Transcript:
Easan Arulanantham:
Yeah, and our first question is we get all the time is, I just started retirement, which accounts do I pull my money from? First, you know, we have multiple buckets of money, we have our taxable tax free and tax deferred. Which one? Should I be pulling my money from first?
Tom Vaughan:
Yeah, so this is a question that comes up all the time, you know, I’m at a party or something, or somebody’s house or neighborhood party. And people come up to me said, Well, you know, how much can I withdraw? What what percentage, you know, always get this, sometimes of trying to corner me, you know, and so there is this 4% rule, right? That’s been out there for quite a while. And, you know, so that’s one rule of thumb, you can withdraw 4%. If you have a million dollars, you can withdraw 40,000 a year, for example, sometimes something like that. You did some research on the 4% rule. Why don’t you tell everybody kind of what you found about that, at least from a historical standpoint?
Easan Arulanantham:
Yeah. And so the 4% rule kind of originated in 1994, from William Bengen. And he had this study where he essentially kind of back tested his data from 1926 to 1993, where he kind of took the historic returns. And then he said, How much money could I withdraw without exhausting my portfolio of investments. And so he took a very simple allocation of 50%, Large Cap stock, and 50% Intermediate treasury bonds. And so that was kind of the beginning of the 4% rule. That was kind of confirmed later by the Trinity study, which was a study from a group of professors at Trinity College. And it’s kind of been updated over time. And so William Bengen, modified that allocation to be 35%, Large Cap, 20%, Small Cap, and then still that same 50%, large intermediate bond. And then he found that you could have a 4.5% withdrawal rate based on that same historic data. And then we had, we’ve also had late last year, we had Morningstar come out with weed, they believe on the 3.3% is a safe withdrawal rate for 30 years. And so their data is kind of what we’re projecting. And then William Bengen came back and said, I don’t believe that, and he kind of had a rebuttal. And so with, he had another kind of modified portfolio, which is 10%, large, 10%, small 10%, mid 10%, micro and then 10%, international, with 5%, kind of treasury notes, and then 45%, intermediate treasury bonds. And with that formula, you get a 4.7% withdrawal rate. And so these are kind of taking those worst case scenarios, how much can I withdraw over a 30 year period, and still have money in the end and not run out of money?
Tom Vaughan:
Yeah, so it’s actually become sort of a controversial subject in the last few years, whether the 4% rule really works and what have you. And so that’s why it’s really hard to answer that sometimes in a, you know, a situation where we go down the wrong path. So anyway, so that that aspect of it is kind of fascinating, you know, as to what what you can really do in terms of withdrawal, as far as that goes. So I think really, what we need to look at is sort of a better way to try to figure that out, right? Where we’re looking at the scenario. The problem I have in these parties, when people asked me, this is just that, that, really, we end up with a snit situation where there’s too many variables to really apply rules of thumb, are, in fact, I would say, in general, rules of thumb in the financial planning and asset management and retirement planning area, very rarely actually apply to the people because we’re kind of all like, thumbprints, we all have different scenarios. I think I’ve been involved in over 6000 financial plans, and there are some commonalities, but they’re all a little bit different from each other. So I really think the best way to figure it out is to use MonteCarlo simulation as a whole. So essentially, I’ll show you an example here. And so, optimally, what we’re looking at is a scenario where we’ve got all of these inputs, how much security Do you have, how much pension you have? How much does that pension grow? Do you have rental incomes? How much of those grow? Do you have, how much and assets you have? How are those assets allocated? Because you can tell from that study that really the allocation, you know, was was, you know, different it made for different withdrawal rates? What is your overall mixture? How much is in tax deferred versus taxable versus tax free? You name it, there’s so many pieces and what you’re trying to do then is figure out well, how much can I take out under that scenario? That’s where MonteCarlo situation comes in. We can test and say, Okay, well, what about this one? How many times does that work? out of 1000? So with this, for example, you know, we push this button here. And we end up with a situation oops, sorry, backwards, there we go, we push this button here, and we’ve got, you know, this 1000 runs through somebody’s plan, and we’re going to try to figure out, you know, what, you know, amount they can withdraw from the asset base as far as that goes. So, really interesting. 85% is a pretty good number for this particular concept. So this point is at 96, we could test this out and figure out how much somebody could spend and still stay at 85%. And then, you know, again, we look at it every six months. So that’s a great way of taking a look at it and making sure that, you know, it’s still working as far as that goes. So I think that, you know, in terms of figuring out, you know, how much money you can spend, this is the key piece here is really using Monte Carlo simulation.
