Step 2 of Retirement Success Plan: Income Planning

Troy Sharpe: How many of you want to depend on the stock market going up to generate retirement income? How many of you want to dig deep into your principal so you can maintain your standard of living? How many of you want to pay more tax on your income in retirement than you otherwise have to? Well, oftentimes, that’s exactly what happens without an income plan.

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Step Two: Income Planning

Step two of the retirement success plan, income planning, is tremendously important. It comes after the allocation, it needs to go in that sequence. For us at Oak Harvest, when we’re building your retirement plan, we’re really doing steps one, two, and three all at the same time. Allocation, income planning, tax planning. I know none of you want any of those things I said to start this video, but what we’d like to see in your retirement plan is multiple streams of income. We want you living off the interest of your principal. We want that income increasing throughout retirement, and we also want it to be as tax-free, if not entirely as tax-free as possible. There’s a moment when it hits you, pre-retirement usually, or sometimes just right when you retire, we call it the light bulb moment.

It’s when you realize that, “Oh my goodness, these paychecks have stopped. Now I have to figure out how much income to take. Where am I going to take that income from?” Eventually, all these other dots connect, like, “I’m now going to have to pay tax on this income. Should I take it out of the IRA or the non-IRA? What about social security? When should I turn that on?” All these questions start igniting and then you realize, “Oh my goodness, retirement from a financial perspective, planning perspective is far more complex than the accumulation years.” That’s why we developed the retirement success plan. There is no retirement without income. What you’re going to learn in this video is what exactly retirement income planning is.

Maybe you’ve heard this term before, maybe you think it’s as simple as withdrawing 4% out of your nest egg each year, but we’re going to introduce you to some of the concepts that you should be aware of. If you’re going to reach out to us and possibly become a client, this is what you can expect. If you’re a do-it-yourselfer, I want to educate you so you can be aware of some of these things that you may have no idea even existed. We’re going to help you hopefully build a better retirement income plan for yourself. A long time ago, when I started income planning, this is exactly how I would map it out. It’d be on a white notebook piece of paper. We would put the ages of the family that we were sitting with, their social securities, we’d map out the different ages, what those social security checks would be at those times, how much money they had in non-IRA accounts, IRA accounts, and Roth.

It allowed me to see in my mind where the gaps were when it came to income needs. My mind was then able to start to put the puzzle together and I could start to see how making different decisions, how it would impact different aspects of the retirement. We would play around with this. Sometimes we’d be in the office here till 10, 11, 12 o’clock at night. This is where we really cut our teeth and learned about income planning. Now, today’s a lot different, of course. We can spend a whole bunch of money on different software. We can input the data, run these different analyses and computations and start to get answers to our questions much more quickly.

When we have complex planning cases, and it doesn’t have to be with tens of millions of dollars, it can just be different investments, different accounts, different times, different wants, needs, or goals for the family, these types of decisions, and then the differing alternatives can make things complex even if you have $500,000, $1 million, $2 million. I will still go back to this– I call it old-school format here because it allows me to better visualize some of the options as opposed to just putting data into a software and then having it compute some number. AI is great, but there is no threat to our business, no threat to what we do from it because the value of a human being with experience and able to visualize and understand the laws, the taxation, how different things interact with one another, it’s still tremendously invaluable.

Income Planning in Conjunction with Tax Planning

Now, I said earlier that we do income planning and tax planning simultaneously, but there’s a reason why they happen in sequence in the retirement success plan. The number one reason is without investments there is no income, without income, there is no taxes. Sequentially that makes sense, but in reality, when we’re putting plans together, the income and the tax planning is done at the same time. Meaning we’re running through different scenarios, various tools, a combination of possibilities, while looking at how much income they can generate because we want to live off the interest of your principal as much as possible, but also we’re looking at the tax impact because it’s not how much income you generate, it’s how much income you keep.

