Retirement Answers

Jacob: 00:01

When you look at your IRA, you just see that it's just one big account and it's either up or down in value that day or month or year. So whenever we use this bucketing strategy, we can kind of get out of that one big pile of money mindset and think of each bucket of having its own purpose or goal. Welcome to Retirement Answers, a podcast built to answer your most pressing retirement questions. If you're someone who's either thinking about retirement or already in retirement, well, you're in the right place. Hey there, my name is Jacob Duke, and each week I'll be walking through different tips and strategies to help you succeed in retirement.

Jacob: 00:38

So let's go ahead and get started with today's show. Hey everybody and welcome back to another episode of Retirement Answers. I hope you are having a great week so far. Today, I wanted to start off with a quick quote from, the great Yogi Berra. He said, if you don't know where you're going, you'll end up someplace else.

Jacob: 00:58

And the reason that I shared this quote is because today we're talking about retirement income planning and how I approach this with my clients. And what's sometimes hard about retirement planning is that there are so many different levels to it. Some people try to really drill down to the exact cent of every dollar that you think you're gonna spend and try to be really precise. On the flip side of that, others are what I call hopers. They just have chunked, you know, 10% of their income into their four zero one k throughout their entire career and they hope that it will be enough one day.

Jacob: 01:25

They don't really have a plan for their income and retirement, and they just, they know a few different rules of thumb and they plan on just following those. Well, I would suggest that there are faults in both of those two different extremes. So hope is not a plan, but conversely, there can be paralysis by analysis. So you should have some depth to your retirement plan, but you don't just keep digging into the smallest of details. There are diminishing returns on figuring out whether or not those intricate details are actually important.

Jacob: 01:51

And and I can assure you that your life will not go as planned. And I can say that with almost 100% confidence because the proof is in your life's history. Things have happened that you never thought would happen and things, did not happen. You are almost certain would happen. We can expect the same thing throughout your retirement.

Jacob: 02:08

As you develop your plans for retirement, both financially and non financially, I encourage you to hold them loosely. You absolutely need a plan, but understand that your plan will be wrong. I actually talked about this in a previous episode. If you wanna go back and check that out, it was episode 24 where it was titled, hey, your retirement plan is gonna be wrong. But today I wanted to talk about planning for your income in retirement and how I like to do this with my clients.

Jacob: 02:33

So there are all these different kinds of ways or strategies and approaches to retirement income planning, but my favorite is the retirement bucket strategy. In fact, it's a three bucket strategy. And I don't know about you, but I like to keep things simple. In fact, the great Leonardo da Vinci said that simplicity is the ultimate sophistication. And what he meant by this is that simple is not necessarily easy.

Jacob: 02:53

He meant that you have to work through all of the complexities and all of the particular, intricacies of any particular situation or idea. And when you come out the other side of that and have a simple straightforward path to execute on those objectives, that is sophistication. So you have to work through all of the different struggles or difficulties of a particular objective or mission. And when you come out of that with, you know, a short list of simple ideas or simple tasks that need to be completed, that's what sophistication is. So simplicity is not easy.

Jacob: 03:25

It's something that actually takes sophistication to get there. And another quote from Blaise Pascal, the French philosopher that I find interesting is that he said, I've only made this letter longer because I have not had enough time to make it shorter. And so once again, his point was complexity or detail is often the enemy of what you're actually trying to accomplish. So with that, I found that creating a simple yet thoughtful retirement plan is important to executing that plan successfully. So I could sit in my office all day crunching numbers that I perhaps don't need to crunch, but I would be doing that out of hope for certainty.

Jacob: 03:56

And remember, there's nothing certain in life and especially there's no certainty in your retirement plan. So what is this three bucket retirement plan strategy? Well, it is as it sounds. You bucket or separate your money into three different silos sections of your overall allocation. So the purpose of this is to create a mental barrier between them.

