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
- YFP Planning: Financial Planning for Pharmacists
- Schedule a free Discovery Call with YFP Planning
- YFP 272: How Much Is Enough? (Retirement Planning)
- YFP 273: Alphabet Soup of Retirement Accounts (Retirement Planning)
- YFP 274: Risk Tolerance vs Risk Capacity (Retirement Planning)
- What Issues Should I Consider Before I Retire?
- YFP 242: Social Security 101: History, How it Works, and Why it Matters for Your Financial Plan
- Social Security Administration
- Your Financial Pharmacist Disclaimer and Disclosures
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.
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