I want to do an exercise with you real quick, and as I run through these different financial tools, I want you to, at home, say how they’re taxed. First one, we have REITs, Real Estate Investment Trusts, subject to income tax, the interest. When you sell a REIT, it’s subject to a capital gain tax or a loss. That capital gain could be taxed at income tax rates or long-term capital gains rates, which we call preferential. Now, if you said that answer exactly how I did, you got it completely right. That’s just the beginning of how complex a lot of this is. Dividends. Dividends could be tax-free, could be taxed at 15%, could be taxed at 20%, could be taxed at 23.8%. They could be taxed at income tax rates if they’re ordinary dividends. Most people just think there’s a 15% tax rate on dividends. It’s not the case.

Interest on bonds. It might be an easy one here. Income tax rates, but many bonds of course could be tax-free. Now they are tax-free, but interest from minibonds can add to what’s called your modified adjusted gross income and cause a domino effect of other parts of your income to be taxed. One last thing about bonds, whether they’re normal or minibonds, when you sell them, you would have a capital gain or a capital loss and would be subject to those different tax rates.

CDs. Interest from CDs, taxed at income tax rates. Annuities. This is an interesting one. Annuities typically are taxed on what we call a LIFO basis, which means last in, first out. You have to withdraw the interest first. It’s subject to income tax. You get into your principal. If this is a non-IRA account, then that’s tax-free. There’s something called the exclusion ratio, which allows you simultaneously to take interest and principal out at the same time.

Stock gains. Similar to dividends in the extent that long-term gains are at 15%, but could be at a higher rate if your income passes a certain threshold. All of a sudden, your long-term capital gains can go up. Short-term gains, taxed at income tax rates. I threw a fancy one in here because some of you invest in these limited partnerships. These are the most complex tax tools out there. You absolutely want to keep these out of your IRAs. They tend to generate higher dividends, but they also tend to have a little bit more risk in them. A lot of times, you don’t get your K1 from the limited partnership until after taxes are due. Many of you were shaking your head, nodding, “Yes. I know, I hate these things.” The dividends themselves could either be income, could be return to principal, or could be subject to capital gains.

I wanted to go through that because when we talk about generating interest, we have tools in the financial marketplace. Of course, that’s not an exhaustive list, but some of the most common. Now, we also have to decide which accounts do they go into? Do we want to put them into the non-IRA? Do we want to put them into the IRA, or do we want to put them into the Roth? When do we possibly want to change which allocation is inside which account? You’re starting to see now how step one, the allocation, step two, the income planning, step three, the tax plan, they all take place at the same time, but they have to go sequentially.

Social Security Strategy

Social security. This is a big, big part of retirement. Your social security, if you’re married, those combined checks could be well over $1.5 million, $2 million, $2.5 million of retirement income.

Social security has its own set of tax rules, which we will get into on the next video, tax planning, step three of the RSP. For income planning purposes, we have to start to map out what makes sense as far as when do we take income and how much from these various buckets, and of course, which tools are we putting inside them? Maybe one spouse takes social security sooner, maybe one defers it, maybe they turn out at the same time. If you’re single, you don’t have to worry about the timing of that between two people, but you do have to coordinate the timing of social security with the income that you’re pulling from your investments. Now we’ve covered some of the basics of what you need to understand in order to start to build a retirement income plan that’s efficient.

Then what we do in the financial planning process, is we try to start to identify where there are gaps in the income. Coming back to my original drawing here from the old days, this is ultimately where we would try to identify gaps in your income. If your social security was starting at $66, then your spending goal could have been, let’s say $80,000 a year, we would have known these gaps right here, right in what that gap was. We would know, “Okay, this is how much we need to put here, possibly this type of investment. This is how much money we need to put here,” and start to look at options to generate income as much as possible. Back then, interest rates were 0%, so you couldn’t really live off the interest of your principal. You did need to depend on the market growth. A little bit different today, but when you’re watching this video, the environment may be entirely different and strategies may need to adjust.

This is looking at the blue, social security income. The red is the shortfall. Now I can put the information to the software and get this pretty graph, and it simply shows me, based on the estimated spending goal adjusted for inflation. This is what we call a go-go income plan, where the client wants to spend more money in the first 10 years of retirement or so. Then the intention is to taper that income down, traveling less, doing less things, but it’s all still inflation adjusted throughout retirement. I’d like to start with an understanding of the power of social security because social security does two things. One, it’s a guaranteed lifetime income stream. Two, it’s an increasing lifetime income stream, and there aren’t many better things than that in retirement than a check that you know is going to be deposited into your account every single month. Additionally, a check that is expected to increase year after year after year. Many of you may be thinking social security isn’t going to be there for you. We feel pretty confident that any one 55, 60 plus, the wide majority of you watching this video have nothing to worry about when it comes to social security.