Jacob: 04:15

I like to create this mental image because when you look at your IRA, you just see that it's just one big account and it's either up or down in value that day or month or year. So whenever we use this bucketing strategy, we can kind of get out of that one big pile of money mindset and think of each bucket of having its own purpose or goal. So starting with bucket number one, this is your cash bucket. This money is gonna be sitting in cash at your bank or your money market account, or it could be cash in your IRA or some other retirement account. But regardless of where that money is held, it is cash and it's just simply not stocks or bonds.

Jacob: 04:49

The purpose of this bucket is is not to grow. Its sole purpose is to be stationary and not go up or down like stocks or bonds will. The cash buckets primary purpose is to provide liquidity and eliminate the volatility over the short term. So by having this bucket, you can meet your short term needs that come up without having to worry about market volatility or selling your investments at inopportune times. And you might be wondering, well, how much cash do I actually need to have on hand at any point?

Jacob: 05:14

Like how much cash do I need to have in bucket number one? Well, inside the framework of this bucketing strategy, I typically recommend having two years worth of living expenses in cash. So what do I mean by that? Well, as you plan for retirement, one of the important steps is determining how much money you actually need to pull from your retirement savings each year to meet those monthly needs. When doing this, it's important to consider your other fixed incomes like pensions or social security benefits or, different or disability incomes, different things that might be coming to you.

Jacob: 05:44

That otherwise means you would not have to pull money from your different retirement accounts. So whenever we factor that in, we have to make sure we're not counting that in our monthly income need from our portfolio. So for example, if you need $10,000 a month to maintain your current standard of living in retirement, but you're gonna be getting 5,000 a month in total social security benefits, then you don't have to have $120,000 of annual distributions from your retirement accounts. You would actually only need 60,000 from your accounts. So you're spending 120,000, but you only need 60 that comes from your retirement assets.

Jacob: 06:17

So when calculating your annual income need, it's important not just to say, hey, I'm gonna spend $120,000 because that's how much I'm gonna spend. Therefore, need $240,000 in my cash bucket to cover two years worth of living expenses. In this example, you would only need $120,000 in cash to fulfill your bucket number one needs. Another question you might have is, well, why do I need two years worth of cash available? Well, the idea is to provide you and your spouse with what I call this sleep at night factor.

Jacob: 06:45

We can all agree that anxiety of losing all of your money or running out of money in retirement are typically some of the biggest concerns that a retiree will face. So I like to ease those concerns by intentionally creating this sleep at night factor by using this cash bucket. And at the end of the day, the best plan is one that you can execute. It doesn't matter if you can make more money doing something in a different investment strategy if you cannot actually stick to the strategy. So bucket number one is the cash bucket.

Jacob: 07:10

And I encourage two years worth of living expenses in cash. This protects you from that short term market volatility and keeps you from having to sell your investments at the wrong time. It's designed to meet your short term expected and unexpected income needs. Next, have bucket number two, and this is the bond bucket. This bucket can consist of corporate bonds, treasuries, CDs, money markets, etcetera.

Jacob: 07:32

Basically anything that's a fixed income investment. And the purpose of this bucket is to provide more income than cash and have slight possibilities for appreciation. Please hear me out. Bonds and CDs are not the way to continue growing your wealth long term. It's just not possible.

Jacob: 07:48

Look at all of history, bonds and CDs are not the way to do that. This bucket is designed to cover your income needs from years three to five from now. So, this means that we need to have at least three years worth of living expenses in bucket number two. So think back on bucket number one for cash. We need at least two years worth of our income needs in cash, and we need at least three years worth of income needs for our bonds in bucket number two.

Jacob: 08:12

Since this money isn't expected to be used until at least three years from now, because we've got the first two years covered with that cash. We can take a little bit more risk than cash in hopes of getting a little bit higher interest rate or return. So think of bucket number two as a midterm bucket. And finally bucket number three is our stock or our equity bucket. This is your long term investment bucket.

