 80%. You just kind of figure out what that is. The logic behind that is that, as you are leading up to retirement, a big part of your paycheck, 20%, 30% is going to be just saving for retirement, and then when you retire, you’re not going to be doing that anymore. Then you have to make assumptions about what your portfolio looks like, so that’s where we kind of go into like a 6%. That’s a pretty aggressive portfolio. And then what that would look like in terms of draw down, and that gets your total needs.

So, as an example, if we look at a pharmacist that makes $120,000, and has $40,000, in the retirement accounts. They’re age 30. They’re going to basically work to 67. That’s 37 years. So, we start with at $120,000, and say, the wage replacement is 70%. That means that we need to plan for, 84,000. So, that’s 70% of 120. Now, if we zero out Social Security, that means that we’re planning the whole need ourselves, that’s 84,000. Now, in 37 years, Tim, when I’m 67, that’s going to be equivalent to about a quarter million dollars. What that means is that every year from 67 to 95, when I die, I need a quarter million dollars to live, which that’s where that kind of gets wonky, because you’re saying, okay, 84,000 is the same as 250,000 in 37 years. And the answer is yes.

[00:30:59] TU: Yeah. Tim, that’s the piece, like, as we’ve talked to so many groups on this. And obviously, for those listening that are near retirement, again, the disconnect is not there, because you’re close to that dollar, and you understand what the inflation that’s happened over time. But when we’re speaking with a group that’s earlier in their career, this is where they see the 3, 4 or 5 million and they’re like, “You all are crazy. The numbers don’t add up. How much money you need?” It’s because we’re thinking about in terms of today’s dollars versus future dollars.

[00:31:27] TB: Right. Correct. So, if we look at that, and you’re like, “Okay, quarter million dollars”, what do I need in the portfolio to sustain a quarter million dollars, essentially, for 28 years between ‘67 and ‘95? And the answer is about 4.4 million. Now, we know that social security is going to be there. So, even if we use something like nominal, and we say that the annual Social Security benefit is going to be something like 30,000, that drops it down to 2.8. So, it is a huge thing, but again, we zero that out. So then, we say, okay, let’s go at 4.4. And you say, okay, Social Security is going to be there. But let’s plan this, we’re going to do it all by ourselves.

That means that for us to get to 4.4, if we assume that we have $40,000 saved already, it’s basically a thousand bucks that we need to invest monthly with that current $40,000. So, to me, this is like the special sauce where I’m like, “Okay, 4.4 doesn’t really mean anything to me. So, how do I make it mean something?” We basically discount it back to like, how will it mean for me today? So, if we basically make a payment, this is a time value money calculation of $40,000, and we assume certain return everything, it’s $1,000. So, then what we do is we say, “Okay, client, how much are you putting into your 401(k), 5%? Okay, so 5% of 120? What’s your max, 3%? Okay, 3% of 120. That’s actually $800. So, 1,000 minus 800, the deficit is about 200 bucks. That’s basically on a monthly basis, where we have about $200 per month drag to get to that 4.4 million.

[00:33:07] TU: But 4.4 just became tangible, all of a sudden, right?

[00:33:10] TB: Right. That doesn’t necessarily account for everything like, fees, and taxes and all that kind of stuff. We’re just going to drag. But the idea is that, then we can say, okay, well, what happens if we max out the IRA? Or what happens if this isn’t an 80/20 portfolio, which is more conservative than like the example that we gave? What happens if we take a little bit more risk? What happens if we do this or that? That, to me, is where you could say, “Wow, we’re actually a lot further along than we thought. We have more options here.”

So, to me, the nest egg calculation, it’s a time value money calculator, that usually gives you this big pot of money that you need. But I think, the special sauce is to kind of discount it back for it, actually means something to me today. And that’s where, I think, great planning can kind of come from there.

[00:33:58] TU: Yeah, and I think one of the things we hear a lot from prospective clients. I know Justin does when he’s talking with folks, and we certainly see the value of this coming to clarity in the planning process, is this is one of those topics for good reason that there’s a lot of anxiety and uneasiness, because it’s a, as we’ve talked about, big number. It’s out in the future. We get into the what if scenarios. What if I don’t have enough? What about this? Am I going to be able to care for my family? Do the things I want to do? And we underestimate, in my opinion, we underestimate the mental toll that that running conversation has in our head. Do I have enough? Will I have enough? What about this? Could we be doing more? And whether we like the numbers, whether we punch this number and we see a thousand, we’re like, “Tim, I’m never working with you again. Don’t show me this number again.” But we have a picture of what’s it going to take each month. And just like we talked about budget and other things, what do we need to do? What do we need to change? Or perhaps nothing to make this goal a reality. So, we’re bringing the unknown, big scary parts of the plan into reality, and something that we can address on a month by month basis, and begin to work a plan if we don’t have it yet in place, that allows us to hopefully make this goal a reality.

