Retirement Answers

Jacob: 00:00

Hey, everybody. Welcome back to another episode of Retirement Answers. My name is Jacob Duke. I'm a certified financial planner, and I help people just like you retire on a daily basis. And today, I wanted to take, a recent question that I got and just kinda flush it out, answer it, give you some thoughts around it, in regards to whether or not this person could retire.

Jacob: 00:20

That was what their question was based on. And so some of these ideas and thoughts, that I had are, I think maybe helpful helpful for you as someone who might be evaluating retirement or perhaps whenever you get there one day, some of these thoughts and questions that I'm gonna be talking about and thinking through might be helpful for you when you get to that point as well. So, today, I just wanted to walk through this scenario and situation where Joe, he is 55 and he's still working. And his real his question is, I've got a million dollars in my 04/2001 k. Can I retire?

Jacob: 00:50

And so he's 55. He's still working. The main thing to know here is that he is single. He has $1,000,000 saved up in his four zero one k and all of that is tax deferred. Currently, he is making $150,000 per year.

Jacob: 01:05

And he thinks he needs around $75,000 a year for expenses, which is right at $6,250 a month of expenses. And then at 62, his Social Security is expected to be $2,300 a month, and at 67, which is his full retirement age, is going to be 3,100 a month. So that's kind of the main facts of Joe's situation, and his question is as well, can I retire? I'm 55. I got a million bucks saved.

Jacob: 01:31

Am I able to do this or not? And so just wanted to run through some different thoughts that I have immediately whenever I think about this question and, just providing a response to it. So the first thing that I notice is that, you know, Joe, you're 55. You're young relative to other people who are retiring. Typically, retirement age is somewhere between 60, 65, or perhaps even upwards of 70 depending on what people have done throughout their lives and then when they got started.

Jacob: 01:57

So on average, 55 is a fairly young retirement age. So my first question is this, is not so much where are you gonna be retiring from, but what are you gonna be retiring to? And this is a big deal to me because I see a lot of retirees. I talk to a lot of them. And the biggest hurdle that most of them face is not a financial hurdle of, can I do this or not?

Jacob: 02:18

Can I retire and stop working or not? It is, what am I gonna do when I get there? I find that so many people mention, well, I don't know how to settle my hands all day. I don't know how to watch TV all day. I don't know how to not work.

Jacob: 02:29

I don't know how to not have a routine of waking up and going to a place of work and and being with my colleagues or coworkers. So this idea of you're just ready to get out of your job that you're currently in, it's a red flag to me whenever someone says, I'm just tired of working, I'm ready to be done, but they don't have any solution to that in terms of how to fill their time whenever they are done working. So my first question to Joe is, what are you actually gonna be retiring to? Like, what are you gonna fill your time with? What are you gonna do whenever you're no longer employed?

Jacob: 02:59

Perhaps you're gonna be, working in a part time capacity or maybe you're gonna start up something that you've always wanted to do and maybe make some money doing that. But in general, what are you gonna be doing whenever you are retired? That's one of the biggest questions I have because the the thing that I see is a lot of people are so miserable once they stop working, yet they have all the money to do it. They they just don't know what to do with their time. They don't have a hobby.

Jacob: 03:19

They don't have friends. They don't have anything to go to that they can fill their time with and enjoy, their retirement years, which is meant for being enjoyed. So that's my first question is is, Joe, you're you're fairly young relative to other retirees, so what are you gonna be retiring to? What are you gonna use? What are you gonna do to fill your time?

Jacob: 03:35

That's a very important step in all of this. So that's the first thing. Number two, I see that you say that $75,000 a year is kind of what you expect for your expenses and that is likely to inflate over time, as things just begin to cost more and more. That's $6,250 a month. My question to that is, what does that $75,000 a year pay for?

Jacob: 03:56

Like, what is included in that expenses? Does that mean there are mortgages somewhere in there? Does that mean car payments are in there somewhere? What are the fixed expenses that are debts perhaps? And then what is just normal spending?

Jacob: 04:08

Groceries, gas, travel, fun things that you like to do. What all is included in that $75,000 a year that makes up the $62.50 a month? Because if there's a mortgage wrapped up in there, because there's a car payment wrapped up in there, that's important to know because those are fixed expenses that have to happen every single month as opposed to maybe I just don't eat out as much this month, or maybe I don't take that trip this month and just delay that again, to next month. So that's that's one of the questions I have there. And if a mortgage is wrapped up in that, well, one of the things that I like to say is the biggest determinant to being able to retire successfully is is having a paid off house.

Jacob: 04:44

Not having a mortgage lingering over you and hanging over your head through the early years of retirement is important, because that's just more money that you're gonna have to be taking out of your accounts early on in retirement to pay for that mortgage as opposed to having it paid for while you're earning a good income, because right now you're earning 150,000. And so, having those, fixed expenses like mortgage and car payments, having those taken care of and completely out of the way while you're still employed and earning an income and not having to withdraw that from your, retirement savings is gonna be very important. So that's question number two. What is that, monthly expense? That $6,250, what is that actually made up of?

