I’m 50 with $800K, Can I Retire at 60? How Social Security, Inflation and Taxes Impact Your Savings
You’re 50 years old, have $800,000 saved, and you want to know, how much can you spend when you retire? In this video, we’re going to look at spending different amounts, seeing how much your portfolio today could support when you do retire at age 60. We’re going to look at what happens when you put money into the Roth 401(k) and a little known rule that can benefit you once you do retire that pertains to those Roth IRA contributions. We’re also going to look at being more aggressive versus more conservative in that investment portfolio inside your 401(k), and which one gives you a greater likelihood of success to retire with more income at age 60.
Understanding the Impact of Inflation on Retirement Savings
In our hypothetical case study today, we have Tim and Jane. They’re both working, they’re both 50 years old, and they both want to retire at age 60. $700,000 of the $800k is inside the 401(k), inside those tax-infested retirement accounts. $100,000 is outside in an investment account. We see, at age 60, I’ve started with a baseline income goal of $75,000. Now, for this go-go spending period, which is when you’re younger and healthier and more active typically, we added another $25,000 on top of this to get to $100,000 of spendable income after taxes in 10 years.
Now, we have to take into consideration the time value of that money, or the impact that inflation over the next 10 years will have on your purchasing power. As you’ll see a little bit later in this video, if we want to spend $100,000 for 10 years in today’s dollars, meaning the value of the dollar today, in 10 years, we’re actually on an estimated basis at about 2.5% inflation increasing over time over that 10-year period. We’re actually going to need to pull out around $135,000. So we’ll pull out more than that actually because of taxes. The after-tax spending amount in 10 years is about $135,000, and that will purchase the same amount of goods and services as $100,000 will today at a 2.5% inflation rate.
That’s the first concept. When you’re talking about planning for future spending, you have to take into consideration the time value of the money and the impact that inflation has on eroding your purchasing power over time. If you want to spend $100,000 in the future, you’re actually going to need to spend more than that in dollars in order to have that equal the amount that you think $100,000 will purchase today.
Exploring Social Security Timing Options
Social Security is a big part of your retirement income, so we want to look at this. Right now, both are eligible to receive benefits. Planning on tentatively taking it at full retirement age, age 67. Tim’s will be $38,636. Hers will be $25,266.
Now pretty cool with the software here, we can just with a simple slide of the button bring this down and say, “Okay, we may retire at 60, but what if we take Social Security early? What would that actually be?” See $36,000 drops down to $33,000. A lot of times what we’ll see maybe is the husband defer there, maybe the wife takes it sooner, $20,000 and $47,000. We like to set, from a planning perspective, full retirement age, because Social Security is extremely valuable. If you just do some quick math, let’s round this to 40, 25, so 65, let’s call it 63,000.
Over 20 years, without taking into consideration the cost of living adjustment that Social Security provides, if we just do 65,000 times 20, that’s $1.3 million of income from Social Security from ages 67 to 87. Now, in the real world, it’s going to have a cost-of-living adjustment. It’s actually going to be more dollars received than that 1.3 million over that 20 year period. Do not discount the importance of Social Security. We run into this all the time. When someone is about to retire or retired and they come in to see us, the very first visit, what we do is we spend time getting to know who you are, what’s important to you, and what you’re comfortable with from a risk willingness standpoint.
How much risk are you willing to take, and are you willing to stick with it through a market downturn? Now, in retirement, it’s a little bit different, because you don’t have those paychecks, you have less time, you’re more vulnerable to sequence of returns risk. Plenty of videos on the channel about sequence of returns risk. You should start to educate yourself about that concept as you get closer to retirement. What we often find is when we do an analysis of the current portfolio, and then compare that to someone’s willingness to take risk, sometimes we’ll find there’s an incongruence there.
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Balancing Risk and Return in Your Investment Portfolio
I’m going to show you the impact that that has for you at this stage of your retirement journey, in this hypothetical case study. Age 50, retiring in 10 years. Right here, we have a risk willingness of a 64 risk score. Now, we use two different softwares here, but this is just one. If you’re a 64 risk score, according to this software, in the Great Recession from ’07 to ’09, you would have lost about 26%. 800,000 would have dropped to 200,000, or excuse me, would have reduced by 200,000 during that recession. In this portfolio, with a 64 risk score, that would be about 61% stock with an average expected return of about 6%, 5.97% here.
In this particular case study, what I did for the portfolio right now, assuming this is someone who came in to see us today, they’re actually 80% stock and 20% corporate bonds, so 80/20. Now, we’re going to see the difference in just a few minutes of only looking at how the portfolio is invested, how that changes the likelihood of success over time. Okay, the current scenario here is looking at the current portfolio, how it is. The 80/20 invested in equities and corporate bonds. When I hit this, what we’re going to see is the likelihood of success. The probability of success here is about 77%.
