How to Retire at 55. 3 Crucial Steps to Optimize Early Retirement

how does retirement planning change if you want to retire at age 55 as opposed to say age 65 well there's a number of different changes you need to make but in general there's three core things that need to be addressed because they might be substantially different than if you retire at a more traditional age so in today's video we're going to walk through Matthew and Sarah's financial plan now Matthew and Sarah we help them to build a plan to retire at the age of 55 and as we walk through their plan I'm going to highlight the three specific areas that are different because of them retiring at 55 than it otherwise would have been had they retired at the age of 60 so as we go through this those three core areas are going to be their health insurance strategy their investment strategy and their tax strategy but let's Jump Right In and I'll show you exactly what I mean so here's Matthew and Sarah here and of course the names are changed but the actual investment details and the actual picture that we're looking at this is the same now some has been simplified just so we can really focus and highlight on those three core areas that we're going to walk through but this is where Matthew and Sarah were when we started running through some of these projections they're both 50 years old today Matthew had about 785,000 in his 401k Sarah had about $812,000 in her 401K in addition to that they had a joint investment account with a little over million and then they have their home worth about $1.25 million with a mortgage of $126,000 still outstanding now Matthew and Sarah didn't have any children so as they came to us they' both been working pretty good jobs with pretty good earnings for quite some time and as you can see they were able to build up a pretty nice portfolio for themselves now whether you do have kids or don't have kids whether you are 50 years old or aren't 50 years old whether this matches your investment values or it doesn't match your investment values the important thing is the framework that we're going to walk through here the Three core principles that we're going to walk through if you want to retire early so don't get too distracted by some of the details but I'm providing this for context so you can see a greater picture of the planning work we actually went through so let's now turn our attention to the goals that Matthew and Sarah had and as we can see here they want to retire at 55 they felt that when they came to us they said look James we don't have children we've been able to really priori ize our futures and prioritize Financial Independence and really is that sense of Independence and freedom that was really important to them they didn't dislike their jobs per se but their jobs did require a lot of them and they were looking forward to getting to a point where they could choose to do what they wanted to do when they wanted to do it as opposed to having to rely upon a couple 3 weeks per year of vacation time so they really just wanted to prioritize Independence they wanted to get to a place not necessarily where they were in a hurry to get out of work or out of their jobs but get to a place of financial independ dependance where work became completely optional and they had no financial obligation to do so to still be able to meet the needs that they had so they had about 5 years left before they wanted that to happen when we went through the exercise of understanding how much they might want to live on when they were retired we saw that that was about $7,500 per month of monthly expenses now this is excluding the mortgage this is excluding taxes this is excluding Healthcare travel some of these other things this is just the core monthly expenses that they wanted to live on the next thing that we look at the next goal they have of course is what we need to pay for healthcare now this is one of those key things if you recall this is one of the key differentiators of an early retirement strategy versus a traditional retirement strategy by traditional retirement strategy I mean age 65 or so or later so the question is how are you going to get health insurance if you're retiring early you're not eligible for Medicare yet you're no longer employed so you don't have employer coverage what are you going to do well there's a whole bunch of different options but one thing that you can do is vanguard's got a great tool called a healthcare cost estimator and we went through this with Matthew and Sarah and just played around with different options what you do is you plug in name date of birth uh just different information here and you select the health care plans that you're looking at now explored a few for them but based upon their needs based upon their health history they decided the open market silver plan would be sufficient with what they were looking for and then we also planned for what Medicare might look like so here's their information and then we can also select a health status excellent average or Matthew and Sarah were in great health they prioritized their health and their Fitness so we indicated excellent for this here and then when we estimated the cost we knew that this wasn't going to be a perfect predictor but what this allows us to do is this allows us to get a general sense for what might their healthcare costs be pre-medicare as you can see here and we're assuming about 11,635 and then also what are their Medicare costs going to be once they're 65 and older now what you can see here with Medicare is there's a range what those costs could look like so we're looking at what's the 50th percentile 75th percentile and 90th percentile to say let's plan on the 75th percentile meaning let let's plan on above average above what might be median expenses which is here and you can see what those Medicare costs would be for them so after doing some of that planning outside of the planning software we came back here and here's where we input that what do we estimate their