[00:35:09] TB: Yeah, it’s so true. And I think that’s why it can be such a cliff to get over, is because when you’re going through this process, you’re setting things up. But idea is that, once you get past the initial setup, life is going to change, and you’re always going to have challenges. But if you know, it’s kind of like what we were talking about, I think before we turned the mic on. If you know in the background, that you’re funding these goals, whether they’re near term or long term, it’s like, that can kind of create scarcity, because you are kind of being very deliberate with how you’re directed money. In the back of your mind, you still know that you’re doing the pay yourself first, or you’re putting those goals that are really important for you and your family at the forefront.

Whereas, if you just throw everything into a pot of money, you’re not clearly distinguishing what are we actually doing? So, to me, that’s super important. A lot of it is like for retirement is, in this case, jacking the employee contribution up 1% or 2%, fixes it, without doing anything else at all. The other thing you could do is just change the allocation to aggressive, and you’re 200 to the to the front side of it. You’re 200 to the good side of it. And that’s what we talk about when we speak about investment, and kind of aggressive Jane and conservative Jane, and kind of highlight in what little tweaks to your portfolio can do. It’s huge. And not doing that, is to your point, can cause that mental bandwidth and kind of caused you to not do anything at all, which is not necessarily good either.

[00:36:49] TU: Yeah, Tim, this is a great start to this series, and starting with a question of how much do I need? And even before that question of where am I going and why am I going in that direction? Right? So, we talked about living a rich life today, making sure we’re taking care of our future selves. And before we talk about, which we’re going to on the next episode, some of the actual X’s and O’s. What are the vehicles that we could use to be able to begin to build this portfolio? So, once we identify, we need three, we need four, we need four and a half, whatever that number is. The next natural question is, “Well, how do I get there? What do I do? What are the options that I have available?” So, we’re going to talk about that on the next episode, but this episode is really about laying the foundation around how much is enough? And what are some of the factors that I may use to begin to make that determination?

Of course, we’re biased, but the team at YFP Planning, whether you’re a new practitioner, whether you’re in the middle of your career, whether you’re nearing retirement, or maybe have already gotten to the point of retirement, our fee only financial planning team of five certified financial planners and our in-house tax team, including a CPA, and an IRS enrolled agent, they’re ready to work with you to build a retirement plan among other financial goals that you’re working on as well.

So, if you’re interested in learning more about our one on one comprehensive financial planning services, you can book a free discovery call. To learn more about that service, determine whether that’s a good fit, and you can do that by scheduling an appointment at yfpplanning.com. Again, that’s yfpplanning.com.

Tim, this wraps up our first four episodes, and we appreciate everyone listening and we’re going to pick back up next week, talking about some of the alphabet soup of retirement accounts.

[SPONSOR MESSAGE]

[00:38:28] TU: Before we wrap up today’s episode of Your Financial Pharmacist Podcast, I want to again thank our sponsor, the American Pharmacists Association. APhA is every pharmacists’ ally advocating on your behalf for better working conditions, fair PBM practices and more opportunities for pharmacists to provide care. Make sure to join A Bolder APhA to gain premier access to financial educational resources, and to receive discounts on YFP products and services.

You can join APhA at a 25% discount by visiting pharmacist.com/join and using the coupon code YFP. Again, that’s pharmacist.com/join, using the coupon code YFP.

[OUTRO]

[00:39:08] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and it is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Thank you again for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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YFP 271: Financing a Home Purchase FAQ

Posted on September 1, 2022November 2, 2022 by yfpadmin

Financing a Home Purchase FAQ

On this episode sponsored by First Horizon, Tony Umholtz takes questions from the YFP Facebook Group related to financing a home purchase including how much down payment is required with a doctor type loan, what to look for when choosing a lender, and ways to reduce the interest rate in a loan.

About Today’s Guest

Tony Umholtz graduated Cum Laude from the University of South Florida with a B.S. in Finance from the Muma College of Business. He then went on to complete his MBA. While at USF, Tony was part of the inaugural football team in 1997. He earned both Academic and AP All-American Honors during his collegiate career. After college, Tony had the opportunity to sign contracts with several NFL teams including the Tennessee Titans, New York Giants, and the New England Patriots. Being active in the community is also important to Tony. He has served or serves as a board member for several charitable and non-profit organizations including board member for the Salvation Army, FCA Tampa Bay, and the USF National Alumni Association. Having orchestrated over $1.1 billion in lending volume during his career, Tony has consistently been ranked as one of the top mortgage loan officers in the industry by the Scotsman’s Guide, Mortgage Executive magazine, and Mortgage Originator magazine.

