Early Retirement - Financial Freedom (Investing, Tax Planning, Retirement Strategy, Personal Finance)

How To Plan For Big One-Time Expenses Before You Retire

• Ari Taublieb, CFP®, MBA • Episode 2379

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This episode focuses on effectively managing significant one-off financial expenses in retirement and the best strategies for portfolio withdrawals. We explore different sources of withdrawals, tax considerations, and how to balance immediate needs with long-term financial security.

• The impact of one-time expenses on portfolio sustainability 
• Analyzing options: taxable accounts, tax-deferred accounts, and Roth IRAs 
• The importance of understanding tax implications in retirement planning 

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Ari Taublieb, CFP ®, MBA is the Chief Growth Officer of Root Financial Partners and a Fiduciary Financial Planner specializing in helping clients retire early with confidence.

Speaker 1:

no-transcript over. Today is a comment that was left in the Root Collective, which is our community. So if you have not seen the previous episodes where we go into detail on that root collective, certainly check that out. It is free and in the description of this episode, whether you're watching on YouTube or listening on our various podcasts, I'm going to read this comment and then we're going to get to address it. So you ready, james, I'm ready, cool.

Speaker 1:

This comes from Gary R and he posts and says his subject line is one time expense soon to be retired. Howdy y'all. I'm in my final recreational employment months. So he's speaking our language either four or 10 to retirement and thinking of having some work done on the house approximately 40 K. This brings up the question of where to pull portfolio funds from. I'm firmly in the 24% tax bracket. Now he's just flexing on us guys. Okay, with the possibility of dropping to 22% post retirement, lower in retirement, confident my portfolio can handle the hit without an impact on my retirement goals. That being said, I'd still like to pull the funds, as Ari would say, optimally.

Speaker 1:

Here are the options as I see them Taxable account, which we call the superhero Of all potential sources. The 40K would represent the largest percentage of our brokerage accounts, other than any cash we have, but we would get the benefit of the long-term capital gains rate. So that's number one, option one. Option two tax deferred account. So although I'm not 59 and a half, I'm still able to pull money for my 401k without incurring a 10% penalty. Whoa, whoa, whoa. How do you do that? We'll mention that in a little bit. I could pull from here and pay 24% without this fear of jumping to that next bracket, 32. And then the third option is tax-free. He says I don't have access to all of the money in my Roth, but I believe I could pull from what represents my personal contributions, which, by the way, he is correct on that is allowed. Which brings us to option four. I could just use cash, but it would more severely deplete my cash reserves. Thoughts all. So the beautiful thing here, james, is he's asking the whole group here, not just us.

Speaker 2:

He probably doesn't even know that he was asking us, but he asked, so we're going to give you the answer, Gary. Thoughts on this. James, there's at least a three-part framework that I would want to go through to answer that. It sounds like he's actually already gone through part of this. The first part is just can you do this? And I think he's approaching this the right way.

Speaker 2:

The you know generally we look at okay, can I retire? Okay, what does that come down to? It comes down to can your portfolio meet the needs that you need it to meet that go beyond what social security or any potential other non-portfolio income sources, like a pension, are going to generate? So, basic example you have $500,000 in a portfolio. You need $20,000 per year from your portfolio. Cool, that's a 4% withdrawal rate that should be sustainable if your portfolio is invested the right way for call it, 30 plus years, Call it good.

Speaker 2:

Well, what about that person that needs $20,000 per year also has a major home renovation that's going to cost them $200,000. Well, you take that $200,000 out of the 500. Now you're down to $300,000. Can that 300,000 still support the $20,000 per year that you need? Now, all of a sudden, that's over a 6.5% per year withdrawal purchases. Is that a new vehicle? Is that a home remodel? Is that sending kids to college? Is that paying for a wedding? Is that all these different things? So think about that first. What portion of your portfolio is needed for these one-off expenses? And then, is the remainder enough such that a sustainable withdrawal rate taken from that portfolio could continue to meet your call it your core basic income needs along the way? So it sounds like that's already been taken care of.

