The Bogleheads' Guide to Retirement Planning (33 page)

Spending more in some years and cutting back in others sounds reasonable, but if your portfolio declines by 20 percent on account of poor market conditions, that translates into a 20 percent reduction in income from your investments. It might be difficult to reduce expenses by that amount. A variation on this would be to smooth out income by setting aside any excess in the up years so that it’s available to you in the down years.

In summary, the shortfall between your expenses and other sources of income will dictate how much you will need to withdraw from your retirement accounts each year. The 4 percent safe withdrawal number is a reasonable estimate of the amount you can take each year without running out of money. It is a good start when planning. Also plan to have enough money to live 10 years past the age your oldest parent or grandparent lived, but don’t plan on living 40 years past that age. You do need to be conservative, but you do not need to be the richest person in the graveyard.

After using Social Security, any pension or annuity payments, and RMDs from your traditional IRA for living expenses, the least taxing way to withdraw money is in the following order:

If you have sufficient income from other sources and do not need to take an RMD from an IRA distribution, it may make sense to take an IRA distribution anyway. If your tax bracket is low, you can do an IRA rollover into a Roth IRA. True, you may have to pay some income tax on the distribution, but once the distribution goes into the Roth, you will never have to pay income taxes on the interest or gains that money earns.

There are two benefits to voluntarily taking an IRA distribution. First, the taxes you will pay are going to be negligible because you are going to do this only if you are in a low tax bracket. Second, taking money when you do not have to lowers the amount you have in the IRA at age 70½, reducing the amount you are required to take as an RMD.

The goal in retirement is not to avoid taxes but rather to control taxes. You will probably pay some income tax each year, but at least you have your hands on the levers that control how much you pay and when you pay it.

It is helpful to plan years ahead in retirement. Consider your probable tax bracket now and in future years. Try to minimize your income in the years you are in a high tax bracket and increase your taxable income in years when you are in a low tax bracket. Here’s an example: assume you retire at the age of 62 and stop receiving a salary. You are not required to take an RMD from your traditional IRAs until you turn 70½. In the meantime, you will have less taxable income, so you could take this opportunity to do Roth conversions each year, to fill up the 15 percent tax bracket. Late in the year, estimate your taxable income for the year. If it looks like you will have room left in the 15 percent bracket, use up the rest of the 15 percent bracket.

Here is another example: assume a married couple filing jointly in 2008 had $45,000 of taxable income. The top of the 15 percent bracket was $65,100, so the couple could have converted $20,100 of their traditional IRA (assuming they made no after-tax contributions) to a Roth and would have paid only 15 percent tax on the entire conversion amount. Another way to use up the 15 percent bracket would be to sell savings bonds that have a large amount of built-up interest.

Keep in mind that this information is based on the current tax laws. Tax laws change frequently and can be difficult to keep up with. It’s not possible for anyone to accurately predict how the tax laws will change in the future, so the best you can do is plan by using the current tax laws and try to keep abreast of any changes that might affect you.

Once a year, sit down and do a little planning. Create some budgeting worksheets as you approach retirement, and then update them annually. Many budgeting worksheets are available free on the Internet. After you complete these worksheets for the first time, updating them each year will be much easier. Paper copies work fine, but it is easier to create spreadsheets on your computer. Follow these five steps.

1. Update your budget worksheet to determine income needs for the coming year.

2. Update your income worksheet to determine how much additional income you will need, if any.

3. Update your net worth statement to get an overview of your financial status. If you are attempting to keep most of your principal intact, your net worth should be the same or larger than it was last year. If you plan on using up some or most of your money, your net worth may well decrease each year. Large stock market fluctuations may make your balances larger or smaller.

4. Estimate your taxes. Use a commercially available program such as TurboTax or Tax Cut, or have your tax preparer do it for you. If this year’s information is very similar to last year’s, your taxes will be similar to last year’s, unless there have been major changes to the tax laws.

5. Update your asset allocation worksheet.

Now, you have all of the information you need to plan your withdrawals. Check your asset allocation and, if possible, withdraw money from those accounts that have a higher-than-desired percentage. For example, if your target allocation is 25 percent stocks and 75 percent bonds, but the stock market has risen recently and you now have 30 percent stocks and 70 percent bonds, specify that your RMD be taken from the stock funds within your IRA.