Jacob: 05:20

Because the components of that are gonna be important. And then next, I see that you have $1,000,000 in your four zero one k, which is awesome. This is a, a great savings amount. You've done a really good job of working, saving, and investing, it sounds like, to get to where you are currently. But you did mention that all of it is tax deferred.

Jacob: 05:37

And so that sometimes can present issues in retirement from a tax standpoint. But the the one thing that I wanna focus on here with, all the tax deferred money is do you have any after tax assets? Do you have a large cash amount or Roth or maybe have a rental income that's coming from different sources? What other options do you have to pull money from that are not your four zero one k and that are not tax deferred? That's really the question.

Jacob: 06:00

Because if we start to think about it, if you need $75,000 a year and you're 55, we've got seven years until we at 62 is the earliest that we can take Social Security. So if we got seven years and we do that 75,000 for seven years, man, we have eaten into your $1,000,000 very quickly in terms of how much we've taken out. And so that $75,000 a year, that is that's 7.5% of your overall savings if you don't have any other cash or Roth or rental income. And whenever I think about having different types of assets, this goes back to a tax diversification kind of question that I like to emphasize and say, hey, this is really important to you as a retiree. Having different sources of income to pull money from from a tax standpoint is gonna be very important because whenever you have all your tax deferred money, whenever you think about it, you've gotta pay tax on that, which means you either have to withhold that from the account or you've gotta pay that from somewhere else or just save it throughout the year to pay the taxes at the end of the year.

Jacob: 06:56

So, having those after tax assets, if you have any, are gonna be very important. So cash, Roth accounts, or just other, you know, income sources, what other options do you have to pull from as opposed to pulling all of your monthly expenses that you need out of your four zero one k. So that's that's question number three. What other after tax assets do we have? And if you don't have any, maybe we need to think about building those up before you retire.

Jacob: 07:21

Because like I said, having cash gives you flexibility from a tax standpoint, but also a spending standpoint. You don't wanna have to sell your investments if the market has gone down. And so there's different things that factor into that, but do you have any after tax assets? That's kind of question number three. And I kinda hinted at it just a second ago, but $75,000 a year out of a million dollars, that's a 7.5% withdrawal rate.

Jacob: 07:43

And, if we know anything about retirement, we've probably heard of the 4% rule, which means that you can take 4% of your dollars out of your accounts if invested correctly for the rest of your life and never run out of money. Now 7.5 is larger than 4%, and so that is somewhat of a higher withdrawal rate. Now I'm not opposed to a higher withdrawal rate early in retirement, especially if we have other fixed sources of income that we know about that will happen in the future, such as a pension that might be kicking in at 65 or maybe Social Security when we turn that on at 62 or 67 or anytime that we're eligible to. If we know that there's gonna be some sort of fixed income that's gonna be coming in at some point in the future, and it will be inflating over time, you know, Social Security has a cost of living adjustment that is applied to it, every single year. So if we know that that's gonna be happening in the future, then I'm willing to have a little bit higher withdrawal rate early on until we get to that point.

Jacob: 08:37

Because if our withdrawal rate is gonna be 7.5% every single year, rest of your life, you will run out of money. There's really no question about it. It's just a matter of when. And so, starting at 55 and perhaps going to 65 or 67 until you take your Social Security at that point, if you retire now today, I would say that it almost forces you into taking your Social Security at 62. Meaning, you can't go much longer than seven years, in my opinion, without having to have some sort of other fixed income coming in that's not your portfolio.

Jacob: 09:09

So that's kind of one of the issues I'm getting a sense of here is that if you need $75,000 a year out of your 1,000,000 and it's tax deferred, meaning you can't just take 75,000 out, you're gonna have to take more than that out. If you're going back to point number three, don't have cash to pay the taxes with, you're gonna have to withdraw perhaps 90,000 or more dollars to account for the tax withholdings out of your 401K account. So that's something to factor in is what do you need after tax, and then how are your assets currently structured? All of your assets are pretax. Therefore, any money takeout, you're gonna have to factor and build into that amount, you know, hey, I've got to pay taxes on this.

Jacob: 09:43

Therefore, I need to account for that, which means my withdrawal rate will be even higher. So that's kind of a concern for me is that 7.5% withdrawal rate, especially for the amount of time in which you're doing it. If you're only having to do that for three or four years, totally okay with it because we know that withdrawal rate will come down to two, three, or 4% once those fixed income sources turn on just like Social Security or pension or something like that. So, that's a concern for me. The withdrawal rate's fairly high for what I'm looking to target for my clients, but I know that it will go down maybe seven years from now.

Jacob: 10:15

So you by retiring now, you might force yourself into taking your Social Security early, which means you're gonna get less benefit than technically what you paid for as you paid in along the way. So, it's a give and take. You know, do you really hate your job that much? That's that's a question. And then, you know, obviously going back to question number one, what are we retiring to?