Younger people probably will see some adjustments to either their benefit or their full retirement age, possibly taxation, but for most of you watching, not a big concern. Looking here early, so this is a couple that’s 65 years old, looking at taking it early. That would be 65, living to 95, but we have over here long life expectancy, the given life expectancy, or a short life expectancy. We can start to see the total benefits, the maximum monthly benefit there. Start to look at some numbers. Now I turn it from early to, let’s say delayed. Jumps up to 2.5 million 90, almost 9,900 a month. Can look at what happens if we have a long life delayed– excuse me, given life expectancy or a short life expectancy. These are conversations that we’ll have with you.

We don’t ever make the decision for you when it comes to income planning. We put a plan together and then when we meet back for what we call the allocation appointment, where we start the retirement success plan, once you become a client, these are the types of things that we start to go through with you, and then in real-time can adjust the plan based on feedback from you. We’ve prepared and have the expert analysis and the experience to help bring this all together. The plan is customized for you and your family. It’s not coming in and trying to fit you into a pre-made box. What we do is we understand you. We use these tools to then build that box around you and who you are. This is a social security comparison ledger, and I like to look at this, but also the bar chart to the right over here.

We can look at different timing of taking social security here, and it just shows us very clearly on a one-page analysis of if you defer it, this is how much-combined income you’ll have monthly as well as if you take it early. We can see what the difference is, but also it keeps a tally of how much you’ve had to withdraw from your portfolio during that timeframe in order to make up that difference because you decided to defer it. Now, for some of you, it absolutely makes sense to defer it as long as possible, but many of you out there, it probably makes sense to consider taking it at 65 or 67, or 68. It all depends on the full financial plan. Over here, this simply shows us normal life expectancy versus long life expectancy. The blue is if we delay it, the red is if we take it at 65. $3.1 million versus $3.8 million. 2.1 versus 2.5.

I bet most of you probably didn’t realize that social security could give you millions of dollars of retirement income. This is why social security is such an important piece to the income puzzle, and it’s why I like to start there. Back to our hypothetical planning and income planning in general. We’ve now made this social security tentative decision. It’s where we think it makes the most amount of sense given the analysis that we’ve went through. Here we’ve plugged it in at 2028. Now we have the red, the red is the shortfall. This is where we have to take the amount of money that you’ve saved and figure out how should that be invested, how can we generate the most amount of income, and how can we get you an income that is increasing over time? Oh yes. We want it to be tax efficient, hopefully, tax-free, if not immediately, down the road.

Determining When to Withdraw

So I don’t turn this into a documentary, I’m just going to keep it high level from this point on. Now let’s say this is the retirement date. Let’s say it’s 2024, and it makes sense. We’ve done this analysis for one spouse to turn it on here, but the other spouse, we want to defer it. Something like this could happen because one spouse worked longer than the other spouse and has a much higher social security. We want to defer that one so we maximize the social security benefit, not just during retirement, but when one spouse passes away, the surviving spouse gets that higher benefit, the other one goes away. Just as an example, we’ve also decided to– Let’s say this is your IRA and we’ve done the tax analysis and it doesn’t make sense for you to defer your retirement accounts like conventional wisdom tells us to do, it makes sense to actually start taking some money out at the same time that we retire and turn on Social Security.

This does a couple of things, which we’re going to get into much more in step three of the retirement success plan video, tax planning. What it does is it helps to keep those balances in check. Later on in life, you don’t have exorbitant required minimum distributions. The lower your balances are, the less you’re forced to distribute and pay tax on oftentimes in future years where you don’t need that income. In this particular example, we’re taking money out of the IRA at the same time we’re taking one spouse’s Social Security check. Maybe this is dividends. Maybe this is interest from a real estate investment. Maybe this is a 4% or 5% fixed annuity or CD. We want to live off the interest here, and hopefully that all matches up with your spending goal. If not, we may need to take income from this bucket. Maybe this is another IRA that we’ve created or maybe it’s your non- IRA account. In this particular example, these two match the goal. This one we’re able to maybe– Let’s say, it’s a 7 to 10-year time frame, able to be a little bit more aggressive. This could be stocks, could be growth, could be value, could be a combination, could be balanced.

