Jacob: What does a retirement plan consist of? Like, what are the actual components that make up a retirement plan or should I say a good retirement plan? That's what we're gonna be talking about today on the show. And if you're new here, welcome. My name is Jacob Duke.
I'm the host here of the Retirement Answers podcast and also the owner of River Tree Wealth, a retirement planning firm where we specialize in helping people just like you retire successfully and with peace of mind. And this podcast is simply an overflow of the work that we do every day. So whenever I talk about topics here on the podcast, I typically like to isolate them and think about them, I guess, in individual topics to make it simple and easy for everyone to understand that way, you know what you're listening to. But today, I'm going to share just an overview of what a true retirement plan looks like or what the components of a real retirement plan should include. And as we go through this, what you're going to find is that most of these things are interconnected and they're kind of dependent on each other rather than operating in isolation.
So for example, an investment plan is not an investment plan that's very good unless you consider the tax plan and the retirement income plan, all these different things that kind of flow into how your money should be invested. They're all interdependent on each other. So what I find is that whenever I talk with someone new and they're like, Jacob, what does it look like to work with you? What I often find is that most people think they have a plan, but it's not a true plan because it's not comprehensive. So they might say, Jacob, I've got my investments, they're they're situated the way they need to be, So what's the point of like talking to you?
Like, what can you do different than what I'm doing in my investments right now? And the answer is, well, maybe nothing on the investment piece if you got that exactly dialed in perfectly, but there's five or six other components here that you probably aren't that I can see you're not considering when it comes to your true retirement plan in the in the grand scheme of things. So any good plan is one that's comprehensive in my opinion, but it also still needs to be simple and actionable. And we're gonna go through these six components of a plan here in just a moment. But what is not a retirement plan?
Maybe that's also something we should talk about. A lot of people want to hear about their projections, they want to hear about what chance of success they have in retirement, you know, of not running out of money or meeting all their goals, you know, buying a new house or doing remodels or whatever it might be. They wanna see what chances of success through a Monte Carlo simulation or projection, they wanna see what that looks like. And here's what I've also discovered, that Monte Carlo simulations or Monte Carlo projections, they are not a plan. In fact, they're not very helpful in the grand scheme of things, because all they do is is they tell you what your chance of success is based on a a lot of assumptions.
Many different assumptions have to come true for that Monte Carlo simulation to work. You might be thinking, Jacob, that's the point of the Monte Carlo is to run thousands of simulations to see based on what you think will happen, what are the different variances, what are the different outcomes that might potentially happen based off that. And and that's correct. Monte Carlo is a simulation of thousands of different times of what could happen if all those variables are different. But what it doesn't do very well is tell you the decision to make in the moment.
Right? So let's say you've planned out, hey, I'm gonna retire next year. I'm gonna need this much money every single month. And here's what that looks like on my simulation, my Monte Carlo projections. Here's kind of what that looks like as a total distribution rate based on my portfolio every single year, and all of it looks good.
But what happens if everything you're basing your retirement success on changes? What happens if your income over the next year actually decreases or you get laid off? What happens if you have to do a major renovation to your house because of an unforeseen issue that arises? Or what happens if a health issue arises and you have additional medical costs that come into play? There's so many things that could change in a short amount of time and Monte Carlo simulations have no way of accounting for those major major changes.
So what I would say is, you have to have a Monte Carlo simulation to know where you stand in terms of what your overall success looks like based on your baseline and kind of what you think is going to happen. But the true work comes in the planning that happens every single month, every single quarter, every single year, whenever you make the next best decision. Retirement success or really just anything in life is really built on the correct decision being made over and over and over again. You're stacking good decisions on top of each other and then you end up with a good result in the end. It's kind of like investing.
If you put money into your four zero one ks for thirty years working at your job and you've also got a match, guess what? Made a good decision for thirty years and now you have this sum of money that you've saved for retirement. Right? And so the same thing happens here in retirement. We have to continue to make good decisions day after day, month after month, year after year, so that you don't run out of money in retirement and you have the retirement that you truly want to have and live.
So that's a few things that I wanted to say there. And really what this is about is simplifying everything. I love the quote by Leonardo da Vinci. It says simplicity is the ultimate sophistication. So does that mean that it's easy?