Easan Arulanantham:
Yeah, I still think there’s a place for the 4% rule, or whatever kind of percentage you want to think about. It’s kind of the idea is, I want to kind of have a rough estimate of a figure that I want in the future, say, I’m in my 40s, I want to have kind of, you know, I want to start saving, how much should I be saving for my retirement at 65. And so it kind of gives you this rough way to estimate. And that’s where this is kind of good. But the 4% rule when you get retirement could be very bad. In essence, that is, is my retirement always gonna be 30 years. And that’s where this kind of study are fixated on 30 years. So it’s like that 65 to 95 range. But if I retire at 55, and go to 95, that’s 40 years, does that 4% rule still work? Probably not. Yep. And also, you have to think about is 4%? Am I leaving money on the table? Am I taking out too little where I could be looking at barrel way of life? Because the 4% rule is based on that worst case scenario. It’s not based on like, the middle ground or that best case scenario. So maybe I should be taking a little bit more money, and I’m leaving money on the table.
Tom Vaughan:
Yeah, that’s exactly right. So I think that early retirement thing is something we’ve been dealing with more and more, a lot of people are interested in that. If you apply a 4% rule to something, you know, again, that was designed for 30 years, if you’re planning on retiring at 45, what are you going to do after age 75? Theoretically, if it you know, brings your money down enough, that could be a problem. So, again, the full financial planning concept using Monte Carlo simulation is a good way to do that. So all together, kind of interesting. So we’ll see how that plays out. But I actually answered a question here in a indirect manner, we were actually trying to figure out where to withdraw the money. And we ended up talking about, you know, how much to withdraw, but still very fascinating piece altogether. It is part of our the overall was trumped withdrawal strategy. But let’s go back to the original question here, too, which I think is really interesting. And that is just simply, you know, what is the, you know, situation in terms of where you get the money from? Because this comes up all the time, right? And so we’ve got these people there, you know, trying to figure out, okay, I’m now retired. Not everybody needs money, right? So I have clients that just to have enough pension, for example, or rental income, and really don’t need to withdraw anything, but most people need to withdraw something. And so then they’ve got to figure out, okay, well, where do I get it from? I’ve got these assets, I got retirement plans, 401k IRAs, and I’ve got this, you know, brokerage, you know, taxable account set up and my trust, maybe I have some Roth assets, right. But where do I start? Which one? Do I withdraw from first, second, third? And, you know, what are the ramifications and actually, the ramifications are pretty dramatic. And this is something a lot of people don’t really think about enough, in my opinion. So I’ve got an example here that we can kind of use to show kind of how this particular withdrawal strategy would fit in. So, you know, again, how much you take is another calculation altogether. MonteCarlo simulations, the way to do it, where you take it, again, is the same type of thing. You want to have all of your variables in there and figure out what’s the optimal strategy for you. Okay, so if I share this, you basically see a big blob of orange there, that’s the, you know, the theoretically the amount of money somebody’s taking out of their, you know, tax, deferred 401k, IRAs, those type of things. The green is their Social Security. And the blue is how much they’re taking out of their brokerage account or taxable account, that trust account, you know, those types of things. And so, really, this particular piece of it is done what’s called pro rata, right? So we’re just doing this for an example a baseline, and so pro rata would be if I needed 10,000 dollars to withdraw, you know, to live off of, I had 10% in one area, account or taxable account tax for, I’m going to take the money from 10% from there and other 20 percents over here, I’m gonna take 20% from there. And I’m just going to take, you know, a pro rata amount from each one of those to make up that $10,000. This is not the optimal strategy, but it is the baseline, you can see that the per fro strategy says $0, more there. Okay. So what we’re going to do is show some different strategies and see how much it impacts that person’s net worth. And we’re trying to find that ultimate strategy that makes our net worth grow over time, looking at taxes, and looking at rates of return for those different accounts. So again, this is different for everybody. But for this particular case, you can see how dramatic it is, first of all, do one strategy, that is really the wrong strategy. And this particular case, and that’s