Tom Gives Us 5 Plus a Bonus Tip for Planning Early Retirement
Transcript:
Katie Nealis:
I’d like to retire early, what are your top five tips for a successful early retirement?
Tom Vaughan:
Okay, now this came in earlier. And so I had some time to prepare some pieces, and I’ll show you, you know, kind of what I’m doing. But what is happening here of least as far as I’m concerned, I’ve seen, you know, the plants that we’ve done for people that are under 40 years of age, vast majority of them wanting to retire early. And this is something you know, and I have clients right now, you know, that retired in their 40s, that are now in their 60s. So I’ve been able to see you know, what it was that they did, and how that works, as one of the advantages of working with a financial planner, honestly, is that just they’ve seen the patterns, you know, they’ve been able to, you know, work with 60 7080 year olds, and even if you’re 2030, or 40, they can kind of see the path that successful people took to get to someplace. So I’ll give you the first tip, which is something I think is really interesting. If you look at all of my clients that retired early, they spend less money than my clients that retired, you know, later. And I think that’s a really big component, you need to spend less money before retirement so that you can save, and then after retirement, because you’re planning on living off of your money.
So long, if you try at 45, or 55, and you live to 90 or 100, or something along those lines, you’re going to be living off this money for a really long time. And so I would say, on average, my Preet my early retirees are spending about 25 to 50%, less than my retirees that retired, say, at 65, or later. And so I think that’s a really big piece of the puzzle. And the first tip is figure out how to structure your life so that you can save more, and then continue that same structure in your retirement, so that you’re not spending as much and so you don’t have as much overhead and those types of things. And so I think that’s an important component of what happens. Now, I will take one group out of the equation here, because here in Silicon Valley, you know, we got a lot of IPOs, a lot of stock options, some companies that have done unbelievable things, and created huge wealth for some very young people. So, you know, for those people you got, you know, $10 million, or $50 million, or what have you, and you’re 20 or 30, or 40, or whatever it might be, you know, that’s a different scenario. That’s early retirement with a lot of assets. What I’ve really got to appeal to today is more than normal scenario where somebody is in a normal situation, and they’re just trying to save and make early retirement work. Okay, so that’s, that’s number one.
Easan Arulanantham:
So the next show going off of like, how do I how do I save more? Like, I know, for myself, I’m trying to save for a down payment. Yeah. And so I really started tracking my budget a lot more using mint. But I noticed one of my leaks was milk tea, I was spending maybe 20 or $30, a week on milk tea. So is it like doing better tracking way? Does it cut down on my expenses and more like where I’m like looking for kind of like big ticket items that I should cut out?
Tom Vaughan:
Well, okay, just from my experience, first of all, Mint is an unbelievable resource. And that’s something that I’ve been trying to recommend to clients, you know, for a long period of time, it’s a, it’s a free program, you can link up your checking savings accounts and different credit cards. And you can track your spending really, really well. I’ve been using Mint since you know, before it was even purchased by into it, and I really like it. But what what really, you know, the most common comment that I hear from clients that have done really well with their finances, is that their savings was something that they just did, and it was it was a 5% or 10 or 25% went into savings, and then they just figured out how to live off of the rest. And so I probably go the other direction and try to figure out, you know, what would you have to save to meet your goals? And let me show you kind of an example here, kind of using Monte Carlo simulation as to how that might work? It’s a great question. And so for me personally, and I will share this.
This is my this is MoneyGuide Pro. I’ve got a hypothetical, you know, client pushed into here. And what this does this financial planning program. So we’ve got, you know, let’s say somebody wants to retire early, and we’ve been able to determine, you know, what their goals are, what age they want to retire, how much income they want to have in today’s dollars to kind of support that lifestyle. What are all the other benchmarks that are going to come in, you know, when does so security come in when you know, and how is that affected by early retirement? You know, what happens at 72 with the, you know, requirement of distributions and so we’re trying to map out somebody’s whole life and all that data is behind this. Once we get that data in there. We can push this button here and do a Monte Carlo simulation. And so what happened here, we just ran 1000 scenarios, or we went through this particular early retirement situation. And we find that it’s 96% of the time it was successful all the way out till they’re kind of age 100 here. And so what, what I would say Easton is just that I mean, once you kind of find a scenario that works in the 90 plus percentile range here on this MonteCarlo, that’ll tell you how much you have to save. And so then you kind of go backwards from that and say, does that really make sense? Can I do that, I mean, I’ve run these before, where in order for them to reach all the goals that they had, they have to save 80% of their current income, that’s not going to happen.
