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Ron: This is the Mach 1 Market Moment with the team at Mach one Financial Group in northwest Arkansas. Welcome to the Mach 1 Market Moment with your retirement income planning specialists at Mach one Financial Group. Today, David Lee is with us. I’m Ron Stud. Today, David is going to talk about some things you can’t control. Let’s think about things that you can’t control and maybe some things that you can. David, in retirement planning, there are a lot of things that are completely out of your control. Fortunately, the things that you can control allow you to deal with those things you can’t. Can you talk about some of those today?
David: Yeah, number 1, one of the things that none of us can have control over is what happens in the market, right?
One thing I always tell clients or potential clients when they come in the door is that – I can’t control the market anymore than you can. I can’t even necessarily predict what the market’s going to do tomorrow, next week, next month or next year, any more than you can, because there are too many unknowns and none of us know the future right?
So it’s obvious that none of us can predict or control the market. However, one thing you can control is how much risk you’re exposing yourself to. You know, when it comes to planning, especially retirement, one of the things I almost always tell clients is – Look, don’t worry about the things that you can’t control. Just worry about those things you can control and take affirmative action. Take positive steps to control those things you can’t control. So, as I just said, we can’t control the market, but one thing we can control is how much risk we’re exposing ourselves to when we make an investment.
So what I mean by that one? For example, if you invest in CDs, if you put money in a CD, you’re not exposing yourself to any market risk, right? You’re FDIC insured up to the FDIC limit. On the other end of the risks spectrum, if you put your money into an individual stock or mutual funds, you’re exposing yourself to either individual stock risk or just market risk in the case of the mutual fund. So, there are ways that you can control how much risk you take with an investment. Obviously, the less risk you take, the lower your rate of return is gonna be.
So, you first need to start when it comes to retirement planning, by understanding how hard does your money have to work for you to be able to meet your income goals on a monthly basis and not have a risk of running out in a realistic life expectancy? Here at Mach 1, we always assume – “Are we planned to age 100?”. Even though you may think, “there’s no way I’m gonna live to 100“. But you don’t know- people are living longer these days, and we don’t want to client to run out of money on our watch, so we always plan to age 100.
We take into account a number of variables, such as how much social security income you’re gonna have. If you’re gonna have a pension, how much? If you do have a pension, is your spouse gonna receive part or all that pension if you die first? Obviously, how much do you have saved so far today, as far as how much is in your 401K or Roth IRAs or other retirement type savings accounts? How much do you spend? You know, what’s your lifestyle? How much do you spend on vacation and travel in a year? How much do you want to spend on vacation and travel in a year? How much do you want to spend on the grandkids, for example?
And then there’s the normal fixed living cost of, you know, if you’ve still got a mortgage, how much is it? If you do still have a mortgage, when is that mortgage gonna be paid off? In a whole host of things like that, all those things go into a good solid retirement plan so that we can be able to project the future from that set of known starting conditions, if you will. And then once we’ve got all that plugged in, we’re able to figure out what kind of rate of return if you’re gonna retire age X – but everybody’s different when they want to retire but – if you’re gonna retire at Age X, with all these known starting conditions, what kind of rate of return do your retirement funds need to average in order to get you safely from here to retirement and then from retirement through age 100? The lower that required rate of return is the less risk we have to take.
So if, for example, we only need to average, say, a 4% rate of return and you can retire on time and not have a risk of running out of money prior to age 100, our advice would be – Well, if we don’t need to take risk, why should we take it? So we would use mostly no risk investment products such as CDs, cash, fixed annuities and indexed annuities, because none of those have any market risk associated with them.
On the other hand, if we needed, say an 8% average rate of return, well, then we’re gonna use a little bit or some portion of all those risk free instruments I just mentioned, but we’re also going to use some more long term growth investment vehicles, such as what we call hedged equity. Where we’re participating in the market upside, getting most of the gain of the market – when I say most it is typically between 72 up to 90% of the gains of the S and P 500 index when it’s up, while limiting our loss in a down year to no greater than, say, 8 to 10%. We call that hedging your risk.
We would use a variety of zero risk investment vehicles, combined with investment vehicles that have some element of risk, but have that risk mitigated or hedged in some way. That way we’re taking a known amount of risk. So even though we may not be able to control what happens in the market next week, next month or next year, we can control how much risk we’re exposing ourselves to. So that’s a very important thing to understand that you can indeed control how much risk you expose yourself to and still potentially get the rate of return that you need to get in your retirement years.