cost to be their medical cost to be Prem Medicare versus what do we expect their outof pocket cost to be AKA their nonp part B and Part D premiums which we're going to include elsewhere in Medicare age or once they turned Medicare age so those were their annual Healthcare retirement costs were also planning for long-term care costs so one of the things they did indicate is both of their parents had had Long-Term Care events and both their parents had some Financial struggles because of that so we wanted to make sure we were properly preparing for that especially because they're retiring early this goes back to that Health strategy one of the biggest risks with early retirement is you might have 40 50 years to live now one of the biggest expenses over those 4050 years could potentially be health care costs especially if you're not planning for it the right way so what we're doing here is we're planning to say how do we make sure that we're estimating your own health insurance costs how do we make sure that we have a plan in place for long-term care costs to make sure we're incorporating that into their plan so once we looked at that the next thing that we wanted to look at was travel so this is what was really important to them they wanted to retire at 55 and have that freedom and Matthew and Sarah really loved to travel now what they talked about was St James for the first 20 years after retiring so if we retire at 55 for the next 20 years we see ourselves doing something and let's budget $115,000 per year like you see here for that extra travel but in addition to that for the first 15 years or so so from 55 until 70 we want even more so in other words we're going to be doing some pretty incredible travel say from 55 to 70 from 70 to 75 we're still traveling but we're probably tapering off a little bit and maybe after age 70 we're not going to travel quite as much and even this 25,000 here you can see this was just every 3 years every 3 years could we just go on an epic trip where money is not really an issue where we can write a check and just take some of these trips we've dreamed about and we want to make sure we're in a position to do so so 20 years of full travel and then for the first 15 years every third year do a big trip above and beyond that so these are the goals that we were planning for and the next thing that we looked at was their income so here's Matthew's salary here here's Sarah's salary now one thing to keep in mind is they both worked at tech companies and they had some potentially pretty lucrative stock options but that's something that's out of their control the stock options were only going to be worth something if those companies did well so pretty good chance of those becoming available but we didn't want to count on them in their base plan we didn't want to count on them to say hey Matthew and Sarah you're good to go if this thing that's out of your control materializes in the way that we want it to materialize we want to say what if you fully exclude that let's just think of that as extra can you get to where you want to go just based upon your salary and your savings and what you already have and then if the stock options become worth something then if the bonuses that you have the potential to hit become worth something maybe that just accelerates some of the planning points that we have so these were their base salaries but they did have potential above and beyond that which we wanted to illustrate with them separately now here's the income sources we're planning for you can see the social security benefit for Matthew here we're assuming at $1,500 per month and you can for Sarah we're also assuming $1,500 per month why are we doing that well if you look at their actual Social Security statements they're eligible for a lot more they're 50 years old today they've got quite a long time until Social Security kicks in and there's a pretty good chance Social Security looks different when they turn 62 than it does today so while this is maybe overly conservative we didn't want to fully plan on Social Security being part of their plan or at least being the core of their plan just to make sure that again with an early retirement we're not over Reliant or overly dependent upon something outside of our control the next thing we looked at is here's their savings so they're both maxing out their 401K they both get a little bit of a match and then this contribution their joint account this tends to be in the form of an annual bonus so they said look at a minimum James with the minimum bonuses assuming we do a decent job at work we can put away $25,000 now if stocks vest if we hit some of our higher targets that bonus could be even higher but again let's start with a conservative amount that we can count on as we're projecting out for our early retirement goals and one more thing here too with Matthew's 401k and Sarah's 401K they were a little concerned if you recall when we looked at their blueprint or their their assets most of their money was in pre-tax accounts so they came to us saying hey should we be doing Roth 401ks instead they make too much money to do Roth IRAs but they asked about Roth 401ks the second thing the second big change we're going to talk about in a second here is a tax strategy so the tax strategy is really different it really changes for people retiring early and because of that I encourage them to keep doing the pre-tax 401K because with the right tax strategy they could essentially save money on taxes when their income was highest and then Implement a Roth conversion strategy in those early years to shift a lot of that into Roth accounts so more on that later but we're doing or we encourage traditional 401ks as opposed to Roth 401ks so let's now tie all this together we took a look at what assets they have we understand what their goals that they have are we know what they're saving we know what their income is the next thing that we want to do is tie this all together together to start to model out year-by-year