Speaker 2:

Gary's already gone through that. He says something I'm trying to look for the exact quote here. He says I'm confident my portfolio can handle the hit without any impact on my retirement goals. So I'm going to make the assumption that Gary has looked at that. The second thing is how are you invested? By the way, the third thing is taxes. To skip ahead. I think Gary's looking at the tax piece, and that's the question. There needs to be a progression here to get to that piece.

Speaker 2:

The first piece is can your retirement still support that? Number two is investments, and this is actually an important one of how should your investments be allocated in order to support that? So, for example, if 100% of Gary's assets are invested I'm using extreme example here. He's 100% invested into McDonald's stock, every single account, all McDonald's stock. He needs $40,000. And after one year of retirement, McDonald's stock has tanked 50% because no one wants their hamburgers anymore. Well, what's he going to be required to do? He's going to be required to sell McDonald's stock when it's down 50% to free up that $40,000. In other words, he's going to have to sell a good chunk of stock at a severe discount.

Speaker 2:

So what do you do? Number one, you don't just own one stock, obviously. But number two, you say what's the right mix of investments between, at a high level growth investments and stable investments? We call it root reserves internally. So what's the growth allocation? Things are going to grow for you to keep up with inflation. What's the right things of internally, as we'd speak about it, root reserves. Root reserves is going to include any outflows you need from your portfolio over the next, uh, call it, five years. So this would be something that Gary would say in addition to my monthly need from my portfolio, how much do I need to pull for this $40,000 to remodel? So now I'll finally get to his actual question. Once you've determined how much needs to be stable so that you have five years worth of that, so that, even in a downturn in the market, you can still meet your needs.

Speaker 2:

Now it's a tax piece. Now this is where you should have a tax strategy that, essentially, is helping to understand what tax bracket we want to be in. Now. Of course, we all want to be in the 0%. If we could just wave a wand and say I'm in the 0% tax bracket, cool, we'd do that. But what do we want to be in today? So that I'm minimizing or not jumping into any extreme tax brackets in the future.

Speaker 2:

So what Gary should do is today he's in the 24% bracket. It sounds like, if I'm reading between the lines, he'll be in the probably the 22% bracket when he retires. That's not the full picture, though. What are you going to be in, Gary, say, 10 years from now, 20 years from now? Who knows some things. But specifically, what about when social security starts? What's that going to do to your tax bracket? What about when required minimum distributions kick in? What's that going to do to your tax bracket? What about when certain I don't know if there's windfalls of selling a home, moving states, other pensions coming into play? Understanding the full landscape of what will your tax bracket look like over the course of retirement. So you're not just looking. Okay, I'm in the 24% bracket today. Well, so what? What are we comparing that to? What we should compare that to is where you're going to be, which, yes, is somewhat of an educated guess, because tax brackets and tax law can and will change.

Speaker 2:

But when he starts to do that, he can start to say, oh, maybe, for example, I shouldn't exceed the 12% bracket. Well, the good news about retirement planning is you get to fully dictate this. I shouldn't say fully to an extent, because you can pull the right amounts from cash versus taxable accounts, versus traditional IRAs versus Roth IRAs. You can manufacture the taxable income that's right for you. So if he's looking at this and if he looks at his whole tax landscape and says I should never really be above the 12% bracket, well then, come up with the right mix of withdrawals. Is that more from cash and brokerage and then a little bit from the IRA, just to fill up the 12% bracket, versus? If he says I should really be filling up the 32% bracket today to avoid being in a 35% bracket in the future, it probably means he has an enormous traditional IRA. So that's kind of an extreme example, but it's essentially looking at where am I going to be, when am I today, as is, and then where should I pull funds from to try to fill up the right bracket.

Speaker 2:

But here's one last thing. There's a theme here. Are you asking me a question? I take way too long to answer it, so sorry about that.

Speaker 2:

But here's what I see some people doing. They have cash on hand and we almost get addicted to that cash on hand because it's there and it's tangible and we're going to you know, we're going to implement our Roth conversion strategy because we're going to be living on this cash. Well, if Gary pulls more money from his IRA today and that pushes him into the 32% tax bracket because he wanted to preserve that cash, and now next year he's living on the cash and converting only up to the 22 or 24% bracket, he kind of shot himself in the foot doing that. He said wait, use your cash to prevent going into the 32% bracket, not to allow you to convert in the 22 to 24% bracket. So we almost have to detach ourselves from being too connected to any of our specific accounts. That cash account tends to be something that people get pretty connected to. To say objectively where should I pull funds from today to minimize the lifetime tax liability I'm expected to pay?