But I would say that, you probably need to get closer to 25% of your current income, if you want to retire early, especially because you’re going to need to be able to really ramp up, you know, the amount of capital that you have, because you’re that capital is going to have to last a lot longer, potentially than others. So that that would be my first thing here is to find, you know, a plan that I can get into the 90 percentile that can work for me. And that has to do with what age I retire, how much income I wanted that retirement and how much I can save now and before retirement. And so I kind of commit to those. So once you’ve got that say, okay, you said I need $700 a month to make this work or you know, whatever it is. And then you go back to mint and say, Okay, how do I carve $700 out of what I’m doing here, and that would be a great example, you know, I’d maybe I do something different with the tea. And, you know, is the tea more important than early retirement, you know, so those are the questions that you kind of ask.
But I also want to do some stress testing here, because this, this MonteCarlo simulation is really, really powerful. But if I’m, if I’m working on a job, and I’m nearing my early retirement age of 47, or you know, whatever it is that I’ve chose, I don’t want to leave my job at this big law firm, or whatever it is where I’m making all this money without really knowing what might happen. And I think a lot of people just kind of pull the plug in hope for the best. And I think that’s, you know, okay for some people, but I really would like to be able to see, you know, first of all this basic MonteCarlo simulation come out at 96%. And then I want to stress test it. So I want to see all of the stress tests coming out in the 90% range, and know that that plan is solid. So here, I’m going to do a Monte Carlo simulation where we know we have a great recession loss. So let’s say hey, I pull the plug on 47. And right, then the market drops 60%. You know, what happens to my portfolio? Well, the projection is with extraction of this portfolio that’s in this hypothetical scenario. 14% drop, so pretty conservative portfolio, right? Well, only 82% chance now survival, if that happens to happen, which it could you could retire and the market could fall apart for five years or more.
And then the other one is inflation. And so you know, I won’t go through all these. But what if inflation just was a lot higher for the rest of my life, then, you know, we expected or it has been average, let’s just say it was 5%, which would be a lot higher, you’re looking at a 54% probability of success. So there’s some work that needs to be done still, in this particular plan, to figure out what this person has to save, or what adjustments we would have to make to the retirement age, or the income needed and those types of things. So you still want to keep working through this. And this will tell you what he can retire how much income you can have and what you have to save to make that work. And what you have to save should be, you know, something reasonable, you know, 25% or less would be my guess. And so it’s a big dedication to get to, you know, early retirement, now you’re going to get a huge reward and that you maybe don’t have to work for 10 1520 years, you know, longer than some people do to get to normal retirement.
Easan Arulanantham:
So is there any way you can like maybe cut down? Like, should I be more aggressive? Should I take more risk? Maybe instead of like a 60/40? Maybe Should I go at 20?
Tom Vaughan:
Yeah, I would highly recommend that, especially in this scenario, you do have to have some the personal risk tolerance to be able to deal with this. And so that that can be difficult, but yeah, that’s a good example. Let me show you. So here. Here’s an here’s an E, our current ESG portfolio. So this is socially responsible portfolio. ESG stands for environmental, social and governance. And this is our current 100% stock portfolio. So that might be something to use, and to place your saving ins into whether it’s an IRA or non IRA. You know, mainly because it has more potential to make money and if it doesn’t work out, you know, maybe you delay your retirement by a year or two and then let it come back. But the one key advantage to a more aggressive portfolio is when you’re putting money in kind of month by month by month, that dollar cost averaging is very, very powerful. Now, maybe I’d use an 80% portfolio, like you mentioned, he said, you know, so here’s 20%, and bond, and the other 80% is in these ESG, you know, components. So, yeah, I would look at a higher risk scenario, personally, just because, again, you’re trying to really push the envelope and trying to retire soon. And I would be okay with that, personally.