No, it doesn't. Simple is not easy. In fact, we have to kind of wade through all the complexities to come out the other side and reach the simple solution or the simple answers. And the way that I like to explain this, you know, to my clients is, is we don't necessarily understand how electricity works all the time. You think about your electricity in your house, you've got wires going everywhere, you've got switches and, you know, breaker boxes and all kinds of power lines that feed energy to your house.
And so what you've got is you've got a really complex system that you probably don't know a whole lot about. But really all that you care about is whenever whenever you flip that switch on, the lights come on, or the AC kicks on, or whatever it is that you're you're trying to accomplish using electricity. The simple solution is, oh, we'll just flip the light switch on and the lights will come on. But there's a lot of complexity that has to happen behind the scenes in order to get that simple solution. So maybe it's a good way of understanding how retirement planning works.
You've got to wade through all of the different potential, you know, income scenarios and investment scenarios. You've got to wade through everything to reach the simple answer of do this because of this. And that's really what it looks like. So that's what I try to do with my clients. And hopefully, that's what this episode is going to help you do as you're building your own plan yourself.
So what's the first component that any good retirement plan has? It is an income plan. An income plan is crucial because everything that you do in retirement, all the projections, everything you base retirement on comes down to how much money you need every single month to live. Now that might be a base spending number, it might be a want to have spending number, it might have a spending number including a lot of extras such as vacations or additional large purchases that might come up. But you've got to have an income plan.
Here's why. Whenever you retire, you are signing up to turn off your income from work, and that can be the scariest thing that you do throughout your life. In fact, it's what holds a lot of people back from actually retiring is, is the fear of oh my goodness, I'm not going to work and I'm not earning an income anymore. What do I do next? Well, that's why you've saved over your entire working career is so that you can now turn off that need to go to work and let your investments produce your income and continue working for you.
So turning off your income from work is going be one of the most frightening parts of retiring. That's why you have to have a really good idea of how much money you need. So what you've gotta do here is you have to understand your expenses. I talk about this a lot. You gotta do a spending audit.
You gotta understand how much you spend on a monthly basis and in a fixed capacity. How much money do I need to get to the next month, bare minimum? And then how much money do I desire to spend every month or what's normal for me to spend every month? And there's typically a variance there. There's a difference between, you know, what you need to have and what you want to have.
So let's say you need to have $5,000 but you want to have 10 to live life the way that you enjoy living life. Well, what you can do is you can look at your income plan and retirement based on those two numbers or maybe somewhere in between and say, hey, can I retire successfully with the $5,000 a month of income need? If the answer is yes, great. Now, can I retire successfully with the $10,000 a month of income that I want? The answer might be, well, maybe.
And so that's not the wrong answer. It doesn't have to be 100%, doesn't have to be guaranteed. In fact, there's nothing guaranteed in all of this. But what you can do is you can kind of begin to play around with the different pieces that make up that additional spending amount. What if I don't have to go on that weekend vacation every month?
What if I don't have to do this? What if I don't have to pay for these additional things that I might be paying for currently? That's a way to think about how you can analyze your expenses right now, and once you've done that, you can have a good understanding of here's how much money I need every single month to keep my current standard of living in retirement, and then you have to build out your plan around where you take your money from, which accounts do you take from first, do you take from your IRA or your Roth IRA? What about your brokerage account? If you have one of those, do I take from those in equal distribution?
So pro rata, do I take the same amount or same percentage from each one or do I take from just tax deferred first or do I take from my Roth ever? Do I always delay my Roth into the future and leave that for kids or grandkids or or someone else down the line? And then what about Social Security? How does that fit into my income plan? Do I take it at 62?
Do I take it at 65? Do I take it at my full retirement age? What about delaying it to 70? What's the best thing for me based on my expected lifespan and family longevity histories and all those different things? What happens if I need to do a split strategy where my spouse takes theirs early and I take mine later?
Is there a benefit to that? If so, what is it? What about pensions? Do I have any sort of fixed income from my job currently, or a previous job that paid a pension? Do I have any sort of fixed income coming in?