Episode Summary

This week, YFP Co-Founder & CEO, Tim Ulbrich, PharmD, welcomes Tony Umholtz, a mortgage manager for First Horizon, back to the show. During the show, Tony answers common questions about financing a home purchase. Tim shares questions he and Tony often hear, plus questions from the YFP Facebook Group community. Through their discussion, Tony tackles the question of incentives, if any, that are available to first-time home buyers, the amount home buyers should expect to put down with a doctor-type loan, and differentiates between doctor loans and loans pharmacists are eligible to take out. Tony touches on home purchase financing for those that are not first-time home buyers, how pharmacist home loan products might be used to house hack, and limits on the various loan types for pharmacists. When asked about what to look for in a lender, Tony shares that his primary factor to look for with a lender is communication, but it’s also critical to make sure that the lender offers a product that meets your needs. We close with insight on lender types, the competitiveness of the doctor-type loan, ways to get lower rates, how student loans are factored into the debt-to-income ratio, and some forecasting on the home financing landscape if we move into a recession.

Links Mentioned in Today’s Episode

Episode Transcript

[INTRODUCTION]

This week, I had a chance to welcome back onto the show, Tony Umholtz, a mortgage manager for First Horizon, formerly IBERIABANK. During the show, Tony takes the hot seat as I asked him questions posed from the YFP Facebook group related to financing a home purchase. Questions we cover include how much down payment is required with a doctor type loan, what to look for when choosing a lender, and ways to reduce the interest rate on a loan.

Before we hear from today’s sponsor and then jump into the show, I recognize that many listeners may not be aware of what the team at YFP Planning does in working one-on-one with more than 250 households in 40-plus states. YFP Planning offers fee-only high-touch financial planning that is customized to the pharmacy professional. If you’re interested in learning more about how working one-on-one with a certified financial planner may help you achieve your financial goals, you can book a free discovery call at yfplanning.com.

Whether or not YFP Planning’s financial planning services are a good fit for you, know that we appreciate your support of this podcast and our mission to help pharmacists achieve financial freedom. Okay, let’s hear from today’s sponsor, and then we’ll jump into my interview with Tony Umholtz.

Does saving 20% for a down payment on a home feel like an uphill battle? It’s no secret that pharmacists have a lot of competing financial priorities, including high student loan debt, meaning that saving 20% for a down payment on a home may take years. We’ve been on the hunt for a solution for pharmacists that are ready to purchase a home with a lower down payment and are happy to have found that option with First Horizon, previously IBERIABANK/First Horizon.

First Horizon offers a professional home loan option, aka a doctor or pharmacist home loan, that requires a 3% down payment for a single family home or townhome, has no PMI and offers a 30-year fixed rate mortgage on home loans up to $647,200. The pharmacist home loan is available in all states, except Alaska and Hawaii, and can be used to purchase condos as well. However, rates may be higher, and a condo review has to be completed.

To check out the requirements for First Horizon’s pharmacist home loan and to start the pre-approval process, visit yourfinancialpharmacist.com/homeloan. Again, that’s yourfinancialpharmacist.com/homeloan.

[INTERVIEW]

[00:02:25] TU: Tony, welcome to the show.

[00:02:27] TONY UMHOLTZ: Tim, it’s good to see you. Happy to be here.

[00:02:30] TU: Excited to have you back, and I always appreciate your expertise and what you have to share with our community. This is an exciting episode, as we’re doing a commonly asked questions about financing of a home purchase, and we’ve got a handful of questions that have come in from the YFP Facebook group. We’ve got some others that we, either you or I, often get asked as well. So we’ll sprinkle those in throughout the episode.

I suspect most of our listeners now know who you are. You’ve been on the podcast several times, but I don’t want to assume that. So give our listeners some quick background on who is Tony and the work that you do at First Horizon.

[00:03:06] TONY UMHOLTZ: Well, thanks, Tim. Yeah. Scary to say it now, but I’ve been in the mortgage business 20 years, and I’ve been with First Horizon now. But it’s been almost five years, and I’m a residential mortgage lender. So I run a team. We’re able to lend nationally, and we focus on residential mortgage loans and specifically helping folks in the medical community and pharmacists. So it’s been a big, fun business, helping people get to the point of homeownership. The relationships we’ve built over the years has been very gratifying. So that’s what we do, a little bit about us.

[00:03:41] TU: Yeah. It’s been exciting to see the fruit of this collaboration. Actually, I haven’t even shared with you. I had someone reach out to me this week, and a colleague of theirs at the medical center had worked with First Horizon on a loan as a part of a move in a job transition, and she had some questions for me about what they were doing personally. So really cool to hear other pharmacists and colleagues talking and helping one another out, as they’re trying to navigate this decision.

We’ll talk here in a little bit specifically about the pharmacist home loan product that First Horizon offers, but let’s get started. We’re going to put you in the hot seat with questions that have come in from the YFP Facebook group about lending and securing a loan as a part of the home buying process.