Now, maybe once you get into retirement, you move that back to 70%, or 60%, or you know, something, you know, more conservative, you’ve built up all this capital, and now you’re going to live off it for the rest of your life. But you got to be careful about getting too conservative, just because, again, if you retire at 45, and you live to be 100, you could be living off of your money for longer than you’ve been alive up to that point, you know, 45 to 55 years. So, you know, and so that, that, you need to make sure you can keep up with inflation over the long term. So, that would be another that would be my other tip, right there is to, you know, first of all, keep your spending low, and figure out how to do that for the rest of your life. And then, you know, use the Monte Carlo simulation to find out, you know, what works and what doesn’t work and how much you have to save, and when you really can retire. And then I would the third tip here would be to use a higher risk portfolio, you know, during your accumulation years, you know, in order to be able to do that. So, the other thing that I would look at is just one thing that gets overlooked all the time is that I have a whole bunch of retired clients who are funneling money massively into a, their retirement plans, like IRAs, and 401, K’s and those types of things, and really don’t have much money built up outside of those retirement plans.
Well, if you’re going to retire at 45, you can’t get to your retirement plans without a penalty before 59 and a half. Now, there is a thing called rule 72 t that allows for some distribution without penalty from an IRA or those type of accounts. But they often have some, you know, restrictions as to what you can really do there. So what you really want to do is continue to build up money outside of your non retirement accounts in order to fund that 45 to 59. and a half year gap that you’re going to have if you’re retiring at 45, that’s part of that Monte Carlo simulation is we put in a non IRA, non 401k type of an account, and we put in a certain dollar amount of savings that we can basically tell somebody exactly how much they should be saving in those non retirement accounts to make sure they’re funding that 15 year peri od. And then they can start to turn on, you know, their IRAs and 401, K’s after age 60, basically, and then obviously, you know, eventually they get social security coming in. And so at 72, they have to take money out so of their IRAs and 401k. So those are the kind of the timelines that a lot of people, you know, get there. And they’re ready to go and realize all of their assets is locked up in these retirement or 401k programs. And they need to funnel off portion 10 to 30% of the savings should be going into this non IRA group, even if you’re not getting a write off. So that I think that’s pretty important, too, as far as that goes.
Easan Arulanantham:
So for brokerage accounts versus like your tax deferred accounts. Yeah. Would you have a different kind of portfolio? Would you be more broad, in a sense? Like, should I be to be more tax efficient?
Tom Vaughan:
So I’d be looking at index funds, or should I still be looking for Kind of, yeah, exactly. Right. It’s one of the things we do too. So if you look, here, we have our if you Oops, sorry, some of the colors got messed up there. But what this shows, half of this is in the broad market, and then half of it is in these targeted indexes. And so that yeah, that’s exactly right. I mean, that’s what we’re looking at there for these taxable accounts. And mainly because, you know, it’s very difficult to make changes, because of the taxation, you know, anything done less than one year, right, it’s going to be a short term capital gains, so we’ve got to be careful there. So this is meant to be sort of a buy and hold portion of this. And these again, these are all screened for environmental, social and governance and this particular portfolio. And so that’s really nice. As far as though goes, you’re not sharing your screen. Oh. So this is this is what I was talking about here is just a different portfolio for a taxable account. And again, pardon the color that is not supposed to be there. But what we’ve got here is roughly half of this portfolio is in a broad market index and the rest is in target. And again, that’s from a tax standpoint. So, yeah, that’s, I think that’s a good, you know, piece of the puzzle as far as that goes also. So that that would be, you know, tip number four is, you know, make sure you’re saving into these kind of brokerage or taxable accounts. And don’t put everything you have into the retirement accounts, because you’re gonna have to fund this period, you know, between your early retirement and 59 and a half, when you can get out those other assets without penalty.
The last tip, and really, it’s sort of two tips. So we’ll call it tip five, and six, and me share my screen again, and I’ll show you is just simply using two things here, number one, I would be very, very much so concentrating on Roth type of accounts, if I’m going to early retire, especially because one of the big tax, one of the big costs you will have will be taxes. So this is a program called Ray capital. And what it does is it kind of shows us, you know, a few different things. And so what we’re looking at right here is a hypothetical scenario for somebody that 45 that wants to retire at route 57. And all of these different lines that are here are different tax brackets. And so proposed strategy right now says $0, more. So that’s important to focus on, and what it’s showing first withdrawal sequence. So now this person is going to be 57, how are they going to get their money out. And so what we’re showing here, just as as a baseline is what’s called pro rata withdrawal, so we’re just going to take, if they have 10%, in one area, they’re going, we’re going to take 10% of the income out of there, if they have 20%, in another area, we’re going to take 20% of the income needed out of that other area. And so, and that’s not the best strategy, but it’s a great baseline. And so what they’re showing here is different sequences. And so this would be the standard one, take it from a taxable account first, which obviously, if you’re pre retiring, or retiring early, that’s going to be a big one, then from your tax deferred, and then from tax free.