cash flows as soon as they retire so here's that cash flow page right here on this cash flow page every year we take a look at what are their income sources and you can see that in these columns here and we compare that to what are their expenses and you can see those in these columns here at the end of the day what we want to understand is what their net flows will be or in other words Matthew and Sarah when we understand your cash flow then we can understand what role does your portfolio play in this plan that we're looking to create for you so the next years are easy they have their salary this is before any bonuses or any stocks vesting they have salary coming in this is going to create all the income that they need to create the expenses or to cover the expenses that they'll have at that time but 5 years from now that salary goes away so that's what we need to start planning for really in 5 years from now if we fast forward to 2029 their income flows dropped to zero and they don't stay at zero forever because Social Security does kick in at their age 67 really a modified benefit kicks in at age 67 but there's a lot of years where there's zero in outside income sources so those are the years the portfolio will need to come into play to fully support all their needs before Social Security kicks in even just a little bit to help alleviate some of that burden so the next thing we want to look at is what are those needs projected to be so in 2029 when they're both 55 and retired well here's those expenses if you remember their base living expenses of $7,500 per month which comes up to $90,000 per year that's what they want to live on but that's today if we assume an inflation rate over the next 5 years it's really going to take close to $14,000 at that point in time to maintain the same purchasing power they would have today with $90,000 then on top of that they're going to have housing costs so the mortgage is paid off by that time so 5 years from now based upon the rate at which they're currently paying down their mortgage the mortgage is paid off but they still have property taxes and insurance so that's an extra expense that we're going to be budgeting for here then on top of housing they're going to have healthare if you recall we went through that exercise to say what might their health care costs be and by the way one of the reasons we show healthare different from core living expenses one reason is because Healthcare is going to cost a different amount before Medicare than it does post Medicare so we want the ability to control for that cost difference but number two we tend to increase these expenses Healthcare expenses by 5% per year whereas we're increasing these expenses by 3% per year I saying that's the way it has to be done but health insurance Health costs tend to inflate at a higher clip than does core inflation so when we start to add all these up we can say what are your total expenses your Total Core expenses that you need to live AKA pay your health insurance pay for your housing and then have the ability to live comfortably beyond that well in addition to that they also have their travel goals and if you remember they have the annual Travel goal that they're going to have until the age of 75 that's here in this column and then they have the other travel goal which is an extra amount for the first 15 years of retirement but only once every 3 years so when we start to add this up we can say here's the amount their total the total amount that they plan to spend on travel and once we do all that we can say each year so starting at age 55 here's your core expenses here's travel here's your projected tax payment and then here's your total Allin expenses now more on this later but the reason this all in tax payment is so low is because they're living primarily on their joint account their investment account that's already after tax so we'll come back to that but that's why this number isn't so high and then it really spikes up later on when required distributions kick in to the point that the tax payments become six figures if they don't Implement a strategy to protect against that so first few years of retirement as we look at this total outflows $195,000 compared to total inflows was Zero no salary no social security what does that mean means every single one of those dollars needs to come from their portfolio so we can start projecting out their cash those and what role will their portfolio play here and this starts to paint a picture for us so we can say hey Matthew hey Sarah we need a portfolio that's projected to be able to support these expenses starting at 55 and continuing on from there so that now becomes what we want to project out next is we know what the liability from the portfolio needs to be AKA we know what the withdrawal needs to be but how big will the portfolio be at least based on our projections so that's where we go to this next page of here's their beginning portfolio B B today about $2.6 million here's what they're planning on saving to their 401k if you look at both of them maxing out their 401K plans here's the employer match they're both receiving based upon the percentage that each of their employers are putting in on top of that they're saving $25,000 per year and we're assuming a growth rate of between 7 and a half to 8% over the next 5 years I want to be very clear that is no guarantee they're going to get that but based upon the types of Investments they have based upon the fact that they're in a aggressive portfolio that's slightly below a long-term average that this type of portfolio would generate so we made it very clear Matthew and Sarah this is a no way an indication that we will get this growth but as we're projecting at least in this initial projection is this a reasonable expectation might this happen and the answer is yeah this isn't unreasonable to expect but we also need to prepare for what if this doesn't happen which is a second part of the planning process but assuming these assumptions or assuming these growth rates and these savings rates 2. 