Intentions are to defer it a little bit longer, take dividends or interest as needed to supplement lifestyle, vacations, et cetera, but we’re tentatively planning on deferring it until then before we take bigger distributions. This one over here, it’s our longer-term bucket. We don’t intend on taking any money from here until then, but again, it’s there if needed. Going to turn Social Security on here. If that was the case, we would either probably defer this one longer or maybe take income or interest from it sooner. I just want to convey that we’re starting to put the puzzle pieces together. This is what income planning is. It’s not just the, “Take all of your accounts and take 4% out.” You can do it that way. Many of you will still be okay, but if you think back to the butterfly effect video that I did, every decision that we make, it’s putting us on one particular trajectory.

Oftentimes in the first three, four, five years of retirement, you can make bad decisions and think you’re doing just good or just fine, but you’re actually on a trajectory that is potentially jeopardizing your long-term security. Having an income plan that ties into the tax plan, that ties into the investment plan, all of those working together, then you staying connected to it and having visibility into the future in regards to the decisions you’re making today, how they’re impacting your future, that gives you confidence and helps you feel secure that you’re making good decisions, you’re on a good trajectory. I think most importantly, if you come to find out that you’re not going down the right path, we can course correct because we have that visibility how our decisions are impacting us.

When I talk about this back bucket here, we’re big believers in dividend growth stocks. The reason we like dividend growth stocks as part of an overall income plan is because, one, dividends are paid from the interest of the money that we invest, but dividend growth stocks are companies that have a long history of increasing their dividend payments. Let’s say it’s a 5% historical average increase to that income. Let’s say you start out getting 50, 000 a year. Most of you want increasing income, so if you have in this longer-term bucket a portfolio of blue chip companies that have a long history of paying their dividends, but also increasing their dividends, 4%, 6%, 7% a year on average, of course, that is going to fluctuate and it’s not guaranteed.

When you have something like that and you can just turn the spigot on and start to receive that income when needed, and before that, we’re reinvesting and buying more shares, which then can spin off more dividends, now we’re starting to have something that can work for us long term. Of course, we have to have a good understanding of the profitability of those companies. Do they have a high likelihood of continuing to pay those dividends? That’s where with the investment team here we talk about SMR. It’s about sales, it’s about margins, and it’s about management teams that have a proven track record of being able to reinvest capital and provide high returns on that invested capital. If you have a good product, you’re going to have good sales. If you have good sales, you can expand margins.

Having a Good Retirement Management Team

If you have a good management team, they can reinvest those profits into projects that have higher expected returns. That’s when you have a balanced portfolio of those types of companies. You can’t guarantee dividend growth, but you can put yourself into a position to where you have a good degree of confidence that it’s going to continue. You can probably tell by now that income planning is much more than just simply putting a bunch of money into stocks and bonds and taking 4% out and hoping for the best. We want to make sure we’re aware of the types of investments we have inside which accounts. We want to time the income withdrawals from our portfolio with when we’re taking Social Security. We want to optimize our Social Security. That’s a big, big part of the retirement success plan is providing a Social Security optimization strategy.

That is not done in a silo. It’s done with respect to how much money you have, your income potential from those various accounts, but also your spending goal, and your longevity. Of course, you can’t do any of that without paying attention to step three, which is the tax planning. I hope this video has been educational and helpful for you on your retirement journey as you gather information and learn as much as you can about retirement because this is a very critical time of life and decisions you make now will determine how much you have in your accounts, how much income you can take, et cetera. Of course, if you want our help, always reach out to us, but make sure to stay tuned for step three, which is the tax planning, the next video in this series, where we’re going to do a pretty deep dive into various tax planning strategies and help you save more money.

Then, of course, step four is healthcare planning. Step five, estate planning. Look forward to seeing you on the next videos.

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