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Donna, a 51-year-old single woman, came to me recently with the question, "Am I on track to retire?" Initially, the answer was no - not really. At least, not on her terms. But with a few important changes, that answer became a resounding yes. Here’s Donna's retirement journey and how small adjustments can have a significant impact.
Donna’s story is particularly noteworthy for two main reasons:
Donna has two adult children she wants to spend more time with during retirement. She loves to travel and has a few bucket list destinations she’s looking forward to visiting in her early years of retirement. Recently, she received a significant raise, increasing her annual income to $220,000, so she wants to make sure she’s minimizing her taxes both now and in retirement. Lastly, she wants to retire with confidence in her plan, knowing that she can spend what she has worked so hard to save up over her career, without worrying about running out.
To get a clear picture of Donna's financial situation, we first took a snapshot of her current net worth:
Donna’s current expenses are around $6,000 per month, excluding her mortgage, property taxes, and home insurance. Understanding her current discretionary expenses helped us plan for what she will need from her portfolio to maintain her current lifestyle in retirement.
We ran two retirement scenarios for Donna:
The Monte Carlo simulation ran 1,000 different projections to determine the likelihood of Donna's money lasting until age 90. Initially, only 57% of the scenarios showed success. Here's how we improved that number:
Donna can now contribute an extra $7,500 per year to her 401(k) due to the catch-up contribution limit for those over 50. This increase not only boosts her retirement savings but also offers significant tax advantages, given her high-income bracket.
Instead of paying an extra $900 per month towards her mortgage principal, Donna should invest this amount in her brokerage account, providing better returns. Paying off a low-interest mortgage early might seem like a good idea, but investing those funds can yield higher returns, offering more financial flexibility and growth potential.
Donna’s current investment allocation is too conservative. By increasing her stock allocation to 70%, she can expect better returns over time. A more aggressive investment strategy is advisable given her long time horizon until retirement, allowing her to benefit from the higher potential returns of equities.
Switching to the retirement spending smile strategy, where spending is higher in the early years of retirement, lower in the middle, and higher again towards the end, provides a more realistic approach. This method accounts for the natural ebb and flow of spending habits as one ages and ensures more accurate financial planning.
We recommended Donna wait until age 70 to claim Social Security, increasing her benefit significantly. Delaying Social Security can significantly boost her monthly benefits, providing a more substantial and reliable income stream during her later retirement years.
Donna is currently earning $220,000 annually. A few years back, she was earning less than half of that. We factored this into her Social Security benefits calculation to ensure accuracy. Her projected Social Security benefit at full retirement age is $3,689 per month.
Donna is also saving diligently:
Donna's monthly expenses are around $6,000, excluding her mortgage. This amount covers her discretionary spending and fixed monthly bills. Additionally, she pays $900 extra per month towards her mortgage, which is scheduled to be paid off in 2036.
Donna’s primary goals include:
By contributing an extra $7,500 annually to her 401(k), Donna will not only reduce her current taxable income but also significantly boost her retirement savings. This strategy aligns with her goal of tax efficiency and maximizes the use of her higher income.
Instead of allocating $900 monthly towards her mortgage principal, we advised Donna to invest this amount in her brokerage account. Additionally, redirecting her savings account deposits of $2,000/month to the brokerage account will provide a better long-term return than the low interest earned in traditional savings.
Donna's current portfolio is too conservative, with only 44% in equities. We recommended shifting to a 70/30 stock-to-bond ratio. This adjustment will increase her expected return to around 7%, which is still conservative compared to historical averages.
We suggested the retirement spending smile strategy, where spending is higher in the early years of retirement (the go-go years), slows down in the middle years (the slow-go years), and increases again towards the end (the no-go years). This strategy aligns better with typical retirement spending patterns.
By waiting until age 70 to claim Social Security, Donna can maximize her benefits. This approach provides her with a higher monthly income, reducing the risk of outliving her savings.
We advised Donna to withdraw from her taxable accounts first, then tax-deferred, and finally tax-free accounts. This sequence is projected to save her $240,000 in taxes over her lifetime. By optimizing the order of withdrawals, Donna can minimize her tax liability and extend the longevity of her retirement funds.
Converting some of her 401(k) funds to a Roth IRA up to the 24% or 28% tax bracket can result in nearly a million dollars more in tax-adjusted wealth. Roth conversions take advantage of her current lower tax rates and provide tax-free income in retirement.
To see if Donna could retire earlier, we ran a scenario where she retires at 62. While this scenario initially showed a lower probability of success, we made some compromises, including:
With these adjustments, Donna’s probability of success increased to 81%.
Donna also expressed a desire to leave a legacy for her children. We factored in a $250,000 legacy goal, ensuring it didn’t significantly impact her retirement plans.
Before implementing these changes, Donna was in an okay position to retire. After these adjustments, she is on track to retire with confidence. Here’s a quick recap:
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