Terry Gerton We\u2019re going to talk about something from a different angle. We often talk together about how to invest for retirement, but you thought it would be helpful today to talk about how to use that money in retirement, and I think that\u2019s a great idea. So let\u2019s start there. What are the strategies for thinking about the spending phase?<\/p>\n
Thiago Glieger So Terry, one of the biggest things that we like to remind people is that when you hit retirement, you have to start managing your money in reverse. And so it\u2019s much more important that you\u2019re thinking about how much money can we keep now that we\u2019ve built our assets and not focus so much about how much you\u2019re earning. You always still need to be outpacing inflation, so we want to invest in stocks to some degree. But if we think about taking money from our savings, we\u2019re much more worried about taxes and market volatility because that\u2019s the kind of thing that\u2019s really going to start creating little cracks in our retirement plan over time. And it\u2019s the type of thing that doesn\u2019t really fail very quickly and overnight. It\u2019s small little changes over years that weaken a retirement plan that we need to be focused on.<\/p>\n
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Terry Gerton So when you think about that retirement plan, let\u2019s talk about the main income sources. For the average federal employee, what assets or accounts are they drawing on?<\/p>\n
Thiago Glieger We like to refer to the income sources as the three-legged stool. This is a very common one known in federal service. So we\u2019ve got Social Security, we\u2019ve got the pension, and then we have your savings, your portfolio. When it comes to Social Security, there\u2019s a lot of decisions that need to be made. Like if there\u2019s two of you, which one is going to file first? Are you both going to file as soon as you hit minimum retirement age, which is 62? Should you wait until full retirement age or should you maximize til 70? Where are those break-even points? I believe there\u2019s something over like 500 different combinations for Social Security, so it can be very taxing to try and figure out which one works best for you. Also, there\u2019s a concern around Social Security\u2019s long-term funding. How are we really going to continue paying the same degree that everyone is still receiving right now? Are we going to see higher taxes? So just some considerations around there. I\u2019m not speculating anything yet, but I do think some changes are going to be merited in the future. And then, of course, there are taxes on Social Security. Some people pay taxes on Social Security income, some people don\u2019t. Depending how you create your income in retirement affects how much of your Social Security actually gets taxed. So this is where things start to get a little tricky. On the pension, we also have the stability and predictability, which is really nice. But the one challenge with that is, is it really inflation protected? When we look at the COLA, everybody jokes that it\u2019s a diet COLA. It\u2019s not really a cost of living that keeps up with real inflation. And then the state that you live in too, may or may not tax your pension. So some retirees do choose to move to a state where their pension is not taxed. The portfolio is probably the more complicated one because this one, we\u2019ve got volatility, it is dependent on the market. When you start taking money out, you have that sequence of the returns that the markets give you. That\u2019s a big risk to retirees. And then the more money you take out from pre-tax accounts, the more your taxes go up. How should you invest the money so you\u2019re getting the income you need? So there\u2019s all these pieces that really come together that we need to be thinking about.<\/p>\n
Terry Gerton And some people say, if I have a pension, why do I need to worry about running out of money?<\/p>\n
Thiago Glieger That\u2019s a really good question. And the biggest challenge comes when we start to look at other things in life. Our pension, we consider that the floor, not the ceiling. And so when we think about long-term care, for example, how are we going to take care of ourselves longer term? What if our roof needs to be replaced? What if we\u2019ve got bigger expenses or other things that we really just want to do in the golden years of our lives? That is where the pension can take care of putting food on the table, clothes on our back, and lights in our house. But it can\u2019t provide liquidity if you need cash all of the sudden. So your risk of \u201crunning out of money,\u201d in air quotes, is much less because you always have that income, which is great, but your flexibility is much more limited if you don\u2019t have other pools of liquid capital.<\/p>\n
Terry Gerton I\u2019m speaking with Thiago Glieger. He\u2019s a wealth advisor with RMG Advisors. Thiago, there\u2019s sort of an unspoken or conventional rule where people say, here, just take 4% and you\u2019ll be fine. Why is that a good rule or maybe not a good role?<\/p>\n
Thiago Glieger The 4% rule is a very commonly known rule of thumb. And the 4% rule came from a study that was based on historical average. And so when we look at how bonds and how stocks have performed in the past, there was a period of time that they looked at that and said, if you take out 4% during these years, you can recover enough and be okay. The problem is if you take that same research and you plug it into a different set of years and market returns, all of a sudden 4% is more than you should take. Sometimes you can take more than 4% depending on which era you\u2019re looking at, so it\u2019s really hard for us to just apply that blanket statement to everybody and say, okay, if you take 4%, it\u2019s not really going to matter. The other thing it doesn\u2019t factor is taxes. 4% of someone\u2019s portfolio is going to differ for one family from another. Some people are going to take home less money simply because they pay more taxes on the same amount that they\u2019re taking out from their portfolio. So it\u2019s a little bit more nuanced than something like a blanket rule.<\/p>\n