Everything that we’ve looked at so far, 800,000, 700 of which is inside the 401(k). Spending 75,000 as a baseline income goal with a $25,000 on top, go-go spending for the first 10 years, and retiring at 60, living till age 90, both spouses living until age 90, 77%. Now, you may be thinking, well, that’s not good. I need to keep working. I can’t retire at age 60 if that’s the case. Hold on, right? 77% means, out of 1,000 different simulations, in 770 of them, you’re just fine. In 230 of them, you run out of money.
Flexible Planning in The Go-Go Spending Phase of the Retirement Lifecycle
Now in the real world, what happens is, as long as you’re connected to your plan, and you understand where you’re at and the impact of the decisions that you’re making, you have the ability to adjust down the road. You can reduce spending, you can change the way the investments are allocated. There’s a lot of things that you can do over time to increase this allocation percentage. When we look at a go-go spending phase here, a lot of times we may be planning for 10 years of that activity, but really, it’s up and down. We’re not just always go, go, go, go in retirement.
This is more planning. What is maybe the outside stretch of our budget? What can we realistically accomplish? Hey, if we get to this point, markets don’t perform or we’re spending too much, we don’t have to spend that extra 25,000 every single year for 10 years. That’s one adjustment we could make to bring it back down. I just want to say, from experience, there are a lot of things that we can do. If you have something that’s a 70% or 80%, I don’t want that to discourage you from thinking you’ll never be able to retire, because that still is a very favorable number.
Again, far more often than not, you’re going to be just fine. In those scenarios where something isn’t working, whether it’s markets or your spending habits, unexpected expenses, surprises, you can make adjustments. That’s what I mean by staying connected to your plan. When you’re connected to your plan, you can model out these different scenarios and the impact that they have on your security. Big takeaway there. Now, what the software is going to do is it’s going to look at this recommended scenario based on the risk tolerance that we just went through.
Now this brings it up to 87%. The current, as I said, looked at 80% equity, 20% corporate bonds. When we looked at the risk score, brought the portfolio in more congruence with your willingness to take risk, and that’s what we’re seeing here, is this is making a recommendation based on the risk score of 64. It’s saying, “Okay, you have about 9% or 10% too much exposure to equities. Bringing that back down within your comfort zone is going to reduce the variance of outcome.” Think of this as guardrails on the Interstate. Right outside of our office here in Houston is I-10, the biggest stretch of freeway in the country, I believe. It’s 20 lanes wide. It’s huge.
That is a very big variance. That is akin to 100% equity. Probably 100% equity and borrowing money on margin to buy more stocks. If you bring your guardrails in, by having a more conservative portfolio, you have less variation of potential outcome in the returns of your portfolio. By bringing it in, we’re eliminating the plus 40, plus 50, but we’re also eliminating or making it extremely unlikely the minus 40, the minus 50. Okay, I wanted to show you now the impact inflation has on the purchasing power over time, because we said we wanted to spend, including the go-go spending, $100,000 for the first 10 years of retirement, but in today’s dollars.
We want to spend today’s 100,000, the value of what that can buy in regards to goods and services in the future. In the future, we see it’s broken down here. This is our baseline, right? This is our go-go phase. To achieve the go-go phase, which is the $25,000 in today’s dollars, on top of the baseline of $75,000 to get to $100,000 in today’s dollars, we’re up here. This is how much we’re going to need to withdraw, and then the go-go phase goes away, and then we’re on this trajectory here. Okay, we have here the individual trial screen.
Breakdown of Potential Future Return Rates in This Scenario
What this is going to do, it’s going to break it down into percentile and show you the breakdown of probability of success given different market performances, different outcomes over long periods of time in the equity markets and bond markets, for that matter, and show us what, one, the impact of inflation on our future account balances, but also, what is that experience likely to look like? Here we are, in the median simulation, out of 1,000. If I move this to the left, those are better return simulations. If I move it to the right, they’re worse return simulations.
We’re going to start in the middle here. This graph here represents the positive year. In between zero and 20% here, we have one really good year, one bad year, minus 17. This one is a plus 35, but for the most part, the median simulation is pretty similar to history. Historically speaking, we have about seven good years in the S&P 500 and three bad ones in a 10-year period. That can change. Of course, nothing in the future is guaranteed. Past performance is not indicative of future results. I like this bar graph because it shows us what that experience may look like. I try to tell clients, put yourself in the shoes in this particular situation.