So first question comes from Randy, Tony, which is what incentives, if any, are available to first time homebuyers? I thought this is a cool question. I bought my first home back in 2009. At the time, you can correct me on exactly what the dollars were and the program, but there was something like an $8,000 first-time homebuyer credit. I know that has changed. So what incentives, if any, are around for first time homebuyers?

[00:04:47] TONY UMHOLTZ: Well, there are several different options for first time homebuyers, but I’ll kind of get into high level. Then we can get into some more of the detail options that are out there. So for example, some of our programs will allow first-time homebuyers put down as low as 3% down. If you’ve owned a home before, you cannot do that, so you have to have been a first-time homebuyer. So it’s limited down payment options. Also, for non-pharmacists, for people who aren’t in that field, there are some limited PMI loans, too, if you’re a first-time homebuyer that you cannot get if you’ve owned before.

Now, there are certain programs that are available for folks that earn under the median income for the county. Now, this can change for lots of different parts of the country. So it’s very different in different states, different municipalities, different counties. But there’s grant programs that are out there, where you can actually get money towards the purchase of your home. The one thing that you have to look out for with this product or those programs is normally you have to earn under the median income for the county. So that’s a challenging thing sometimes to qualify for. This actually can be harder to qualify for that grant than it is to qualify for the mortgage.

The other thing to look out for too is a lot of times these grant programs are set up as like a forgivable loan, if you live five years or more. But those are certainly out there, and I encourage people to look for them if they think they qualify. But it can be a little tough to qualify for them, based upon that income qualification.

[00:06:24] TU: So many pharmacists probably won’t meet that median household income requirement. Certainly, we’re looking forward, but I think that’s a good segue to the other options that you’re referring to of potentially lower percent down for first-time homebuyers, which is the question we have that I think Matt is alluding to, which is how much should we expect to have to put down on a primary home with a doctor loan, if we can find a bank that will allow a pharmacist to qualify?

So important words we need to differentiate here would be the doctor loans and those that pharmacists are eligible for, which is not all of them, even though pharmacists are doctors. They worked hard to get that degree. So talk to us about the doctor loan umbrella, and then we can talk more specifically about the pharmacist home loan product that First Horizon has.

[00:07:10] TONY UMHOLTZ: Sure. So there is an MD, Do product out there that’s designated for that segment of professionals. Then, of course, there’s the pharmacist product that we offer. A lot – There is doctor loans that different banks have, and most banks do not include pharmacists in that MD program. They typically focus just on MDs and VOs. We do have that product too, and we have had a lot of success with that in that community.

But the pharmacist product is very similar. It has no PMI. Really, the only major difference is the loan size. It won’t go as high. So currently, our loan has a cap of about 650 for the maximum loan amount versus the MD product will go higher. But it’s got the same elements, similar rates, and, of course, the No MI is a nice – It’s the biggest benefit of it. To answer that question, definitely there’s two different types of programs out there. There are some for dentists, veterinarians that differ a little bit from this program that we’re discussing for pharmacists.

[00:08:19] TU: Yeah. That was one of the reasons we were excited to begin this collaboration a few years ago was to have an offering that reached most 48 states across the country for pharmacists. Obviously, the maximum loan amount, I think, for many pharmacists is within range. Certainly, folks that might be in higher cost of living areas, think about the Northeast, out west, might rub up against some of the limitation there.

But just to reiterate what you said, 3% down first-time homebuyers, no PMI, maximum loan amount around 650. Other thing that’s noteworthy here is minimum credit score is around 700. Is that correct, Tony?

[00:08:55] TONY UMHOLTZ: That is, Tim. Good job. 700.

[00:08:58] TU: So my next follow-up question here is what if someone is not a first-time homebuyer? So I’m thinking of the pharmacists listening that maybe have been in a home or two are still looking at taking advantage of a product where they might not have to give up so much cash or use some of the equity they’ve already built from their previous home. Is there an option still available, even if it’s not a first-time homebuyer?

[00:09:17] TONY UMHOLTZ: Definitely, yeah. Really, just the down payment just bumps up to 5% down. So you’re just going up slightly, with a little higher down payment up to 5%, still No MI, all the same elements of same programs, just a little bit more down.

[00:09:32] TU: Okay. One of the common questions I get is is there – We’re not going to talk specific rates because you and I know this change by the hour, by the day. Each time we record these, obviously, we’re seeing significant fluctuations over rate. But a common question I get is, is this product or doctor loans at large, are they competitive with conventional rates? So obviously, I’m having an advantage here that I’m not having to put maybe a traditional 20 percent down, especially if I’m trying to use that cash for other financial goals. But am I potentially giving up rate on a product like this? How do you typically answer that question?

