Spending money is complicated—and retirement doesn’t make it any easier. In this week’s edition of Tired & Rich, we’ll unpack the strategies and challenges of spending your own money in retirement.
Spending Your Own Money in Retirement
Deep in the Tired & Rich survey results was a question I want to discuss today: How do you pay yourself in retirement?
This is a universal problem for retirees with savings and investments.
At first glance, it’s an easy question to answer: You move your money as you do between your checking and savings accounts.
But the deeper you get into this question, the more complex it gets.
We’re currently working with several Fjell clients to develop a streamlined distribution strategy as they approach retirement.
About two-thirds of you are in the “retirement planning zone,” so this question should be on your mind.
To the younger readers, keep reading because this knowledge is gold.
Contributions Define Distributions
If you want to know what your retirement distributions will be like, look no further than where you are contributing today.
Think about it:
- Assuming you have a 401k at work and a brokerage account, these are likely the places you will pull from.
- If you’re married and your spouse contributes to a 401(k), that will also become part of the mix.
Your retirement distributions will come from where you’ve built your savings—makes sense.
But it gets more complicated.
The Hard Part
A solid starting point for what your portfolio can afford to give you is the 4% rule.
If you have a $1m portfolio when you retire, spending 4% or $40,000 / year is a safe withdrawal rate assuming your assets are growing 4%+ per year.
Easy enough, but hardly anyone has exactly $1m in one investment account, from which 100% of their retirement distribution is coming.
We currently serve 200 clients at Fjell and manage over 575 individual investment accounts.
No one has one investment account solely responsible for funding their retirement spending.
Most have 3-5 accounts working in concert to support their lifestyle in retirement.
Some people come to us with 7+ accounts, drowning in how-on-earth-this-will-work.
Here’s an example couple ten years out from retirement with $1M saved:
- Roth IRA A – $150,000
- Traditional 401k A – $350,000
- Roth IRA B – $250,000
- Traditional 401k B – $50,000
- HSA A – $25,000
- JT Brokerage AB – $175,000
According to their retirement plan, this couple is doing well, with a targeted portfolio of $2m by retirement.
But how should this couple pay themselves when there are six different accounts to consider, each with varying tax treatments?
To briefly touch on taxes, the list above includes four different account structures, each with different tax treatments.
- Traditional 401(k): Tax-deductible contributions, taxable distributions
- Roth IRA: Post-tax contributions, tax-free distributions
- HSA: All around tax-advantaged for healthcare
- Brokerage account: Taxable yet supremely flexible
Each account has pros and cons. Each is useful in different ways. And at retirement, you need a rock-solid, tax-efficient plan to pay yourself from these different accounts.
A real-life example: Roth IRAs. Many of our retired clients with well-funded plans rarely take Roth IRA distributions. Why? They want to leverage the tax-free growth and leave those assets to their kids. It’s an inter-generation tax and estate planning play, not a tax-free distribution strategy in their retirement.
Nuanced? Absolutely.
The Curveball: Known Unknowns
Here’s what screws up retirement plans: You don’t spend the same amount every month.
In our webinar about retirement planning two weeks ago, I put a chart on the increase in car prices over the past decade.
As you know, they have exploded in price.
And people in retirement need to buy cars.
You will probably buy 3 – 5 cars in retirement.
“Tom, no, I won’t.”
Yes, you will.
Here’s the math.
- If you are married and retire at 65, you are statistically likely to live until you are 85. Still, from a financial planning perspective, it’s best to add an extra 5 years to your life expectancy (having no money at 87 is a horrible place to be).
- Assuming you and your spouse drive a thousand miles a month, on average, throughout retirement, you and your spouse will drive a combined 600,000 miles.
You can calculate how many cars you’ll need, given this mileage.
We’re discussing buying cars because I call cars “known unknowns” in retirement planning.
You will buy more cars in the future. You just don’t know when.
In retirement, these “known unknowns” costs need to be planned for in addition to regular monthly spending.
Here is what a typical yearly spending pattern could look like for our example couple above.
- January – $6,000
- February – $5,750
- March – $12,000
- April – $15,000
- May – $6,000
- June – $6,500
- July – $8,000
- August – $5,700
- September – $6,000
- October – $26,000
- November – $7,000
- December – $8,000
With three high school and college kids, this couple usually spends around $6-8k a month, but there are a few outlier months.
March, April, and October.
- In March, they took a small family vacation that cost $5,000
- In April, they had to pay an extra $6,000 in taxes.
- In October, Mom bought a new Kia Telluride, and they put $20,000 into it.
This is right here a typical year of spending in life.
Whether you are working or not.
75% of the months are “normal,” then a few outliers.
Download your bank statements, and this is what you’ll see.
When it comes time to pay yourself in retirement, you should 100% factor these “known unknowns” into your retirement distribution strategy.
If you are ten years out from retirement, think about this now so you can contribute enough to the correct accounts to optimize your retirement plan and grow your money tax-efficiently.
Thanks for getting into the weeds with me on retirement planning. This stuff is essential to get right.