In 10 years at retirement, you started here with 800,000, up to about 2.3, okay? We had pretty good market returns. We were saving money inside the 401(k). What I did here was a 20% contribution on $100,000 salary, so that’s $20,000 a year, and I actually broke it off to go into the Roth 401(k) part for the savings component from age 50 to 60. I’m going to come back and touch on that in just a minute. We have 2.3. Put yourself in that position. Okay, 800,000, markets perform well, you earn a decent amount of money inside that account interest-wise, and you continue to save.
Now look, as you go through retirement, you are in the distribution phase, right? You’re spending more money, in this go-go phase specifically. Do not be surprised if your accounts go down. This is where we really need to stay connected to the plan, because this should be expected for many, many people out there, depending on how much you spend. This is why managing risk as part of an overall plan is so important. When I say overall plan, I’m talking about managing risk with respect to your investment portfolio, how much income you’re taking, the impact that that has on the overall trajectory of your account balances, as well as the tax side of things.
Now we get into this period where things stabilize, the go-go spending period is really over, and then look, we have some good market returns. It just takes one. It shoots us way up here. Then things finish off pretty good. Put yourself in the shoes right here. Where you’re retiring, you have a decent amount of money here relative to where you started, but now it starts to go down. How does that make you feel? Do you start to change your spending habits? Do you start to change how you invest the portfolio? Emotionally, seeing these accounts deplete in the first six years of retirement or so, how is that making you feel?
Start to think about this. The more you prepare mentally for retirement, the better off you’ll be once you go through these things in retirement, because it’s quite likely you will go through them. Now, let’s see what happens if we have a worse outcome in the markets over time. Here, we can see much more red in the beginning. We see the impact that has on our account. Now, here in 2034, we have 1.28 million versus 2.3 million. This is a range of possible outcomes. This could happen. We have no idea what the next 10 years of market performance will be.
Now put yourself in the shoes here of, what does this look like? What does this feel like? Now we’re 2041, we’re down to 527,000. In the real world, you wouldn’t be able to see what’s happening out here in the future. You stick to the plan, spending reduces once you get past this go-go phase, and look, the account balances gradually start to increase. Now, it should be pointed out that the market also cooperates in this time frame here. If we had some significant downturns, this probably would not, it would not be nearly as high.
Hopefully, these concepts are soaking in, so to speak, because these are just numbers, this is all hypothetical, for educational purposes solely, but I’m trying to help you understand some of the things you may experience later on in retirement, and how the decisions you’re making today, and the decisions you will have to make in the future, how they can impact your retirement holistically. I guess I’ll look at one more negative. Here we have some pretty bad years. This is when it gets bad. When you have the down years in the beginning, this is what we call sequence of returns risk.
It’s the combination of losing money and taking money out of your portfolio as a negative compounding effect on the values. Not too bad here, though. We still have several good years out of bad. Several more good years than bad in the beginning. Now, once we get out here, we’ve spent a decent amount of money, and then we get hit with this one, two, three, four, five out of eight or nine years of bad returns, and we see the impact that that has on the portfolio. This is where we might start making some adjustments.
Okay. I just want to show you broken down into the percentiles here.
I typically, if you look here, this is the 99th percentile, so this really, really good performance in the market over time. This is horrible performance in the market over time. I like to focus on these three. Then we have end of your plan, so when you pass away, the dollars, the future dollars that would actually be in your account, and then how much those dollars are worth in today’s value. If we look at the middle three, somewhere between 1.4 and 7.8 inside the accounts, but in today’s dollars, it’s somewhere between 500 and three million, 533 and 2.9.
Roth Conversions and The Role of Diversification in Your Tax Buckets
I said I was going to come back to the Roth part here, because I meant to cover this in the beginning of the video. For the ongoing savings, for this hypothetical case study, I have the $100,000 income for Tim in this example. We’re taking 20% of that, saving it into the 401(k). Tim already has 700,000 inside the pre-tax part of his 401(k). Between ages 50 and when you retire, maybe 55 and 65, depending on what your circumstance looks like, you really need to start to focus on diversifying the tax characteristics of your accounts. Meaning, your tax buckets, right?
You don’t want to have all the money inside that tax-infested retirement account, because then when you pull money out to spend, it’s 100% taxable. That impacts your Social Security, that impacts possibly Medicare, possibly impacts the taxes you pay on your investment portfolio. It has a domino effect. Starting to diversify your tax buckets. Here, what we did is we took that $20,000 of 401(k) savings and we put it into the Roth part of the 401(k). Now we’re starting to diversify, because when they get to retirement, the goal would then be, at age 60, to have choices of where you can withdraw your income from.