[00:10:09] TONY UMHOLTZ: Well, you’re really not, especially on the 95% product. I’ve found that that program actually carries better rates than if I had like a non-pharmacist client that put 20% down. So you actually can feel good and confident that you’re going to be getting probably a better rate than most, even folks that are putting more down than you.

The 3% down product sometimes can be about the same as the [inaudible 00:10:37]. The 5% sometimes is a little lower rate, maybe an eighth to a quarter, depending on the day in the market. But it’s very competitive. I mean, I’ve compared it to 20% down, and some days it’s an eighth or a quarter better rate to do that program versus another client getting the 20% down. So I’ve been very happy with that.

[00:11:02] TU: That’s good information too, knowing the 5% down might be a little bit different than 3%. So as folks connect with you or learn more about the product, evaluating that in the moment doesn’t make sense to put an extra 2% down or not, and they can obviously run the math on that as well.

So is this just single-family homes? I’m thinking about folks that are maybe looking at multifamily house hacking type of scenario. So are these products limited to single-family homes?

[00:11:29] TONY UMHOLTZ: No, no. It’s available for condos, townhomes. Now, multifamily, two-unit properties, for example, that’s going to require more down. So the LTV does change if you do a two-unit, and the product will not do anything more than two units. So a triplex and quadruplex would not be available under this program. You’d have to do a normal conventional loan or an FHA loan if you’re going to live in the home property. But two units would require 15% down, but you have No MI. So that’s still nice because MI is much higher on a multifamily versus a single-family. So it’s a pretty solid opportunity if you were able to find a duplex.

Then I will mention, just because I have had numerous clients who have acquired triplex and four-unit, if you live in one of the units, it can be a great long-term investment. I do make this joke, though, because I was looking at one when I was usually dating my wife, and you probably can’t be married and move into a three or fourplex. I’m just generalizing, but I remember when I did it when I was much younger or looking at that time. But it can be a great investment because you live in one unit. You have three renters or two renters paying your rent building equity. I’ve seen tons of success with that.

It is hard to find them because they’re limited due to primarily zoning in most cities. But FHA is great because they expand the loan levels. You can put 3.5% down in some cities. I mean, I’ve written $700,000 fourplex loans with 3.5% down. So it’s pretty cool.

[00:13:10] TU: Under the pharmacist home loan product, there’s an option for two units, but it’s going to require higher down payment, still benefiting on the No PMI. But then if it’s more than two units, no good under the pharmacist home loan product.

[00:13:23] TONY UMHOLTZ: That’s right. Yup.

[00:13:24] TU: Probably looking at FHA or other type of loan. Gotcha.

[00:13:26] TONY UMHOLTZ: That’s right. That’s right.

[00:13:28] TU: Next question we have comes from Sarah. What should I look for when trying to find and select a lender and red flags to avoid? So what thoughts and, obviously, I think folks know the disclaimer is that we’re talking about the service of which we collaborate here. But generally speaking, as individual are looking at a lender, what are some things that they should be looking for to make that choice?

[00:13:53] TONY UMHOLTZ: Well, I think one of the most important is communication. I think that that’s critical. Are you getting your questions answered? There’s different types of lenders out there, and there’s a lot of good lenders out there. I think finding one that has a product that fits your needs is important. Obviously, communication, to me, is very important.

I’ll kind of just go into a quick little summary of the different types of lenders out there. There’s direct lenders that are part of a bank. That’s like myself. There’s correspondent lenders, and then there’s mortgage brokers, who are basically middlemen between the lender and the client. Correspondent lenders, they’re not bank typically banks, right? They’re just independent lenders that will borrow money essentially to lend your money, and then they get rebated on when they sell the mortgage, either Fannie Mae or Freddie Mac, and service can be good across the board.

But the one thing that I suggest you look out for, and I find it’s really been a challenge with some of the really bigger banks and a lot of banks in general, is the service side because a lot of lenders are set up with what’s called a centralized processing center and closing and underwriting. So those are three critical elements of the process. For example, centralized processing is like a call center in a lot of ways. After the loan originator takes your loan application, you feel comfortable with that offer, they will send it through this centralized system, where a lot of times in that loan originator’s defense, they can’t get an answer. So they can’t really communicate with you.

I find that a lot of the times where I have to get involved in a transaction, after it’s been started with someone else, it’s because of that centralized process. It’s just hard because the service isn’t there. The communication is not there. Things usually don’t happen on time. So I would just say that that would be something that a lot of, especially first-time buyers don’t realize, is out there, and they get disappointed in the end. It’s just because of the size, the scale of the operation. They centralize everything.