Jacob: 08:33

We have to have this bucket in any good retirement plan because it needs to be growing over the long term because this is the only portion of your money that will beat inflation and continue to outpace the cost of living increases that are almost certain to happen. A lot of people think that they need to get really, really conservative whenever they enter retirement, but I would argue that that is not the smartest move. Yes, we need to have a portion of your assets and more conservative investments, but if you plan on living another twenty plus years, you can't afford to not be investing in stocks and refer back to episode 26 of the Retirement Answers Show for more context on this, where I talk about what the real risk of stocks is and what the real risk of stocks is not. So here in this bucket number three, your bucket, it's designed to grow long term and because we have bucket number one and bucket number two allocated correctly, under no circumstances would you need any of this money from your stock bucket in less than five years. Remember because bucket number one is two years, bucket number two is three years worth of living expenses.

Jacob: 09:27

So so bucket number three, which is your stock bucket means, hey, we've got all of our short term needs covered. Therefore, this bucket can be invested for the long term. So we've kind of created this five year buffer before we ever need to sell stocks to create income for your retirement. Now, one of your questions might be, hey, why did you think about five years? Like, did you create a five year buffer?

Jacob: 09:46

Well, if we look back to the great financial crisis of two thousand and eight, we can see that it took just under five years for the stock market to get back to where it was before the crash began. So that took until 2013 from o eight to 2013 is kind of the timeframe there. This is the longest recession or bear market that we've seen in recent history. So this is a good framework, I think, to go on. Now you also might be asking, well, if the market goes down for two years and I have to use all of my cash bucket, how do I refill that whenever the market is down?

Jacob: 10:15

And that's a really good question. And I'm really glad that you asked. One important thing to remember in all of this is that your investments will be producing income, throughout this whole process. Your bonds, your CDs, your money markets, and stocks, they'll all be producing dividends and interest. And based on my experience, anywhere from 30 to 60% of your income needs on a monthly basis or quarterly basis are gonna be covered by those dividends and interest alone, which means that you don't really need to pull, from the principle of your investments and you would only need to pull a small portion from your cash bucket every single month.

Jacob: 10:48

Also, stock market is not always flat, bond markets are not always flat, and so there are gonna be years where the markets are up and they're gonna be years where the markets are down. So in the years that the stock markets are up, we would trim gains off the top as those stock investments are appreciating, and we would send that to you as your income instead of taking money from your cash bucket in number one. So when the stock market is down, you can use your cash and bond buckets for income, and when stock markets are up, you can use those gains as your income. And all along the way, you're gonna have dividends and interests as well. And back to earlier in the episode, when I mentioned that absolute accuracy is almost impossible to attain for planning like this, we aren't necessarily trying to be rigid in how we're gonna pull income and where we're gonna pull it from.

Jacob: 11:26

I think it's a fluid situation and deciding where to pull your income from each month or quarter should be based on the market environment at that particular time. I just think of it this way. Like I said, you know, this is not to be exact. The purpose of this bucketing strategy is to say, here's the direction we're trying to head. We know that we're going this way, but we're not trying to be exactly pinpoint on when we pull certain types of money and where we pull it from and what happens if things don't go according to plan.

Jacob: 11:52

The idea is let's just set ourselves in the right direction. We know we have a good guide. And from that point, we can make alterations, make adjustments, make changes as necessary. And in some sense, deal with the consequences as they come. The purpose of this is not to say that we have it all figured out.

Jacob: 12:07

The purpose of this is to give you the most flexibility to be able to withstand any different market fluctuation or risks that come up along the way so that you have the most opportunity for success throughout your entire retirement. So I'll just wrap up by saying this. I like this three bucket retirement plan because it is simple and easy to understand. It works and it helps you sleep at night knowing that you don't have to give up your long term growth that is needed for any retirement plan to work, but you're also covering your short term needs and eliminate some of that short term volatility that otherwise could be a bad time to sell those investments whenever you're trying to create income. And one thing that you'll notice about this is I have not mentioned anything about a sixtyforty or an eightytwenty portfolio.