Terry Gerton So if it\u2019s not that simple percentage, which is sort of basic math that we can all do, how complicated do we need to get in terms of thinking about rules and guidance when we plan to take our income out?<\/p>\n
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Thiago Glieger I believe in simple financial planning. The simpler we can make it, the easier it is for us to follow it. And so what we like to tell people is to simply just start with a monthly budget. Now, I don\u2019t like the B word, budget. Nobody really likes that fun word. And so we often use the term intentional spending. So how much do we need and how much does it cost to live our life? How much of that can be filled with Social Security and with your pension? How much is still needed from the portfolio? And once you figure out that portfolio need, now you can determine, how much does my portfolio have to pay me every single month? What does it need to earn every single year, so that it is paying me that, inflation adjusted and after taxes? And once we develop that figure, you can take a look at that and say, okay, what percentage is that? How does that apply to the 4%? Is that way over 4%? If it is, we need to think about, is this a sustainable withdrawal in the long term?<\/p>\n
Terry Gerton But markets typically don\u2019t move in straight lines. So if you\u2019re thinking about, if you come to all of those calculations and you get sort of a percentage, how do you adjust for good market years and bad market years in that portfolio return?<\/p>\n
Thiago Glieger Yeah, Terry, that\u2019s a really good question. What you\u2019re referring to is sequence of returns risk that I mentioned earlier. As we start to draw money, this is one of the biggest risks to a retiree. Taking money from your savings and your portfolio as the markets are going down in value. One way that we can help prevent problems is by using a bucketed approach where some of the money is really conservative, some is more, a little bit more aggressive, others are very growth oriented and invested in stocks. So when the markets fall, the aggressive bucket is going to fall in value. And that\u2019s not really the one that we want to be touching and pulling money from. However, if we think about our conservative bucket, things like cash or CDs, money markets, when markets are falling in value, those assets are typically protected. So that\u2019s the pile of money that we use to be able to still support our lives and not be forced to sell the stocks that have fallen at a loss. That\u2019s one really helpful tool that feds can use.<\/p>\n
Terry Gerton One of the questions, or one of the options people have now in the TSP is creating a Roth account versus the IRA sort of version of this. Should people think about spending their Roth money first to keep their taxes low?<\/p>\n
Thiago Glieger That is one scenario where it can be helpful to use a Roth to say, hey, if I need $10,000 and I\u2019m $5,000 before hitting another tax bracket, another, we call it the IRMAA Cliffs, where if you spend $1 too much, now you\u2019re penalized an IRMAA up to thousands of dollars. So sometimes using the Roth can keep you under that threshold, and it\u2019s a very good planning tool. The problem in just using your Roth only in the beginning and keeping your taxes super low in early retirement is now, later in retirement, when you likely have your highest expenses through medical and things like that, all of your money is going to be fully taxable at that point and you might end up pushing yourself into a higher tax bracket later on. So you kind of have to mix and match a little bit of the money to get the most tax-efficient strategy.<\/p>\n
Terry Gerton Thiago, this all sounds a little complex. So as people are trying to sort it out, what are the biggest mistakes that you see early retirees make?<\/p>\n
Thiago Glieger I think one of the biggest mistakes we tend to see people make is to focus on the performance of the markets. The amount of growth that you\u2019re going to get in retirement should not be the same amount of growth you\u2019re going to get when you were working at 40, 50 years old. The type of risk that involves getting that kind of growth is simply too much for a retiree. The problem is that\u2019s what everybody knows leading up to retirement. That\u2019s the only job that a portfolio has leading up to retirement, is grow. And so all of a sudden, we have to change the way we\u2019re thinking about our money and focusing on some of these other things is often something that people neglect, like taxes and income planning. They tend to just focus on investments. That\u2019s the big one. Also, not thinking about the sequence from which to pull the account, you asked earlier. Do we take the Roth first? Do we use our brokerage account? Should we use the pre-tax TSP? That combination, there\u2019s a lot of rules of thumb out there that simply say, hey, use your brokerage account first, then use your Roth, then use the traditional, let the pre-tax grow forever. And often that helps the IRS out more than it helps you. And while that\u2019s okay, there\u2019s some things that we can do to help us save on taxes, and more money saved in taxes is more security for your retirement.<\/p>\n
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