Obviously, would be taxable, but you have to consider all these different sources of income or perhaps rental properties where you've got rental income coming in every month. You know, all these different components make up the income plan, which is again, one of the six components of your overall retirement plan, but you got to factor this in because everything you do from this point on is based on your income need and and your expenses in retirement. So you gotta get your income plan right before you can do anything else correctly. The second component of any good retirement plan is an investment plan. Now, Jacob, why didn't you put this one first?
Thought investments were the most important thing. Well, they might be the most important thing because if you do all these other things right and you do investments wrong, guess what? It doesn't matter. But if you do everything right on your investments, you do everything else, and you do all these other components wrong, you might still can be successful. So they're not all weighted equally in terms of importance, but why do I put investments second?
Well, the reason I do that is because I always want my income plan to inform my investment plan. I want my income to tell me how I should invest. Now, Jacob, why would I do this whenever I can follow a fifty fifty portfolio or sixty forty retirement portfolio? I thought this was this was proven. Hey, you just follow a basic retirement portfolio, and your chances of success will be great.
It's like, well, that's fine, but we're not here to just be average and and you know, accomplish the end goal of not running out of money. I want you to have the most money throughout the rest of your life, that way you can have more fun and do things that you wanna spend money on rather than just sit at home and have enough money. So it's crucial in my opinion to know what your income needs are before you build out your investment plan rather than doing the investment plan first and then the income plan. So the investment plan should be told what to do by the income plan. Now, what's one of the biggest concerns for most people whenever it comes to retirement, or the first five years of retirement?
It's going be sequence of return risk, meaning what happens if I retire today and then the market goes down 30% in the first year of retirement? What then? What are the big things that could happen then? Am I still able to be retired if that happens? Those are the big questions.
Right? So we have to cover for that. Now, how do I like to do this? Well, with my clients, I like to have a minimum of two years of living expense need in cash. Now that can be cash at the bank.
It could be cash in IRA. Doesn't It really matter necessarily where it's held. Obviously, if it's held outside of a tax deferred or a tax sheltered account, then that's optimal, meaning it's after tax if it's in your bank account. But regardless of where it's held, I want it to be in cash in terms of the investment type. It's just in a money market, it's gaining some interest, but it's not gonna go up and down like a volatile stock market fund or even a bond market fund perhaps.
So it's just designed to be there. So that's the first thing. I wanna have two years of expenses in cash. The second thing is is I want to have three years holding expenses in fixed income. That could be treasuries, that could be CDs, that could be corporate bonds, and pick what you like.
You know, there's different thoughts. There's different philosophies around how to do that. But in general, you want something that's fixed income that's gonna yield in theory a higher return than money market, but also it's not going be volatile or yield as high returns as stocks. So by doing this, you're building out what I call a three bucket income plan. And so you've built out the first two buckets.
That's five years at a minimum that you have in what we'll call conservative assets in terms of volatility. You've got five years worth of those assets between cash and then also your fixed income buckets. So that gives you a five year runway to outlast or outright any sort of market turmoil or downturns or economic corrections that could be in play immediately after retirement. And you kind of monitor this and keep these buckets updated throughout your retirement. Now, the third bucket is going to be your stock plan.
That's going to be how you invest for the long term growth. Because in fact, one of the issues that most people that I see run into when it comes to retirement is they get really conservative and they fear running out of money because of market volatility or market declines. But in fact, if that but the real risk is not but that's not the real risk in my opinion. The real risk is not having your money work hard enough for you over the next thirty years so that you're beating inflation. If you don't have a long term mindset around your retirement, that's what you could end up doing.
And you might get to 80, 85, 90 later in life and end up with a lot less money than you thought you would have because you didn't have anything working for you over the early over the first half of your retirement. So it's important to remain aggressive at least in one of your investment buckets, don't remain aggressive in all of your investments. That's why we build out this bucketed plan based on when you might need the money. So that's the way I like to build an investment plan. But in addition to that is going to be, you know, making sure you're diversified that eliminates a lot of unnecessary risks.
The risks of, you know, picking wrong. If I try to pick just US or just international, there I could be wrong on either side of that coin. So it might make sense to own both, even though one will perform better than the other at any given time. The point there is to be diversified, so you eliminate the opportunity to pick wrong. And you have to think about, you know, what does rebalancing look like?
How often should I make adjustments to my investments? Or should I focus on dividends or high growth investments? Like, what's the best thing for me? Well, that's gonna be based on again, your situation. So just take all these things into consideration as you build out your investment plan.