Jacob: 12:47

Most of the time we try to create an investment allocation and fit it into our income needs. But I suggest creating a bucketing plan like this based on your income needs and based on that plan, then we can derive your asset allocation. So the income plan informs and dictates your investment allocation, not the other way around. I So hope this helps as you develop and think through your retirement income plan. And let's go ahead and answer this week's listener question.

Jacob: 13:13

All right, this week's listener question says, is my traditional IRA contribution deductible? And this is maybe not as straightforward as you might think. The first thing you have to know is if neither you nor your spouse is covered by an employer retirement plan, your IRA contribution is gonna be 100% deductible regardless of your income. So married, filing, jointly, if neither of you have an employer retirement plan that's available to you, you can deduct your IRA contributions no matter what. If you're single and not covered, then you could deduct no matter what as well.

Jacob: 13:43

Now, if either of you is covered by a retirement plan, your contribution may not be deductible or it may be partially deductible. The deductibility limits change each year and it's based on whether or not you have a certain amount of income and that will dictate whether or not you can deduct your IRA contribution. So first, if you're married filing jointly and you are the person that's covered by your employer plan, meaning you're eligible to contribute, you are not able to deduct any of your IRA contributions if your joint income is more than $136,000 in 2023. So just to kind of restate that, you know, if you are covered by an employer plan and you're married filing jointly, and you make combined more than $136,000 in 2023, you will not be able to deduct any IRA contributions at all this year. So if both spouses are covered by an employer plan, both of you would have to follow this $136,000 income limit for deductibility.

Jacob: 14:39

Now there's a little bit more to this. I encourage you go on the IRS website and check this out. But if you're under $1.36, there are there's a particular range that means that if your income is in that range, you have a partial deductibility option. And if you're under that lower limit, then 100% of your IRA contributions will be deductible. Not gonna get into the weeds of that.

Jacob: 14:59

You can go check that on your own, on the IRS website. But if you are married and you're not covered by an employer plan, but your spouse is, they would be subject to the income limit of 136 because they are the person that's covered by that employer plan. But you would be subject to an income limit of 228,000 in 2023 because you're not covered by an employer plan, but your spouse is. So you have an income limit, it's just not as low as theirs would be. So if you're not covered and your spouse is, you would only be able to deduct an IRA contribution if your joint income is less than that $228,000 So obviously this is really confusing and I see a lot of people getting this wrong.

Jacob: 15:39

I highly encourage you to check with your trusted advisor or financial planner to make sure you're doing this correctly. Now you can contribute to your IRA and not deduct the contribution. This is what's called a non deductible contribution. And if you do this, you're required to submit form 8,606 with your tax return. So the IRS knows what is pre tax and what is post tax within your IRA.

Jacob: 15:59

So here's the general rule I like to follow. Just simply don't make non deductible contributions to your IRA. It's not helpful. It doesn't make any sense. It's really confusing and creates a mess in the future whenever you have to start taking money out of your IRA because now you have what's called basis in the account and it's a whole different thing.

Jacob: 16:16

A lot of confusion there. You might end up paying tax twice on that non deductible amount. So I only make contributions to an IRA if you can deduct them and following these rules that I've laid out. I hope this has helped answer the question and didn't make things more confusing. So please reach out if you have any follow-up questions to this or if it is more confusing for you now.

Jacob: 16:35

I really appreciate you tuning into this week's episode and listening to the show. Hope you have a great week and look forward to talking with you again next week. Hey, it's Jacob again, and I wanted to extend a quick offer to you. If you have a question and you would like to have it answered here on the show, please email me at jacobretirementanswers dot net. And I'd love to answer that question for you right here on the show.

Jacob: 16:57

Also, wanted to remind you that nothing discussed in today's episode is meant to be financial, legal or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode. I look forward to talking with you again next week.