One of the contingencies for me to come to this company was that we had our own group, our own processing group, our own closer, our own underwriting group. That way, that communication and that flow would be there, and we wouldn’t have that communication gap or miss any of the milestones that are part of the transaction. Again, just going back through the summary is the communication, to me, is critical. Having the right product, of course, and just making sure you have a process that is going to fit your needs, especially in the purchase market.

If you’re refinancing, you can wait three months, right? You don’t want to, but you could wait three or four months and be okay. But if you’re in a purchase transaction, you have to execute on time. You have to have your loan commitment on time. So you want to make sure you work with a lender that can do all of those things. Again, I’m being general here because there’s a lot of good lenders. So I’m going to take that as a general list.

[00:16:14] TU: Yeah. That reminds me, Tony, of we talked about shopping for a long-term savings account or shopping for car insurance policy, homeowners insurance policy. It’s easy to get stuck on comparing rates. It’s easy information to gather. You can’t easily compare things like closing on time or accessibility if I have a question or communication, quality of communication interaction. I think that’s where talking with peers, referrals of folks that have worked with somebody before are so important.

Anyone who has gone through this process knows that there will be a bump in the road. That’s going to happen. There’s a lot of moving pieces or parts when you think about everyone involved in the process of buying or selling a home and, ultimately, getting to the point of having keys in hand. So bumps are going to happen. I think, for first-time homebuyers, I know. I can remember being in the shoes. Those feel big, and they’re weighty, and they certainly are, especially if you’re trying to sell a home to buy a home, and you’re typing things up, and all those moving parts that are involved. But when those bumps arise, having someone that you can communicate with that you feel confident you already have some relationship with, and you can get a hold of quickly is so important. So I think that’ll resonate with many folks that are listening.

Another question from the group, from Sierra, that I think is a timely one is if we’re going into a recession, and the housing market is still overpriced, is it better to wait? Is it better to wait to purchase? You and I were talking a little bit before we hit record that even from three months ago, when we recorded, we’re seeing some changes that are happening in the market in terms of the competition that’s out there and the bidding wars. Certainly, we’ve seen a change in interest rates, as well, recently. So what are your thoughts here on Sierra’s question about the timing of purchasing a home, especially given the current economic conditions?

[00:18:53] TONY UMHOLTZ: Well, that’s a great question, and a lot can go into that question. There’s a lot of information that we could talk about here. The main thing I would say is everyone’s situation is different. We’re all in different situations. So if you’re in the middle of renting right now because rent rents are going up at a nice clip each year, and they’re forecasted to continue to go up over the next couple of years. So if you put that against homeownership, a lot of times it’s going to be way ahead to rent or, sorry, to buy versus rent.

What I’m seeing right now in the market is a very healthy normal market. What we saw the last two years, the last year and a half, wasn’t normal. We had a spike in demand, not enough inventory. I mean, I have a lot of clients that couldn’t get a property, and some of them bowed out of the market. A lot of them actually are coming back in now because the markets – It’s easier to get a home under contract, and you can get better terms, instead of having an appraisal gap contingency, can’t get an inspection, all these other things that were going on.

Now, you can get a normal inspection done. You don’t have to – You can have an appraisal contingency, maybe even some negotiating power on that appraisal. If something’s coming back on the inspection, you have some negotiating power to get the price lowered. I’ve seen that happen a few times lately.

[00:20:20] TU: Normal stuff, normal stuff.

[00:20:21] TONY UMHOLTZ: Normal stuff, right? Normal stuff, right? Great stuff. Then as far as the housing market recession – There is a chance, guys. There’s no doubt. There’s a chance we could have a recession. But one thing I’ve learned is no recession looks alike, and we can’t go back and say the recession of 2020 – Obviously, it’s unique. The 2008 recession was unique.

I started in the business in the dot-com one that we had, and that was unique, right? All of these have their own elements. The dot-com crash that we had, the stock market got penalized, but real estate actually did very well. So everything is – Nothing’s going to be – History does not always repeat perfectly. Everything’s unique in a lot of ways. We learn from history, but that doesn’t necessarily mean that it’s going to repeat that way.

I would say you always want to be aware of what’s going on, and one housing metric I’ve used over the years is the Case-Schiller Index. Okay, that’s been one of the best housing metrics that I’ve used over the years, and it’s still forecasted to have positive returns I think over the next couple of years last time I looked. So that’s a good forecasting tool.

The other thing I’ll say is everyone’s market is different, okay. Everyone’s markets different. We can’t generalize and say, “Well, real estate’s just not going to be good,” because every pocket of the country is going to be a little different. So there’s actually been even the last couple of years but a few pockets that have went down a little bit, so not a lot. There’s been a few pockets. So just keep that in mind that real estate can be very much a geographic situation. To say it’s overpriced is tricky.