I like to have the income plan, which was number one, inform how I invest my money in retirement so that my investments are optimized for me specifically rather than following some rule of thumb. The third component of any good retirement plan has to do with taxes, and that's going to be your tax plan. So whenever we think about this, there's multiple things here that could be at play. You could think about Roth conversions, you could think about asset location, and you could think about tax loss harvesting or tax gain harvesting, which is way more valuable in my opinion than tax loss harvesting. You gotta think about RMDs or required minimum distributions, and also QCDs, qualified charitable distributions that can correlate with those to help offset any tax burden on that end.
So let's dive into this a little bit. What does it look like for Roth conversions? How is that beneficial? Well, the idea of Roth conversions is to essentially move money from a tax deferred account being a traditional IRA to a Roth IRA, which is an after tax account. So by doing that, you are electing to pay the taxes on the amount of money that you are moving.
Then there's a few things to know here. There's there's no maximum amount that you can convert in any given year because they're not contributions, it's just a conversion. And also, it's not always wise to convert everything from tax deferred to Roth. There are some benefits to actually having some tax deferred money, which I won't get into today because that's a whole another episode. But Roth conversion can be valuable if your tax rate today is going to be a lot less or even just a little bit less than what you could pay in the future.
So for example, let's say you're 60, you just retired, you have no other income coming in, and you have no income to that's going to be filling up your 10%, 12% or even covering your standard deduction, but you have some brokerage account money maybe, or you have some cash that you've tucked away, and now you have the opportunity perhaps to do Roth conversions because you got a tax deferred IRA, and you're like, I don't know if I should be moving this to the Roth or not. So you have this opportunity in front of you because your income is now low. Now, once you turn on your social security in the future, your income is gonna increase. You're also gonna have RMDs perhaps in the future, and that means you would have another income increase. So what you might have is this little window of time, might call it gap years, where your income is going be lower than it was in the past, but also what it might be in the future as well.
So you have an opportunity to do Roth conversions, moving money from a tax deferred account to a tax free account during these low income years at the lowest income tax brackets. That's the idea. If you're making a ton of money today working, and your income is going to be a lot lower once you're retired, doing a Roth conversion while working might not be the best decision because you would be paying a higher tax rate today than you would in the future. So it's really a game of when you're gonna be paying your highest taxes and when you're not and deciding how to fill up those lower income tax buckets with Roth conversions perhaps. Now, another thing that a lot of people overlook is asset location.
Now, what is asset location? It's essentially aligning the investment type stock, bond, cash with the account type in regards to how that account is taxed. So an IRA, you have deferred your taxes into the future and you're gonna pay taxes anytime you withdraw money from that account in the future. You So didn't pay tax on the front end, but you will on the back end. A Roth IRA or Roth four zero one ks for that matter is the opposite.
You pay tax on the front end to put the money into the account, and once you're 59.5 and the accounts been open for five years, you can take that money out tax and penalty free. So taxed on the front end, but not on the back end. Now, a brokerage account is a little bit different because you're going to use after tax money to add to that account. But what you're going to do then is you're going to not necessarily pay taxes whenever you withdraw money out of the account. That specific account type is taxed annually on any dividends, interest, or capital gains that are created by making a trade or selling or creating a transaction of an investment that has gone up or gone down.
So a brokerage account is taxed annually rather than on the front end or the back end. So you've got three different buckets, you will, three different tax buckets here that tell you how the dollars inside of each bucket are going to be taxed. So whenever we think about this, if a bond creates interest, interest is always going to be taxed in a short term capacity or at normal income tax rates. Now, a stock, you could have qualified dividends which are taxed at a long term capital gain rate, that's why they're qualified, or you could have long term capital gains by selling a stock or stock fund that has gone up in value and you've held that for more than twelve months or three sixty five days. So you achieve a long term capital gain rate whenever you hold that for more than one year.