This allows you to manage what goes on your tax return. Think about it this way. If everything’s in the 401(k) and you want to spend $100,000, you have to take out 100,000 and pay tax on that. It goes all on your tax return, the full 100k. If you have, let’s say, a million in the normal IRA and 300,000 in the Roth, well now, depending on what the tax environment is like in the future, maybe we take 40,000 from the IRA and 60,000 from the Roth. Maybe we take 70,000 from the IRA and 30,000 from the Roth. You are in more control of what goes on your tax return and therefore how much tax you pay.
We’re just building diversification. It’s another way to diversify, to protect yourself heading into retirement, because we don’t know what taxes are going to be in the future. We personally believe they’re going to be higher, simply because we’re spending far too much money as a country. We have significant problems with the liabilities on the books for Social Security and Medicare. It’s going to have to come from somewhere. Diversify your tax bucket. That’s what we did here. We’re going to look at some planning scenarios first here, but I want to give you one more good piece of information.
Social Security Decisions
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If You Are Putting Money into The Roth Part of Your 401k, Look Into This
If you are putting money into the Roth part of your 401(k), make sure you open up and make a contribution to a Roth IRA. Now, there are certain income limits in order to be able to contribute to a Roth IRA. There are some possible ways around that, with what’s known as a backdoor Roth, but there are some complexities. You want to talk to your CPA about that. We do have videos on the channel, but here’s why you want to do it. It’s because there is a five-year aging rule for Roth IRAs. If you have all the money in the Roth 401(k), then you just open up a Roth IRA upon retirement and move the money into there, you’ve just now opened up your five-year waiting window.
You can make withdrawals of principle, but if you withdraw earnings, it’s going to be subject to income tax, and it can be a little bit complex. If you’re on this path where you’re putting money into the Roth 401(k), but you do not have a Roth IRA open yet, I would strongly consider opening up a Roth IRA. Hopefully, your income falls within the limits, to be able to make a contribution. You get that clock ticking on the five-year window, so when you retire, you can roll the money into that Roth IRA, and you’ve already achieved that five-year waiting period. You can withdraw whatever you want without any consequences. Post age 59 and a half.
Conservative vs. Aggressive Probabilities of Success
Okay, so now we have, this is the current scenario. This is the more aggressive portfolio. This is a bit more conservative portfolio that is in congruence with the risk score. Then we just have a copied scenario here. What I want to do is focus on these two. I’m going to change, first and foremost, the return. We have, this is before retirement, and then this is after retirement. As you can see in the current, we have the more aggressive portfolio, with a higher expected return, but here’s the number that really matters. It’s called the standard deviation. That’s that guardrail concept I spoke of earlier.
In my portfolio, I’m 100% stock. I plan on working for a long time, I don’t own any bonds, and I don’t really care what happens to the market in the short term, and I’m not retiring anytime soon. Theoretically, if the market does really well, I will have more money by being 100% equity, but there’s no guarantee the market performs well. What the probabilities tell us here is by mathematically eliminating some of the radical outcomes and narrowing those guardrails, that increases your probability of success. You may personally want to take more risk.
This is where it starts to come down to your willingness to take risk, your willingness to accept a bad outcome, willingness to stay committed to an overall plan, and I’d say most importantly, just being connected to a plan, so you know how things that are transpiring, how they’re impacting your ability to spend, your ability to retire, and everything that goes along with that. More conservative portfolio eliminates some of the radical possible outcomes by bringing those guardrails in. That increases the probability of success. I’m going to keep this here, because this is our baseline now, the recommended version. Then over here, I’m going to say, “Okay, what happens if we get really aggressive?”
Now we have a standard deviation of 17%, an average expected return of about 7%. Post-retirement, we’ll bring it back down. We’ll bring it back down to where we are here. Let’s just calculate this scenario and see the impact that this has on the probability of success. We’re getting more aggressive in the 10 years leading up to retirement, and then more conservative. We see here, it actually reduces the likelihood of success. Let me show you why. What we’ve done here, as you see, by being more aggressive, we’ve simply expanded those guardrails.
If you want to go back and rewind a little bit and look at the potential outcomes between the 75th and the 25th percentile, by taking more risk, we’ve simply introduced more possible outcomes. A wider variation of outcome. By doing that, you actually lower your probability of success. Now, if markets perform how they have historically, that’s probably going to put more money in your pocket. Are you willing to take that risk? That comes down to your personal situation, your personal circumstances, and who you are. You have to know yourself.
