Life's Transition - A Case Study
Today’s blog will take on a little different format, instead of simply discussing planning topics - we will actually be walking through a mock scenario that showcases the power and impact planning can have in one’s situation.
The Mock Clients
Meet Josh & Lauren….
Ages: 56 & 57
Kids: 2
Household Income: $400,000
Current Net Worth - Approximately $6 million
Current & Future (estimated) Living Expenses: $150,000
Primary Residence: $100,000 mortgage balance left on it – 3.25% interest rate
Investments Accounts: 401k’s (both) ROTH IRA’s (both) taxable investment account (joint), 529 plans (currently being used) cash at the bank (savings / checking)
Background / Objectives
After over 30 years of working in corporate America, Josh and Lauren are hoping to confirm they can make the transition to a more relaxed way of life, by the age of 60. By that time, both children will be out of college – hopefully off the payroll 😊 – which means they could consider downsizing their home or using a portion of the proceeds to purchase a vacation home.
They have done a wonderful job saving over the years into their employer-sponsored 401k plans, ROTH IRAs, and taxable investment account. The primary objective of engaging a CFP® team was to confirm age 60 could be a realty, especially if they choose not to pursue some level of part-time work. In addition, they hoped to put their affairs in order from an estate and legacy planning perspective.
However, the more they thought about this potential transition, more questions came to light:
- Have we saved enough to retire at age 60?
- What will healthcare coverage cost / look like if we do not work part-time? Do we have enough assets to afford this and still live our intended lifestyle?
- Which investments will we tap first? Will we be ready mentally to do this?
- Are the investment accounts properly aligned for withdrawals and continued growth?
The First Step
Once we engaged, the first thing we did was establish a baseline of values and objectives for Josh and Lauren – we talked through their current spending habits, what they value spending money on, their view on supporting their children after graduation (if need be), their thoughts on continuing to work part-time to keep busy.
At this point, both were excited at the idea of ‘taking a step back’ age 60, however, there was a level of uncertainty, that I assured them was more than normal! If you consider the fact that we are taught to save and invest for 30-40 years –- and now the day has come to use this bucket of money to fund our lifestyle, it can be quite daunting!
In any event, once we established baseline assumptions that aligned with their values and objectives, we proceeded to build the vision.
The Outcome
Working together as a team, along with estate planning attorney, we accomplished the following:
Cash Flow / Retirement Analysis
- Created a cash flow assessment to understand what comes in, what goes out, what they pay in taxes, and how much they save – both were surprised at how much at they actually on oncer taxes and savings – this opens the door for effective tax planning IN retirement
- Next, we ran a longer-term retirement analysis that determined they should be in a good position to retire at age 60, and still leave a legacy behind
- The goal here was to establish choice and flexibility, not to provide certainty – as we all now life continues to evolve, and circumstances can change
- In short – we want to avoid making an expensive mistake by overspending too early in retirement
- We ran a few additional scenario’s showcasing outcomes if they worked part-time, downsized their home, increased their expenses to help their children – all were positive
- Using the current resources provided by the State Health Insurance Market Place, we made assumptions around the cost of securing good health coverage prior to Medicare at age 65
- We also worked to model out what type of Medicare bracket they would be in to compare costs and prepare for this as we implement near term planning opportunities
- This analysis provided a structured timeline for this ultimate transition
Tax / Investment Planning
- Rearranged their current retirement contributions to better plan for current and future tax efficiency
- ROTH vs. pre-tax vs. taxable monies
- Repositioned their investment accounts to prepare for distributions at age 60, while remaining aligned for continued long term asset growth
- We came up with a strategy for identifying which account type they will withdraw from first – with a focus on minimizing taxes not just today, but throughout retirement
- Under this umbrella, they realized they were being underserved by your current tax firm, and decided to switch over tax filing services to our affiliated firm to take advantage of integration and simplicity
- This involved utilizing asset location – allocating more risk in their ROTH accounts, less in their pre-tax account, and kept the same risk in their taxable investment account
- We also modeled out an approach that would capitalize on several years of Roth conversions once retired
- The goal here was to see if the math works out to complete Roth conversions sooner than later to aim at reducing taxes down the road caused by Required Minimum Distributions (RMDs)
- In conjunction, but using these conversions to reduce their overall lifetime tax bill from RMDs, Josh and Lauren are also putting themselves in a position where they would never jump a Medicare premium bracket ever again once the conversions were complete
- Versus, if they did no conversions and the taxes generated from RMDs pushed them into a higher effective tax bracket AND higher Medicare premium bracket - FOREVER
- In conjunction, but using these conversions to reduce their overall lifetime tax bill from RMDs, Josh and Lauren are also putting themselves in a position where they would never jump a Medicare premium bracket ever again once the conversions were complete
- The goal here was to see if the math works out to complete Roth conversions sooner than later to aim at reducing taxes down the road caused by Required Minimum Distributions (RMDs)
- We also modeled out an approach that would capitalize on several years of Roth conversions once retired
Estate Planning
- Coordinated with their attorney to begin the process of setting up:
- Wills, Medical Directives (Healthcare Proxy), Financial Powers of Attorney
- Revocable Living Trust
- They live in a state with a State Estate Tax – which required specific language to maximize exemption amounts
- Additionally, they had specific thoughts on when their children receive assets – so we worked with the attorney to build in the appropriate language that also corresponds with new rules on inherited IRAs
- Updating beneficiary designations to reflect the new document elections
Conclusion
With a framework in motion that reflects their values and objectives, Josh and Lauren now feel more equipped to navigate the next few years and ultimately make the retirement decision at age 60.
All of this is not done in one day; it is a structured process that takes TIME to develop and implement – don’t let anyone convince you otherwise.
Everyone’s situation is vastly different, even for families with similar asset levels – work to find a team that works and adapts alongside of you, not FOR you
Disclaimer: the above financial planning case study does not involve an actual client. This case study is hypothetical and is for educational purposes only. The information listed should not be taken as advice.