So maybe what you're starting to see here is if you hold your stocks in your brokerage account right, because stocks receive a more favorable tax treatment than bonds or other fixed income type assets, you might want to hold those in the brokerage account to lower your annual tax burden. But then also, if we think about the Roth IRA versus the traditional IRA, since the Roth IRA is going to have tax free distributions in the future, I kind of want that one to be as large as possible, meaning I want that one to grow as much as possible, because that's just tax free money that's just accumulating in the account that I can take for myself in the future. So I would want to hold my high growth assets and typically that's going be your stocks. If you look at historical returns, that's what's going to be the highest performer because you're taking the most risk. And so if you do that by holding those in the Roth IRA, using the tax type of the account to your advantage, because again, it's going to be tax free in the future, so you're going to want to grow that as much as possible.
And then finally, for the traditional IRA, since you're going to pay tax on that in the future, whenever you take money out, you might want to limit the growth in that account type just a little bit. You might want to hold your fixed income and some of your cash there, because that's not going to grow at the same rate that a stock might, but then also, you're gonna save yourself taxes on the back end by not creating an even larger tax bill for yourself because you've grown the account so much. Also on the tax deferred IRA or the traditional IRA, what you've got is you're going to have required minimum distributions in the future, so you're going be forced to take money out of that account, whether you reach age 73 or 75, it depends on your birth year for when your RMDs will begin, but you're going to be forced to take money out, which is essentially a forced taxation on your retirement savings. So all these different factors play into decisions around how you want to plan out when you take money from different places, how you take money out of those different accounts, and then year by year and kind of quarter by quarter, you can make tactical decisions around should I do a tax loss harvest this year?
Do I have some losses that I can realize and then also carry forward? Or is my income low enough to where I can realize some gains and do tax gain harvesting and pay a 0% tax rate on those long term capital gains? Again, that's a different topic. Think I've done an episode on that before. Maybe I'll do another one here soon just to kind of talk through that.
But these are different components of a tax plan that you've got to be thinking through as you build out your retirement plan, as it coordinates with your investments and your income plans and everything else, and even your estate plan, you've got to think about this tax side of things so that you don't pay more taxes than you otherwise have to, because you've thought through it and planned it out strategically. The fourth component that you've got to have in your retirement plan is going to be an insurance plan. When we think about this, we've got to think about health insurance primarily, right? That's going be one of the biggest ones because you don't get Medicare until 65. But before then, what do you do?
That's always the biggest problem for folks who retire before 65 is what do I do? Do I go find some sort of, you know, private policy where the premiums might be a little bit higher? Do I have the opportunity to do COBRA through my employer that lasts typically about eighteen months? What do I do? What's the best scenario?
Should I wait to retire until I'm 65 so that I don't have to go through this, you know, private insurance scramble to get insurance before I get to Medicare? That's always a big question. And sometimes there's not a perfect answer for it. It's really personal preference, but also it ties into your other, retirement plan needs. So for example, if you got, $2,000,000 and you in an IRA and you don't need that much, let's say, and you're gonna need to do Roth conversions, well, you've got to analyze, hey, is it worth paying a little bit higher premium on my private health insurance before 65 in order to do some conversions, which will save me thousands of dollars in the future over the rest of my life in taxes?
It might make more sense to pay the higher premium that year rather than keep your income lower. We also have to think about Medicare and which types of Medicare we want. Do we want a Medicare Advantage Plan or do we want a Medicare Supplement Plan? What's the differences? What's the pros?
What's the cons? What's the cost differences? Which one's better for me specifically based on my health situation? All those different things have to be thought through and planned out, and then it has to be acted on, right? You got to take the right steps in order to get those policies and those different things in place.
Another big question is, Jacob, do I need long term care? Do I need a long term care insurance policy? And that's always a hard one as well. Long term care is a difficult thing to figure out because about thirty percent of the population only ever needs long term care, but what happens if you're in that thirty percent? Or what if maybe you don't need insurance to provide for long term care one day?
What if you're able to self insure, meaning you have enough assets to take care of yourself? Or maybe you own your primary residence outright, and you're able to simply liquidate that, and then the proceeds from that house liquidation, that now can be your long term care insurance. So you have the cash to pay for a stay somewhere in some sort of long term care facility. So that's that's always a hard one to figure out. It's gonna be a lot of personal preference in terms of what you desire or what your primary goal is.