The second thing that we can’t control, for the most part, is how long you’re gonna live.
You can’t control how long you’re gonna live, right? Because you never know. You know, none of us are promised tomorrow -you’ve heard that before, but we can control how much emphasis we put on creating the lifetime income stream. So one of the primary risks today that retirees face is the possibility of living a very long life. You don’t normally think of living too long as being a risk, but it really is, if you really think about it, because there’s a real risk that you could run out of retirement assets if you live long, especially if you retire early or if you live in a really high lifestyle. Those two factors can can increase the possibility of running out of retirement funds in your retirement years. So, you wanna control how much emphasis you place on creating lifetime income streams rather than trying to control how long you live. You want to make sure that you carve out a portion of your total retirement funds to create what I call a ‘private pension plan’.
Most people out there listening probably don’t have pensions. They’re becoming a thing of the past rapidly, especially for younger generation’s. Most people are especially younger people are not gonna have a pension. So it’s even more important for younger folks to think about carving out a portion of their future retirement savings, to allocate to what I call a private pension plan, also known as a lifetime income annuity. So that’s another area which Mach 1 can help.
You don’t want to put too much there because then you might not have enough liquid assets in a retirement. But you also want a place too little there because then you might not have enough monthly guaranteed income to meet your living expenses. So we first want to solve that income problem by making sure between social security, pension and private pensions, (also known as annuities), we want to make sure that between those income streams, we’ve got enough income coming in to meet our basic day to day living expenses such as our grocery bill, our utility bill, mortgage if you have one. Not necessarily the fun to do stuff like your annual vacation or your two or three times a year vacation or whatever it is, but definitely covering the day to day living expenses. We can’t control how long we live, but we can control how much emphasis we place on creating those lifetime income streams.
Third thing, we can’t control what tax rates will look like in the future, but you can control how much of your wealth you leave in places that will be taxed in the future.
So what do we mean by that? Well, in an IRA, for example, most of you probably know when you get to your retirement years and you start withdrawing from an IRA, you’re gonna pay taxes on every withdrawal at whatever your tax bracket is. Well, the same applies in the event of your death. If you die and you leave an IRA to your children or grandchildren, they’re gonna have to take all that money out over a period of time and pay taxes at their tax bracket. And obviously one of the risk there is, is what if tax rates are significantly higher in the future than they are today? Then you’re just essentially passing on a what could be a significant tax burden to your heirs. So, even though we can’t control what Congress is going to do, relative tax rates in the future we can control how much of that we pass on in terms of tax burden to our heirs.
So how do we do that? Well, one way, one important way we can think about doing Roth conversions, a Roth conversion is where you take money out of an IRA today. Pay taxes on it today at today’s tax rates, which are relatively low historically speaking and convert it to a Roth IRA. Once it’s converted to a Roth, it’s tax free forever. Even upon death, it passes on to the next generation without any tax cuts. Or another possible solution there is, is you could just simply purchase a life insurance policy, a permanent life insurance policy that pays a tax free death benefit to the next generation, equal to the amount of tax burden that you anticipate them having to pay when they ultimately inherit the IRA.
There’s some other things that you can do, if you’ve got stock, for example, one thing we see a lot in our area is Walmart stock. If you’ve owned Walmart stock for a long time, and you’ve got a low cost basis in it, well, if the ways tax laws were written right now, you receive a step up in basis at death, which means that your kids would inherit that stock with no tax consequence. There is a lot that I could talk about there, but for time’s sake, I’m gonna move on to the last one, which is?
The fourth thing we can’t control is we can’t control what will happen with social security in the future.
But you can control how heavily your income plan relies upon it. So, none of us knows what’s gonna happen relative to social security in the future, even the government themselves is saying the trust fund is gonna be depleted by something like 2034. So there’s a significant risk, if you’re relying on social security to be a big part of your retirement income plan, you could be putting yourself in a precarious position. So you want to come in and talk to an adviser like us and let us go through some of the alternatives that we can put in place to make sure that your retirement plan is not too heavily dependent on social security.
Those are the four things that I came up with.
1. You can’t control what happens in the market, but you can control how much risk you’re taking by hedging and using other zero risk investment vehicles.
2. You can’t control how long you’re gonna live, but you can control how much you put in lifetime income streams.
3. You can’t control what tax rates are gonna be in the future, but you can mitigate that tax rate burden by doing Roth conversions and life insurance planning.
4. You can’t control what is gonna happen with social security, but you can control how heavily your plan relies upon it.