6 million you can see what that turns into after a few years of doing this there's about $4.6 million that they would have in their portfolio by the time that they retire so they're getting some good compound growth again no guarantee but assuming these returns and average return of about 7 and a half to 8% they're adding a lot to their portfolio and they're starting with a good portfolio balance today so that 4.6 million that's what needs to be able to create the withdrawals that we just looked at on the previous page so here's what that looks like if you put it all together here's their portfolio today we know they're saving and growing over the next number of years they retire right here and once they retire we're assuming their portfolio grows about 65% per year again absolutely not a guarantee but that's something that we're going to use in our initial projection and then we can stress test it from there well once they retire we're projecting how much is coming out of their portfolio each year and how much is their portfolio growing by and if it happens that way then this is what that projection or that trajectory looks like if Matthew and Sarah you retire and while this is happening you're traveling you're spending you're enjoying life and your portfolio is projected to continue growing you can see here there's a kind of a Sharp drop off it's because we're projecting out long-term care expenses and so that takes a chunk out of their portfolio but in general they're in a good position to make this happen at least as it stands right now at least based on what this looks like here now here's the thing with this straight line projection here this does not account for what we call sequence of return risk this doesn't account for what if the Market's up way higher or down way lower this simply assumes a growth rate of 65% per year throughout retirement and then a higher growth rate between now and then what we really want to look at as a probability of success to say Matthew Sarah we know we're not going to get exactly 65% per year that's never going to happen but what if we model a thousand different scenarios using the asset allocation that you have what percentage of the time are you likely to be successful under these assumptions that's where we look at their Monte Carlo analysis which is just a thousand different simulations using their risk and return profile the assets that they have to say hey 60% of the time this plan works you're going to be successful unfortunately what that means there's 40% of the time a relatively high percentage of the time this isn't going to work at least without you making a serious change without you making some improvement or enhancement to the plan as it stands well what do those enhancements look like what do those improvements look like what do those changes look like I should say because sometimes you might not necessarily call them improvements well it could be Matthew and do you cut expenses in retirement it could me Matthew and Sarah do you work another year or two before making this happen it could mean Matthew and Sarah do you invest differently or Implement a different tax strategy what are the things you need to do to increase the odds of success now by the way 60% that's not a way of saying that this isn't doable that that is doable it just means 40% of the time you're going to need to make some adjustment in order for this plan to work out so let's take a look at some of those adjustments and see how that impacts their probability of success so here's things as they stand right now but what we started playing with is saying let's let's change some of this let's change some of these assumptions what if it wasn't 7500 per month that you lived on what if it was $6,500 per month how would that change things well what happens is your probability success goes from 60% to 70% so that's pretty substantial that being said there's a meaningful trade-off for that it means you got to find $1,000 in your monthly budget to take out in order for this to happen so this is where retirement planning becomes about tradeoffs what's more acceptable to you retiring when you want on a lower amount so 6500 per month versus 7500 or would we rather work longer or save more or do something else along the way so we talked with them about that and they didn't really want to cut expenses and we've said that makes sense we're looking to retire for freedom for the ability to do things you don't want to retire and then feel more limited or feel like you can't actually do the things you want to do so let's move this back to $7,500 per month what we looked at next was we said look Matthew Sarah you said you didn't hate your jobs in fact you kind of like your jobs they just prevent you from doing some of the things that you want to do outside of work sometimes what if you simply work one extra year the both of you how would that change things well your probability of success goes from 60% it goes up to 68% so a pretty significant change now what if 56 you say that's instead make that 57 and by the way this is back to 7500 per month of living expenses not 6,500 per month well now all of a sudden that 60% probability success that went to 68% after working one more year now it's at 75% after working two more years so what we can start to see is hey some of these changes this is very possible but what are the trade-offs do we retire and cut back a little bit versus do you keep working a little bit longer and then Fully live on what you're expecting to live on now let's reset both of these go back to base case one of the things if you recall was they said look we've got some stock options we have some bonuses that's not unrealistic to assume that that might come due that could be an additional $100,000 that we save towards our plan so we looked at that what if instead of saving 25,000 per year that they could do even if they didn't hit their target bonus even if they didn't have some of these stock