If your account needs further rebalancing, whenever possible rebalance within your tax-deferred account to avoid selling anything in your taxable account.

Advanced planning and annual monitoring of your financial situation is crucial to a successful retirement. Spend some time before you retire planning out your budget, estimating changes to your spending, and analyzing your housing situation, asset allocation, investments, and taxes. Then all that’s needed is a little time, once a year, to plan withdrawals. Enjoy the rest of the year, knowing you have planned your finances for the year. In addition, you may even want to consider long-term, generational planning by taking into account the amount you may want to leave your heirs, if any.

Early retirement! Who doesn’t like the sound of that? The Bogleheads’ path to early retirement is similar to the Bogleheads’ path to a normal retirement: create a viable plan, execute the plan, and
stay the course!
The earliest age that will be considered for retirement in this chapter is 40. We will describe several strategies and sources of bridge income that can support you during the interim between your last day of full employment and your first Social Security payment sometime in your 60s. A case study in each section will assist you in visualizing your needs when writing your own successful early retirement plan.

Perhaps after reading this book, you will realize that you already have enough resources to retire early. You pick a retirement date two months out, calculate how to bridge your income, make your final list of to-do items, and then tender your resignation. You go on to enjoy early retirement immensely, secure in the knowledge that you will have enough resources to weather any financial storm. Your only regret is that you didn’t retire earlier. You go on to live a full, satisfying life during an extended retirement. If you save early and often, live below your means, and do not go off on a rock star lifestyle, there’s no reason you should not be able to retire early, on your own terms. So, let’s go figure out how to make that happen.

Historically, retirement meant quitting a full-time job around age 65. A longtime employer gives you a retirement party and a gold watch or a clock, and then you spend endless days puttering around the house, traveling more, and perhaps enjoying hobbies such as golfing or fishing. It is an idyllic scene from the classic movie
On Golden Pond.

That was your father’s retirement. Now there is a new option available that can be called a soft retirement. A soft retirement has several differences with the traditional definition. It can be an easing of employment from full-time to part-time to none at all; it can mean a paid or unpaid sabbatical every few years, followed by a return to part-time or full-time work; it can mean becoming a self-employed consultant with a flexible schedule, preferably part-time; or a complete change of careers to an occupation that satisfies your spiritual needs rather than your financial needs. Whatever form soft retirement takes, it will not be the abrupt change of going from 100 percent full employment to no employment at all on your 65th birthday.

There are also a few windfall early retirees. They are the lottery winners, Hollywood celebrities, professional athletes, young entrepreneurs who sold their businesses, and people who received large inheritances or lawsuit settlements. Receiving a rags-to-riches windfall is a dream we all have, but they are few and far between. This chapter is primarily written for the other 99 percent of the population who are researching early retirement without the aid of a lucky lottery number or a 100 mph fastball.

There are millions of American military personnel who enlisted at 20, worked 20 years, and retired at 40 with a full pension and medical benefits. However, if you are not working and are younger than 40, let’s just say you are in between jobs. Even though the Social Security Administration (SSA) considers age 67 the new retirement age, nobody considers retiring at 65 to be early retirement. While some people are able to retire prior to 40, and there are octogenarians working full-time, we will define early retirement as that sweet spot from age 40 to 64.

There are important ages to consider when working on your plan for early retirement.
Table 13.1
lists some of those important ages.

In addition to the age information in
Table 13.1
, you may be affected by other age-related events. For example, your employer’s pension may offer an early retirement option after a certain age or according to a work-plus-age formula. Your employer may also offer medical coverage until Medicare starts.

Your pension benefits may be a significant factor in determining your retirement date. Typically, employees are not fully vested in their pension plans or stock options until they turn 60 or 65. However, prospective early retirees are eligible for an increasing percentage of these pension benefits as they approach their full retirement age. This makes the early retirement decision difficult and stressful. Delaying early retirement by one year often means an additional 5 to 10 percent in pension benefits. Delaying by two years means an additional 10 to 20 percent. And so on. You must weigh the pros and cons of delaying retirement by a year to get the extra benefits, and then do the same analysis each year.