I had lunch last week with a builder that I’ve known for some time, and this kind of hit home with me when he told me what it cost for them to get trusses, materials, labor to build a home. It’s hard for me to see prices, really – I mean, if we look at that metric, it’s hard to say prices are going to really drop because those – I don’t see it as –

[00:22:22] TU: Cost [inaudible 00:22:22].

[00:22:24] TONY UMHOLTZ: Yeah. The underlying commodities are not going to fall that much, and labor is still there. So I mean, it’s still going the other way. So I think it’s a tricky – It’s a good question. It’s just hard to say that if we go into a recession, that that’s going to equal guaranteed lower housing prices because it may not be the case. I always say, if you’re going to be in a home for at least – If you project yourself living in a home or an area for five years, it’s going to make sense to own. It’s hard not to. I mean, if you look back at history, you’re usually going to come out way ahead versus renting.

[00:23:02] TU: Especially with your comment before about where rent rates are at today. That’s changed, even in the last three, four years. Certainly, the pandemic has escalated that as well. That is really where – We talked about is your home an asset. We talked about this on the podcast before. When you see people that have been in their home 20, 30, 40 years, and you see the appreciation and also not just the equity that’s been built but also the costs that come through transaction. So if you’re moving every three to four years, transaction costs, closing costs, moving costs, refurnishing the house costs come with all that as well.

I think that longer term view, if possible, and that’s not always possible, right? Jobs, family, certain things take us different areas. But if we can find that home and be in that home for the long run, that’s where we really start to see I think the home become an asset and a part of our financial plan.

[00:23:55] TONY UMHOLTZ: No question. Having that equity. Just the monthly payments going towards some equity every month, it adds up over time, the tax benefits. I mean, if you’re comparing it versus renting, it’s hard to not own, even if it’s a flat market, even if the market zero over five years. You’re still going to typically come out well ahead because rents are going to go up.

The one thing too you have to watch is these commodity costs. We’re still underbuilt as a nation. We didn’t build enough inventory the last 12 years to support our population growth and our incoming population by migration to the country, immigration to the country. So as long as that continues, we’re going to be in this situation of rising rents and rising prices. It’s inventory levels you have to watch. If suddenly you see in your area, you’ve got over 6 months to 10 months of inventory, then prices will probably come down some. So I think that’s the metric you watch too is inventory levels, and local realtors can provide color on that.

[00:24:59] TU: Which is another great reminder of how local the markets can be and how inventory is going to fluctuate from one market to another. Sierra also asked, “What are some ways to get lower rates?” I suggest the question. I suspect the question here is outside of just making sure that the individual product and offering is competitive. I suspect this is referring to perhaps purchasing points and trying to lower rate that way, which might be top of mind for folks right now, considering where rates are relative to just a couple years ago. So what thoughts do you have in that area, Tony?

[00:25:32] TONY UMHOLTZ: Yeah. It’s a great question. So a couple of things. I think one thing I would say is you always want to make sure your credit score is the best it can be. That’ll always help you with the best rates. Typically, 740 and above is going to be the best premium best rates available. Then there’s little segments under that.

I have different times – We look at the market quite a bit, right? I follow the market. I will admit, I’m a bit of a nerd when it comes to that stuff. So I do follow the mortgage market pretty closely and the rates. This has been a time since probably March, even earlier, maybe February. I have not been an advocate of buying points this year because I felt like they spike so quickly. We’d see lower rates, and we have. Since the peak a few months ago, rates are down about 50 basis points, which is half a point from the peak.

My gut is, over time, we’ll see rates come back to the mean a little bit. But points are always a way to buy a rate down, okay. So you can pay points for that. Again, you got to make sure you have the payback period in place because if you pay one point, you may only get a quarter or three-eighths. Usually, it’s a quarter off the rate on a 30-year fix. It’s going to take you four years of payments to just break even. At that point, you’d be in the money.

I’m only an advocate of it in certain times and when people are in a position where, “Hey, I’m going to be your forever. I’m going to keep this asset for a long time.” Then we’ll do it. But especially when we see these rates go up quickly, and the yield curve inverts, which is what we have right now, basically the 2-year treasury note is higher than the 10-year treasury note, typically, that is going to lead to lower rates in the future. So I’m not a huge fan of my client paying a lot of points for that, to buy rates where I think they could refi in the future.

But I think the other thing I’ll mention too, to answer Sierra’s question, is how to get lower rates. This takes a little bit more courage, and I’m more of a person that likes to lock loans, unless it’s a pretty clear market that rates could go down. Then the other thing, it’s the client’s decision. It’s not my decision. It’s not my staff’s decision. But there are times where – Like I have a few clients who are financial people, and they follow the markets, and they’ll say, “Tony, I want to float the market. And when you see this, do this.”