taking tax deferred first, taxable next and tax free after that, right. And you can see the big orange piece is now expiring itself early, right? Because it’s higher, because you’re taking everything out of the retirement plans. First. This is actually one of the most common strategies we’ve run into is that people will say, Oh, you know, I’m retired now, I’ve been saving for a long time into these retirement plans, like an IRA or 401k. So I’m going to take the money out of my retirement plans first, right. And then when I’ve expired, those, I’ll go to my trust account or my brokerage account, I’ll start to take the money out of there, for example. So that’s tax deferred, first taxable next. And so you can see, though, that versus pro rata just taken an even amount out of each one, you know, from based on how big it is, it’s actually $888,000, less in net worth, that’s a lot. That’s a lot. And that’s just from the strategy of where you’re taking the money from first, second, and third. So let’s look at a different strategy. Alright, in this case, and so there we go, we’ve got a taxable first. So we’re gonna take a look at that brokerage account that trust account, individual account, transfer and death, they’ll have a bunch of different names. But basically, it’s a taxable account just means that when you make moves in it, you pay taxes on those moves, potentially, right. If there’s a dividend or interest paid, that ends up in your tax return that year. And tax deferred, of course, would be those IRAs and 401k. So if we start with the taxable, kind of run it down, and then go to the tax deferred, you know, after that, it’s 1.3 million more.
Easan Arulanantham:
Yeah, that’s a $2 million swing, if you’re going for the worst strategy, the best strategy.
Tom Vaughan:
Yeah. So think about that. That’s $2 million more. And all you’ve done is identify the optimal sequence of withdrawals, where to take it from first, second, and third, and that optimal strategy for them, right. And so that’s, that’s incredible to me.
Easan Arulanantham:
Yeah. And you can also remember that you’re not market dependent doing this, you’re just being smart and tax planning properly. You’re thinking about your taxes, and where are you is the most tax efficient way to take your thing long term? And so if the market has an 8% return every year, it doesn’t matter. It doesn’t affect you.
Tom Vaughan:
Yeah, exactly. Because that’s one of the things that happens for us all the time. People ask us questions. And it’s hard to answer. Because of the market, you know, nobody, we don’t know where it’s going. Nobody knows where it’s going for sure. Long term, I feel good about it. But it’s hard to tell. And so to have a strategy that doesn’t rely upon that is really critical. And that is one of the things I like about tax planning strategy. Taxes do change, you know, the rules do change, but a lot slower than the market does. The market changes every day, minute by minute, tax laws change a lot slower. So you can make plans with the tax laws that are in place, and then make adjustments as those change. And so again, this is one of the situations that you’d want to kind of check on on a regular basis. Where should I be taking my money from first, second? And third, what is the optimal strategy in this particular case, if take it from taxable first and wait for the tax deferred, and you can see that that orange part jumps up at 72? Because that’s when you have to take money out in tax deferred does Required Minimum Distribution. And so you know, you’re living off of those taxable assets prior to that the overall taxes are fairly reasonable at that point, and then, you know, obviously, that Orange Park continues to grow because the requirement of distribution grows as far as that goes. So still ends up in a better situation.
Easan Arulanantham:
Yeah. And like that RMD age may change in a couple of years. You don’t know where it’s going to be. Yeah, there’s a secure act 2.0 is kind of passed the House and Senate is also working on some similar bills, and both of them have pushing out that RMD age to, you know, another 75 is what they have right now, but we don’t know where it’s gonna end up. But just pushing that back and back means your money grows tax deferred for a little bit longer.
Tom Vaughan:
Yeah, that would be it would make this even more powerful because you don’t have to start at 72. We’ll see how that goes. As far as that goes. And we’ll let you know, actually, we’ll talk about that act. We’ve looked at it a few times, there’s just too many moving pieces right now, you know, within the Senate and trying to reconcile what the House passed. But it’s very fascinating bill all together, it looks really interesting. I do think they’ll get something done. They did pass the House part, you know, 415 to five. So there’s some there’s some bipartisan support for these types of things. So really, really good. So anyway, that’s what’s happening here.