Impacts of Taking Social Security Early to Add into Your Portfolio
If you can’t have that portfolio, and then when the market tanks, you try to sell everything. Because then you have to decide when to get back in. Studies have shown time and time again that it is very difficult, if at all possible, to time that accurately and do so consistently. Okay, I want to look at one more here, and that’s Social Security. I’m going to bring this back to where we were, our original baseline. For Social Security, we have taking at full retirement age, full retirement age, this is our baseline. Let’s say we want to take it as soon as possible, at age 62. Okay, so we see here it dropped down to 82 percent.
One of the, I don’t want to call it misconception, but it’s a common theme that we see all the time is, “Well, Troy, if I take Social Security early, that’s more money I can keep in my portfolio.” Yes, that’s absolutely true in the near term. Because by having less guaranteed income inside from your Social Security, you’re ultimately putting yourself into a position, because of inflation and potentially higher taxes in the road, that you will later in life have to take more money out of your accounts, leaving you more vulnerable to sequence of returns risk, and therefore, increasing the probability that you may run out of money.
It’s not a misconception to think you’re preserving your accounts by taking Social Security earlier, it’s just a misunderstanding, really, that you are, by keeping more money in there now, taking more investment risk, because if the market goes down or your accounts go down, that’s on you, right? You have less guaranteed income now and less money in the accounts. Really, what you’re doing is you’re just temporarily. It’s a stopgap, right? You’re temporarily keeping more money in your accounts, but if you live to be 77, 78, 82, 85, beyond, down the road, you will have to start pulling out a lot more money than you would otherwise if you had deferred Social Security longer.
Different Spending Options
We’re not in the boat of everyone should defer it as long as possible, everyone should take it sooner. It’s a personal decision. It’s based on your circumstances, how much investment risk you’re willing to take, how much you spend, if you have a go-go spending, slow-go. How all of those things work together can dictate what makes sense for you in regards to taking your Social Security and the timing. There really are an infinite number of what-if scenarios I could go through. I just wanted to cover some of those, for you watching this video. Obviously for clients, we customize these and we go through a lot of different scenarios.
I’d want to get to the Play Zone in this video so we can look at spending different amounts of money in retirement. Play Zone, pretty cool. This is one of the favorite features of our clients, because they can come in here. We have it set here on the recommended. This is a bit more conservative portfolio. Still 60% equity, but just not super aggressive leading into retirement. We have the go-go spending here and the basic living expenses. We’ll get notifications whenever clients come in and change these, and they add it to their favorite, because then that’s their new target.
As the account balances change over time, they save more money, whatever it might be, all of this updates in real time. It’s cool, when people come in for reviews, to have those conversations of what it’s like seeing these numbers change, and dealing, looking at spending more versus spending less. I just want to show you, so we bring this up, let’s say 35,000 almost, for the first 10 years on top of the 75. Okay, look, 81. Look, if you’re a client of mine, I’m telling you 81, this is not bad news. I would personally feel pretty comfortable retiring at 81.
Now, I have the tools and resources to stay connected to my money. I have the experience to handle this probably better than a lot of people out there. It’s not a bad situation to be in as long as you stay connected, and you can see the impact that the decisions that you’re making and the investments that you’ve made, their market value fluctuation, how they’re impacting your long-term security. This is something we would want to monitor, right? Sure, Mr. Client, go ahead. Let’s spend this 110,000 for the first year of retirement, but let’s check to see how everything is impacted six months from now, 12 months from now, and then reassess. Make some adjustments if needed.
Just like a recipe. When you get done cooking, maybe it needs some more salt, maybe it needs something else. You taste, you adjust, and you go from there.
Conclusion
Okay, so we’re actually going to have a part two to this video where we go through the tax side of this. Primarily, I’m going to focus on if you did not put the money into the Roth 401(k) over the next 10 years versus putting it into the Roth as we did here. Now, it’s a preference, right? We don’t know what taxes will be in the future. I do believe they will be higher.
We do know, in a couple of years, when the Trump tax cuts expire, they’re likely to go up, but we don’t know what they’re going to be in 10 years. It’s a preference, and what we want to do is start to show you how that could possibly impact your retirement, the amount of taxes you pay. Does it impact it at all? What about Social Security? Because I have inclination that your Social Security taxes would be impacted as well. Not doing the Roth versus doing the Roth part of the 401(k).
Part two of this video, we’re going to dive into the tax planning side of this equation, not just pre-retirement by making those Roth contributions versus pre-tax contributions inside the 401(k), but we’re going to look post-retirement and start to look at some conversion strategies and the impact that different decisions you can make from a tax standpoint may have on your retirement as it pertains to this hypothetical case study.