options vest what if they did have that and added $100,000 per year which I know is significant but added that to their savings here's the thing it didn't change things all that much and the reason it didn't change things all that much it moved their probability of success from 60% to 64% is their portfolio is doing most the heavy lifting at that point for them assuming some growth the savings that they had already done the compound growth on that the amounts that were already going into 401K plus match plus the 25,000 per year the extra 100,000 was significant but not relative to what the savings and growth they were already projected to get would be so in other words we said there's not a ton of pressure to save a whole lot more it's going to be another detail that moves the needle a lot more significantly for you by the way if this is helpful to see I know these are longer videos we're actually fully flushing out a financial plan for a sample client here let me know if this is helpful or not let me know by leaving a comment and hitting the like button below and also if you're looking at this I get a lot of people asking where do you get this software well this is a software that we license as financial advisers it's not available to the retail public but what we do have is we have an online course called retirement planning Academy the link is below and if you sign up for retirement planning Academy you actually get full lifetime access to this software no advisor support nothing like that but you can at least model some of these scenarios on your own and again you can find that in the comments right below this video so let's go back to Matthew and Sarah's plan and we looked at well what if you work longer what if you cut expenses what if you save a whole lot more and some of those made a big difference some of them didn't make that big of a difference another key difference I mentioned I wanted to highlight to you as we go through this what are some of those things some of those aspects of retirement planning that significantly change if you're going to retire early versus you're going to have a more quote unquote traditional retirement well your investment strategy is one of those your investment strategy if you retire early this isn't a universal thing but in general you need to be really hyperfocused on having a portfolio that's going to outpace inflation over time one of the bigger risks of retiring early is actually being too conservative with your Investments because if you're too conservative and you have 40 50 years of retirement in front of you you're not going to outpace inflation your portfolio is going to gradually dwindle over time as inflation and cost of living goes up and up and up so one thing that we initially plan on here is then having kind of that traditional moderate portfolio in retirement now this is want to be very clear up front simply us projecting different portfolio growth rates doesn't mean they're going to get them but at least provided some context to say how does the growth rate you're going to affect or the growth rate you're going to get affect the planning that we're doing well we said look more of an 8515 allocation 85% stocks 15% bonds based upon your portfolio based upon your expenses that's what we felt would be more appropriate for them the long-term growth we're planning for on that is closer to 8% again that's not a guarantee that's not something I told Matthew and Sarah we can assume this is going to happen but it is important to at least project that out because if you see here not working longer not saving more not cutting expenses that alone simply shifting to what we felt was a better allocation for their long-term needs that increased their probability of success pretty dramatically now if they did that and worked one extra year what you start to see is all of a sudden their probability of success starts to get a lot closer to what we'd want it to be over time there's not a magical number here that we're shooting for but you can start to see how some of these changes impact that so the two big changes that pertain to people retiring early we've covered so far is number one what's your health strategy your health insurance strategy and we covered that for Matthew and Sarah secondly we highlighted the importance of having the right investment strategy that made a pretty critical difference in Matthew and Sarah's plan the last thing is their tax strategy tax strategy for people retiring early not always but in many cases becomes extremely important because the opportunity Available to You becomes much greater let me show you what I mean here's Matthew and Sarah's plan what this is showing is this purple here is highlighting what their projected taxable income is going to be so for the next few years you can see their taxable income is going to be relatively high they both have salaries and those salaries are fully subject to taxes then when they retire you can see there's a major dip a major Valley here what this is is this is that tax planning window of if they're living primarily off of money from their joint account they're not in a very high tax bracket so that's great for a period of time until later on in retirement until Social Security kicks in until they start living off their IRA distributions until required distributions kick in and if you recall from a graph a few minutes ago their required distributions are going to put them in a situation where it's not unlikely that they'll have a six figure tax bill each year because of how much they're forced to take out so so the next thing that we did for them is what you can see all these lines here they're kind of small but what this is is this is overlaying the various tax brackets seeing for various levels of adjusted gross income or taxable income what's the tax bracket here there's a 10% tax bracket in the blue then the 125 2225 there's a slash because after current tax law sunsets at the end of 2025 the 22% tax bracket will go to 25 2428 so on