So if you look at this, this adds $1.3 million more. So again, you’re retiring early, you’re putting tons of pressure on your assets to last for the rest of your life. Hopefully, you’re spending, you know, a reasonable amount of money. And then you want everything else to go as well as you possibly can. So one of the keys is to figure out the sequence of where do you get the money from first, second, third, and fourth, super important. And let me show you so you doing it the right way, added 1,000,003 more to the net worth in this hypothetical scenario? What if we did it the wrong way? What if you took the money out of tax deferred first, right, and then taxable and tax free. And so that actually adds up to $800,000. Less. And this is a very common strategy, lots of people go after their retirement accounts first, because their retirement accounts, and now they’re retired, and they think that’s where we should go first. But the difference is dramatic.
I mean, you have $800,000, less than net worth versus $1.3 million more in net worth. So that’s tip number five, make sure you completely understand the sequence of withdraws as you head into retirement, because it makes a really big difference in terms of how much money you’ll have throughout that retirement, and then start saying, basically, a client could just make $2 million, by just doing the simple task of taking from the right accounts in the right order. Yeah, that was the wrong like. So like you and you’re worried about investments or, or performance per se, to get that money. Now, you don’t have to be more or less aggressive, you don’t have to do anything, you just have to have the knowledge of where to get the money from in which sequence and how that changes the tax structure of your overall retirement. It’s an amazing piece, I would say that I very, very rarely meet somebody that actually knows that. And I’ve met lots of clients over the years that, you know, have been advised by other advisors, unfortunately, to take money from their, you know, retirement accounts first. And again, it depends on your situation. And I got to be careful with blanket scenarios here, because there are situations where that can work. And that’s why we run this program, we use the one I just showed the MonteCarlo simulation. And we use this to figure out sequence of withdraw. Yeah, it’s it’s amazing. I mean, so that’s roughly a $2 million differential just by knowing where to take the money from. Right. That’s kind of incredible. Yeah, it is actually it’s, it works. I’ve been doing this for decades, actually. And I can attest to this. There’s a lot of reasons why it works and I will get into that.
The last piece and I’d say it’s Tip number six, get bonus tip here because I said five. Tip number six is really just I would really seriously consider using only Roth type vehicle. To find my retirement if, if possible. So if you have a 401k at work and your work has, you know, a Roth 401k option, I would use that. And even if it meant paying the taxes now, because really what you’re trying to do is while you are working, you’re trying to do everything you possibly can to set it up so that your retirement, which is going to be early can work. And it can work great. And it can work for a really long time. And so I would be paying the taxes. And that’s the difference, a regular IRA or regular 401k. When you put the money in, you get a write off. And so you know, you don’t have to pay taxes on that money, but when it comes out, and you can see that right here, see this little jump, and this big increase in this is their taxable income is big green blob, right? That’s the, that’s the, you know, computer programs, you know, calculation there, if I convert, whatever they do have in retirement plans, let’s say I can slide this over. So what this shows here is I’m going to convert their current plans now, if I can, if I have access to them, and I’m just going to every 24% tax bracket, I’m going to fill that in every year. And that’s where this little line comes in, you see that orange line is the 24% bracket. And the blue blob that came in there is the conversion of these retirement assets to Roth. And then what happens is now I’ve just increased the net worth by $4.1 million dollars.
So I’ve taken the right sequence in terms of taking the money out in the right order. And I’ve fully funded my retirement with tax free growth, which That’s the difference. So a Roth IRA, you have to pay taxes to put it in and same thing with the Roth 401k, you don’t get the write off that it grows tax free. And that’s an amazingly powerful tool long term. And so reducing your taxes and efficiently managing your taxes in an early retirement situation is even more important than for somebody who’s retiring at 65 or or beyond. So that those are kind of low spending, use Monte Carlo simulation to figure out what really works, I probably looked at some higher risk portfolio before retirement setup some type of an accounts that are not retirement accounts that you can get to before 59 and a half what we call taxable accounts, I would look at Roth versus that then that non Roth and make sure that you’re doing the sequence of withdraws properly. Right. So those are your those are your steps. And I think, you know, that’ll get you a long ways towards getting to your early retirement. And it’s a really fascinating area. I like working on these cases and I have several that we’re working on right now. And people are really have to be dedicated but it’s it’s very powerful.