So there’s a couple people like that, that I’ll have every year that that will float the market and a lot of times can get better rates that way. It takes a little bit more courage and depends on the cycle that we’re in. But if we do like go into a recessionary cycle, floating the rates may be a pretty good way to get a lower rate. So that’s another way to do it.

[00:28:17] TU: Yeah. I think they get their risk tolerance, comfort level margin in the budget or not, right? I think especially for first-time homebuyers, you know, that may or may not be something that folks will be comfortable with.

[00:28:29] TONY UMHOLTZ: Agree, Tim. Sleeping at night is more important.

[00:28:31] TU: Yeah, that’s right. But for people that want to nerd out on that and feel comfortable with that risk, that’s an option. Two last questions I have for you, one about the pre-approval, one about student loans. So let’s start with the pre-approval. How long does a pre-approval last? I know this question is coming up a lot because of maybe people are going into this process, and then they decide, hey, I’m going to bow out. Then they decide to get back in. So talk to us about how long that pre-approval period will last.

[00:28:59] TONY UMHOLTZ: So when we do a pre-approval, and this is pretty much general for all lenders, when we do a pre-approval letter, we run a credit report. Typically, that credit report is good for about 90 days, is when that credit report is good through. Then after that 90-day period, typically, we’ll have to do another credit poll. I don’t always do that. I mean, if I feel like the client hasn’t had any credit –

Like we’ve had that conversation. Don’t buy anything new. Have you bought anything new? I haven’t bought anything, no new cars, new credit card things, or new credit cards. As long as that’s the case, we usually will keep it pretty active. But if they need an actual letter updated, we’ll typically run credit again. So 90 days is to answer the question. So I’d say every 90 days, if you’re going to go out beyond that, you probably need another credit update.

[00:29:48] TU: And a good reminder. If folks haven’t heard you say that before, just to sit tight. We don’t want to have major financial changes or decisions that are happening in that 90-day window.

[00:29:58] TONY UMHOLTZ: That’s right. We try to keep any of those big transactions to a minimum, when you’re looking.

[00:30:02] TU: Last question is student loans. This keeps coming up a lot because we’re now two-plus years into the federal administrative forbearance, set to expire end of this month. So we’re recording mid-August. We’re expecting an announcement literally any moment now from the Biden administration. But nonetheless, we’ve had more than two years since March 2020, where folks have not had to make a payment on qualifying federal loans.

So the question that comes up here is how are my student loans factored into the debt component, the debt-to-income ratio, especially since I haven’t been making payments, and there isn’t necessarily a track record of what repayment plan I’m in?

[00:30:42] TONY UMHOLTZ: Right. Now, that’s a great question. So there’s two ways to do it. We might have a lot of clarity in the next few weeks, so you may know. But in the case of absolutely no payments being made, there’s a factor we use on the total amount of student loan debt. It’s not as high as like Fannie Mae or FHA would, basically conventional loans and FHA loans require. It’s a lower factor. It’s about half of that. But we basically take a factor of your payments. So let’s just say you had a $10,000 student loan. It would be $50 per 10,000.

[00:31:19] TU: Yup. I’m following you.

[00:31:21] TONY UMHOLTZ: Yeah. So $100,000 would be 500 a month.

[00:31:26] TU: I think I’m doing the automatic conversion in my mind because we have so many people, and it’s 100, 150, 200, 250,000. Yeah. That’s one of the challenging things because some folks might be on a forgiveness pathway, where they’re paying a very small monthly payment, but they haven’t necessarily started making those income-driven repayment.

Again, another example where I think working with a lender who, number one, you communicate with, number two, who has some experience working through these issues and answering these questions that I suspect many of our listeners have would be really helpful.

Tony, this has been great. I love to see the engagement from the community on this topic. I know home buying continues to be a topic of interest among our listeners. So really appreciate you taking time and sharing your expertise.

[00:32:09] TONY UMHOLTZ: Thanks for having me, Tim. It’s great to be here.

[END OF INTERVIEW]

[00:32:12] TU: Before we wrap up today’s show, I want to, again, thank this week’s sponsor of the Your Financial Pharmacist Podcast, First Horizon, previously IBERIABANK/First Horizon. We’re glad to have found a solution for pharmacists that are unable to save 20% for a down payment on a home. A lot of pharmacists in the community have taken advantage of First Horizon’s pharmacist home loan, which requires a 3% down payment for a single-family home or townhome and has No PMI on a 30-year fixed rate mortgage. To learn more about the requirements for First Horizon’s pharmacist home loan and to get started with the pre-approval process, you can visit yourfinancialpharmacist.com/homeloan. Again, that’s yourfinancialpharmacist.com/homeloan.

[OUTRO]

[00:32:52] TU: As we conclude this week’s podcast, an important reminder that the content on this show is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.

Thank you, again, for your support of the Your Financial Pharmacist Podcast. Have a great rest of your week.

[END]

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