and so forth and what you can see is there up there today then they're projected to be in a much lower bracket and then by the end of their retirement they're projected to be right back to where they would have been even higher than they are today so the question is well what can we do in these years here when they're in a really low tax bracket to minimize the impact of taxes throughout retirement well that's where we want to quote unquote fill up the bracket this is what a good Roth conversion strategy does I'm going to show you a very very simple thing that they can do that has extremely or big profound impact on the rest of their retirement I'm showing what if they fill up the 10% tax bracket and what I mean by fill up is convert just enough from their Ira to create enough income to fill up the 10% ordinary income tax bracket that really simple strategy because they have such a big tax planning window because they're retiring early have a brokerage account that they can live on for so many years that single strategy saved them or added over $1.7 million to our tax adjusted ending portfolio so why does that have such a big difference why does that have such a profound difference well number one and by the way this is a tax cheat sheet here I'm going to include a link to this in the description below so if you want to have access to this PDF you can just download it below what you see here is they're not really just filling up the 10% bracket they're really filling up the 0% bracket plus the 10% bracket because there's something called the standard deduction so if they retire and they're living all in their brokerage account well they have a standard deduction of 29,200 now these are 2024 numbers by the time that they actually retire these numbers would be different of course but if they have zero earned income because all their income is from qualified dividends and long-term capital gains hypothetically if all their income was there they could convert $29,800 from their Ira to their Roth IRA and that simply gets washed out by their standard deduction so that conversion is done at a 0% tax bracket in this simplified example then then they can convert an additional amount from 0 to $23,200 they're doing it this year at the 10% bracket before moving up into 12 22 24 so on and so forth so that one simple change by the way we went much deeper than this with them but just simplifying how much this looks like or simplifying what this looks like that change adds a significant amount to their portfolio because here's what their adjusted gross income looked like before their taxable income I should say looked like before and this green is what it looks like after so it's shifting some of the future tax Li liability to today but then it's bringing down what that future tax liability might look like now here's a mistake some people make they say oh gosh we're projected to be up in the 24 28% tax bracket later on in retirement why don't I convert all the way up to the 24% bracket today to avoid being there in the future let's see what that looks like what if they converted all the way up to the 24% tax bracket what that does is that actually costs them almost $3 million because they overon converted they didn't have a complete picture of what's in front of them and they paid way more taxes doing that than they otherwise would have had they simply done nothing so that's the real risk here with Tax Strategies make sure that you're converting enough but also not overon converting because the difference can be millions of dollars in either direction so as we showed all that to Matthew and Sarah we really wanted to highlight those three key things that we wanted to focus on do we have the right Health strategy in place do we have the right investment strategy in place that's unique to you in your desire to retire early and have a much longer retirement than what would be considered maybe a traditional retirement and then finally number three do we have a tax strategy in place that can save you lots and lots of money over time which simply adds to your probability of success when we showed all this to them we said look there's no guarantee that you can do this by 55 but it's not unlikely that you can so let's start implementing some of these things let's start moving in that direction and as life changes and inflation changes and markets change as we get closer and closer we're going to continue to update this plan so that when 55 comes you're going to have a very clear sense of what exactly is needed for you to move on to this next chapter of your life now in this video we talked about the importance of making some of those investment changes some those portfolio changes we didn't really get into the specifics if you want to see what some of the specifics look like I actually did another case study where I walk through what actual investment changes would I make I included a link to that video here and on that I went through a more in-depth exercise what we would have done for Matthew and Sarah here where you can see based upon their cash flows their income sources their portfolio needs how does that tie into not just the allocation that you should have but how can you find specific funds to help you fill that allocation take a look and I think you'll like it once again I'm James canol founder root financial and if you're interested in seeing how we help our clients at root Financial get the most out of life with their money be sure to visit us at www.ro Financial partners.com

Channel: James Conole, CFP®

Views: 85,040

Keywords: investing, retirement planning, tax planning, financial planning, retirement, personalfinance, taxes, dividend investing, financial planning at 50, how do I retire?, long-term investing, financial planning at 60, roth conversions, roth ira, IRA, individual retirement account, benefits of investing, pros and cons of investing, donor advised fund, financial education

Id: X2BqucSNd6Y

Length: 30min 59sec (1859 seconds)

Published: Sat Apr 13 2024