Case Study: We have a $2.4 Million Portfolio, Can I Retire Tomorrow and Continue Our Same Lifestyle?
Tim presents a case study for a couple with a net worth of nearly $3 million and $2.4 million in investable assets. Charlie is retired, while Lucy is considering retirement. See how Charlie and Lucy can best prepare for retirement, and ensure that they continue their same lifestyle.
Today we are going to walk through a case study for Charlie and Lucy Brown. Today's scenario is based off of a couple that I recently met that have a little over $2.4 million in investable assets.
Charlie is a little bit older and retired, while Lucy is not retired yet. She wants to know if she can retire tomorrow and if they can continue having the same lifestyle that they have had. Let’s look further into this scenario.
Example Scenario
Charlie and Lucy Brown have a net worth of just under $3 million. They have a $500,000 house that is paid for and a joint brokerage account with a decent amount. Both have similar pre-tax accounts, Lucy’s is a little bit higher at about $950,000, and Charlie has about $850,000. Charlie has a little bit more in his Roth.
Next, we want to take a quick look at their goals. They are currently spending about $9,000 per month for living expenses. We have to take into account healthcare whether it is getting coverage up to age 65 for Lucy until she can get Medicare or for Charlie who's already 65 and on Medicare.
They are going to pay about $4,000 in health expenses above and beyond what they're actually paying for their health insurance. That is pretty much standard for this time of life and in 2024.
Next, we have Social Security. Charlie filed for Social Security last year, and he's getting about $2,500 per month. With Lucy, we are going to propose pushing hers out until age 70 to get the highest, most beneficial amount.
She is going to be at about $3,500 at full-retirement age, so if she pushes that out to age 70, it's going to be a little bit higher then because she's going to get to 8% per year that she can wait. Then of course, if the market should go down in the meantime, we always have her Social Security in our back pocket that we can flip on. The key thing is that we always want to have options.
Planning Software
We plug that information into our planning software. We have income inflows coming from Charlie’s Social Security. We are treating this as if Lucy were already retired and is not going to have her working income moving forward.
Charlie’s Social Security is a little over $24,000 per year. Then their expenses are about $126,000 per year because we have their living expenses at $108,000 and their healthcare total is about $18,000 per year now.
That means that we are going to be taking $172,752 out of their nest egg to make sure that they have enough money to meet their expenses for the year right now.
The software shows that their tax payments will be very low for the next four or five years. Then their tax expense picks up because they're going to start drawing from their tax deferred accounts for expenses.
The net flow of how much they're pulling from their nest egg to live off of will drop back down when Lucy's Social Security kicks in at age 70, so they won't need as much from their nest egg.
Roth IRA Conversions
Now an opportunity for Roth IRA conversions arises. We want to pay taxes when they are the cheapest. Right now, tax rates are historically low, so we want to take advantage of filling up those lower brackets with Roth IRA conversions and getting that money out of their tax-deferred accounts.
They currently have $350,000 in a joint brokerage account that is taxable. They have almost 2 million in tax-deferred assets. That means they are going to have almost $2 million of ordinary income at some point in their future.
They’ve got that silent partner in Uncle Sam. We need to start chipping away at that in their gap years between retirement and Required Minimum Distribution (RMD) age.
They can take advantage of filling up those lower brackets and mitigating a tax tsunami or a tax bomb down the road, so we want to try to get as much of this tax deferred money into a Roth IRA in the most efficient manner possible in the gap years.
Instantly, when I see somebody like this, I know that we can do good tax planning for them. Assuming that they're not at RMD age yet, which even if they are, there's still stuff we can do. It would change our approach because we cannot convert that into a Roth IRA all right now.
Withdrawal Rate
How much of the nest egg are we going to have to pull out each year to make sure that we are getting them up to whatever amount they need to spend, around $120,000 a year and it's inflation adjusted after that.
We like to keep the withdrawal rate for the most part at 6% or under if we can, certainly as an average over time. In this case, Charlie and Lucy start at 3.9%, then it increases into the 4% range, and then it drops back down in the 2% range when Lucy's Social Security kicks in. Then it kicks up again, but it's right around that 4% rate the whole time. This couple is in really good shape now.
For Charlie and Lucy, we are looking out to age 90. It is important to remember, Lucy is 60 and Charlie is 65. If we look out to his age 95 and her age 90 and they do everything the way that they're planning, spending what they want to spend, and we have about a 7% return over that time frame out to age 90, they will have a little over $7 million at that age.
Is that the goal? No, the goal is to live!
Cash Flows
Let’s do a little hypothetical situation. One day they say “hey Tim, this is great to see, but maybe we want to try to spend another couple thousand a month.” We can raise their current $9,000 monthly expenses up to $11,000.
They are still in pretty good shape, but it's now calculating that they will have $3.5 million less at the end of the plan. The couple will still have almost $4 million, and they have been able to spend an extra $24,000 a year.
Let's say they retire and say “hey Tim, we want to travel, but probably for just the first 10 years.” My question would be, how much do you think you will spend? The response, they thought probably around $10,000, give or take.
We know they can spend more because we've already added 2,000 a month to what they're going to spend on just retirement monthly expenses. So now let's say they're going to spend $10,000 a year on travel on top of the extra $2,000 a month. This is going to drop about another million, but they're still going to have almost $3 million at the end of their plan.
Tax Planning
I want to go back to tax planning. What is typical in retirement is that taxes are your largest expense. Sometimes it's medical, but of course, we would rather it be taxes right because that means that we're not spending a ton of time in a nursing home or hospital.
We want to look at Roth conversions right now. If we do all of our tax planning and Roth IRA conversions, we make sure that we are investing the proper assets in the proper location, or asset allocation, and withdrawing from the proper account at the proper time. At the end of their plan, this is going to allow them to have almost $2 million more in tax-adjusted ending assets.
You want to pay attention to the tax drag or if you're sitting on a tax bomb. Not only are you going to be paying a higher tax rate than you needed to, but you're going to have to pay higher Parts B and D premium on your Medicare Income-related Monthly Adjustment Amount (IRMAA), because your Medicare expenses are based off of your income.
So another reason why we want to try to fill up the lower income tax years and the gap years is to keep your RMDs from getting too high later on. It will also make your Medicare cost go up as well, which is why we call it a tax bomb. This is all just to reiterate that tax planning is very important.
It certainly is very important in retirement because your tax rate in retirement is going to be determined more by where your income comes from or your cash flow that you're using for expenses than your actual income itself, like your Social Security.
Bottom Line
The bottom line is that, yes, Lucy can retire tomorrow, and she and Charlie can continue to live the same lifestyle they have been and still have a little extra at the end.
If they want, they can go ahead and start spending now because, of course, once they walk out the door, we are going to start adjusting stuff.
I hope this makes sense. If you want to see how we do this, feel free to reach out and we can run through some numbers for you.
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