Jacob: 10:32

Because if you just hate your job and you're like, I don't wanna work anymore, well, you're gonna get miserable from not working at some point, and then things are just gonna spiral out of control. So starting at 55 is is somewhat of a potential issue from all the reasons that I mentioned. But also just know, I wanted to point out a fact here that that's important to a lot of you is that there's a rule of 55, which applies to withdrawals from a four zero one k. If you retire from your employer at 55 or later, then you get the opportunity to take money out of your four zero one k without the additional 10% early withdrawal penalty that normally would apply. So that's important to know is that you can do that.

Jacob: 11:11

Once you're 55 or older, you can retire from your company, and then you can begin taking money out of your four zero one k with no extra penalty. All you would owe is the taxes on the tax deferred portion. Now what's important to know here is how this is different from an IRA. You can do the same thing with an IRA, but you have to take equal distributions over at least a five year period for that to be possible with an IRA. Within the four zero one k, there's no rules on how much you have to take or having to take equal distributions.

Jacob: 11:39

The main thing that you have to know about the rule of 55 in regards to your four zero one k and being able to take money out before 59 and a half is that your money has to stay in the four zero one k for the entirety of your time doing that. You can't do a rollover from your old four zero one k once you retire if you're taking money out of that. So you can't begin taking money out at 55 or later using that rule of 55 from your four zero one k, and then a year into retirement rolled over to an IRA, and then keep doing the same thing. Once you roll that money over to an IRA, the rule of 55 then no longer applies because that only applies to four zero one k's. You would then have to follow all rules for IRAs, which means you would have to do that equal distribution rule, or you would just have that 10% penalty apply to any distributions that come out of your IRA.

Jacob: 12:23

So, yes, you can take money out before 59 and a half out of your four zero one k. The money has to stay in the four zero one k until you reach 59 and a half, and then you can do a rollover. So that's just a couple important things to know. I wanted to point that out because Joe here, he his question is, hey, I'm 55. Can I retire?

Jacob: 12:38

So that's an important piece. Right? Will I be able to access my money without taxes or penalty? The taxes will apply. But in this situation, since the money's in his four zero one k, you would not have that 10% penalty because of that rule of 55 that's, available to you.

Jacob: 12:53

So can he retire? That's really the question. The answer is, I think he can, but I don't like it. You know, if it's an absolute last resort, Joe, I would say that you could. I'm just not a big fan of it because of that big high withdrawal rate that I mentioned earlier.

Jacob: 13:10

At 7.5%, if not more, because of the taxes that will be associated with it, your lifestyle will have to change. Right? Right now, you're making a $150,000 and you're really only spending 75 to a 100, somewhere in there. So you're making more money than you need, and so that probably feels really good. But once you get to retirement and you have to live on a tighter budget, you have to make sure your pension pennies a little bit more, that will not be fun, in my opinion.

Jacob: 13:34

And so I would say if you can, perhaps delay that retirement a little bit longer because it might not be worth it to you to start just living on that budget that you otherwise are not living on already. So I'm just not a fan of the withdrawal rate, the the the taxes that would be owed. Perhaps some of the different issues in terms of, like, we can't take Social Security or have any other income sources until 62 at the earliest. That's just a little bit of time. That's just a little waste from here.

Jacob: 13:59

And, obviously, you you might not even wanna take it at 62 to get your full benefit perhaps at 67, so that could be even longer. So those are some of the reasons that I would perhaps caution you from retiring, but that's all to say that mathematically you could. Obviously, I don't know enough about this situation, but just know that, you know, fixed expenses, mortgages, cars, if we can have those paid off, if we can have other cash assets, at least 50 to $100,000 saved in cash before we head into retirement, that gives you a ton of flexibility. So maybe in these last couple of years, maybe delay it, but focus on these other items. If you have that mortgage, pay that off if you can.

Jacob: 14:36

If you have the ability to save extra cash, begin doing that because that will be, important, like I mentioned earlier. So, if you're listening, this is just some of the ways that I like to think about, retirement in terms of planning for it and some of the decisions that have to go into it. You know, can I retire? Can I not? Are my assets structured in a certain way that is beneficial or perhaps hurtful?

Jacob: 14:58

So this is what I like to do for my clients in terms of planning for their retirement. So just wanted to give you a little bit of insight into this today. That way you can see how I think about things and some of the questions that I ask or think about whenever I'm beginning to to kinda question someone's retirement. Well, what are their opportunities? What are some of the issues that might be there that they need to look out for?

Jacob: 15:16

So, hopefully, this will help you as you continue to evaluate your retirement and whether or not it's possible. I encourage you to think about these different questions, but, this was helpful. Thanks so much for tuning in to this week's episode of Retirement Answers. Once again, my name is Jacob Duke. I look forward to talking with you again next week.