And then from there, you can create a plan around that. Now, another question is, is life insurance? Do I need life insurance? Well, that's going to be again dependent on your situation, but also your dependence. Meaning if you have a really high mortgage that's still outstanding, if you got hit by a bus and your family's reliant on your pension to make those mortgage payments, then you might want to have some sort of policy to help your beneficiaries to cover the mortgage and cover their lifestyle.
So the insurance plan is a big piece. You got health insurance, you've got life insurance, you've got long term care insurance, all these different things are rolled in, and you got to think about these based on your specific situation. The fifth component is an estate plan. And it's one of the most overlooked things that I see whenever I start working with people. Most of time I say, hey, I've got a will, and I think that's good.
I think I've got everything written down in there that I want. Well, that's fine, but the problem is that wills go through probate and create a lot of hassle and headache and cost a lot of money for your heirs one day. So an estate plan is more than just a will, but you've got to think about what do you want to happen to your money and your assets whenever you die? Do you want the house to go to this child instead of this child? Do you want it to be split fiftyfifty?
Do you want one person to receive an IRA, one person to receive a Roth? Or what happens if you want to give to a church or a charity whenever you pass away? Which account should you leave to them? And then which account should you leave to your family? You got to think about the tax implications of these different decisions.
But one of the biggest things that I would say around this is you have to have it in place written down on paper. You have to have your will, your trust, your powers of attorney, all these different things created so that when things don't go according to plan or things get harder, someone passes away, whoever's left over picking up the pieces doesn't have to figure out the puzzle. It's been figured out for them. They just have to go execute what's been written down. That's the dream, because there are so many horror stories around families getting in fights and arguing over different things whenever someone passes away without a good estate plan established.
I'm sure that's the last thing that you want for your family. So getting those things taken care of right now prevents and eliminates those big issues that could cause a lot of strife within the family later on. And the final and maybe the most important thing that you've got to think about as it pertains to your retirement plan is gonna be your purpose or your vision. You've got think about what does your dream retirement look like? You know, you hear about retirement from your friends or families and people that have gone before you and maybe you read online, but what is it actually for you?
I found that most people are looking to retire and do nothing. I think it's less about what you are leaving and way more about what you're jumping into. So it's not so much about what you're stopping, but what you're starting. And if you kind of think of retirement as a launch pad into something new, something purposeful, something that's important or valuable to you, that's gonna give you excitement about it, right? If you just leave work to stop working because you hate it, and don't have anything next for yourself, you might find retirement isn't as fun or as enjoyable as you thought.
And in fact, it could lead to a lot of loneliness and depression if you don't have anything that you're looking forward to or accomplishing in retirement. So does that mean, hey, I stopped working entirely? No, you might can find a different job or maybe more passion project type thing or just start cutting back on how much you're working, work part time or maybe work in a consulting role or something like that, or you're still using some of your expertise and some of your skills, but you're doing it in a way that's less dependent on you having to show up every single day, and you have control over how much you do and don't want to work. So think about what you want retirement to be, what do you want to get better at? What do you want to pick up that might be new?
What's what's something you want to learn? What are the things that you haven't been able to do while you've been working and how can you start doing those now that you have the opportunity and the time to do them? So these are the six things that I think any good retirement plan has to have in order to be successful. You gotta have an income plan, an investment plan, a tax plan, insurance plan, estate plan, and you have to have a purpose or a vision for what this retirement thing even is for you. So this isn't comprehensive and doesn't include everything it probably should be there.
But generally, it gives you a framework, right? It gives you an idea of what you should be evaluating for yourself. And you if have questions on this, feel free to shoot me an email. It should be down listed in the description below. So just shoot me an email if you have questions or wanna follow-up on this a little bit.
Also, too, I've got a 2025 important numbers document that might be valuable for you as you kind of go through your income planning and tax planning for this year. It's related to tax numbers and all the updates here for 2025. If you want a copy of that, shoot me an email as well saying that you'd like a copy of that. I'll send it straight over to you. And it's free, so you can use that however you would like.
Alright, thanks for tuning into this week's episode. We will see you again next week. Hey, it's Jacob again, and I wanted to extend a quick offer to you. If you have a question and you would like to have it answered here on the show, please email me at jacobretirementanswers dot net. And I'd love to answer that question for you right here on the show.
Also, I wanted to remind you that nothing discussed in today's episode is meant to be financial, legal, or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode. I look forward to talking with you again next week.