Speaker 1:

Great answer. The fourth one I would add is sleep, which you're not going to see. If you look it up on any forum of analysis, it's not going to see the sleep analysis, but sleep. And so what I mean by that is is there an amount of cash that you want to have at all times, no matter what? I have clients that will say no matter what, I need 50,000. I couldn't tell you why. It's not scientific, I just sleep better. Okay, great, then your analysis should not be cookie cutter.

Speaker 1:

Even though the conversion analysis or the withdrawal strategy says you should pull from this account over that account, it should be based on yeah, take the finances into consideration and then go, wait a second. I'm a human, I'm not a robot, and the mistake that we'll see is let's just use Gary's example for a second. Let's assume Gary goes optimally. If I don't want to pull from cash, what are my options? Okay, so I could use this rule of 55 thing, I could try this Roth tax-free thing. I could do this superhero thing. Well, on paper, the capital gains rate seems great, but we have no idea if Gary's got all McDonald's because he hates Burger King, like. We just don't know. So what we need to get clear on is like hey, what's going to let you sleep at night and what does the tax answer say?

Speaker 1:

With assumptions that are well-known and I apologize because I've told this story a few times, but I'll do it one more time because I think this is helpful which is I went to a doctor this was months ago and I said, doc, what you just said there, it sounded great. I think you think it sounded great. Don't know what you just said, so try again. So he goes, okay. So he starts explaining to me the lab that the pills are made in that he wants to give me for my issue, and I said, doc, respectfully, I don't care about the lab, I need to know why I need to take this pill or why I don't need to take this pill, and I'm not going to take it blindly. So I want you to educate me as to why I'm going to take this pill.

Speaker 1:

But you're going too deep in the lab and sometimes this analysis paralysis occurs. Gary, I'm not calling you out to be mean, I don't know if you're doing this, but if we are spending all of our time on the analysis when, in reality, there's a simple answer that's going to allow you to take action. Maybe it's not even optimal, which you know how much I hate saying that, since you called out my optimal word in here. Sometimes that can be the best answer too. So we want to give you guys hey, here's like the pill, but here's what I need to know about first, what's your health goals? Legacy, yada, yada.

Speaker 2:

Yeah, one more thing I'm going to add into this too is kind of just like a tip for people who are planning for one-off expenses. Let's assume, just for simplicity, that someone has they're retired and all their money's in an IRA and they're pulling money out of their IRA and they're partway between the 12% and the 22% tax bracket and they're not doing the Roth conversions because they say, you know what we? We don't need to because required distributions aren't going to be a huge issue for us in the future. We're just going to, we're going to live here in the middle between the technically a 12% bracket, but partway between 12 and 22%, and that individual is planning to have a big home remodel in five years and that home remodel is going to cost $150,000. Well what? And then in year five they might spike up into the 24% bracket and then back down to the 12th.

Speaker 2:

Well, how do you plan ahead for that? That's actually pretty simple. It's the same concept of a sinking fund. You know, if I want to be able to take one big trip with my family once a year and it's going to cost $12,000, to use a easy math number, well, I'm not going to try to pay $12,000 from one month of salary that month I actually take the trip. I'm going to set aside $1,000 a month each month, so that by the end of that 12th month it's all there and I'm good to go to take my trip.

Speaker 2:

Well, same thing here. Almost think of like a sinking fund. Don't just wait for year five to take out a giant amount from your IRA that pushes you up a couple of tax brackets. Take out enough in the years leading up to that to say, okay, I can still take a little bit more at a 12% rate and maybe I put that into a brokerage account or maybe a cash account, depending on how far out I am from the incurring the expense. And in doing that, you're preparing for this one-off expense using your lower tax brackets, as opposed to getting trapped in a much higher one.

Speaker 1:

Really good tip, especially with like an RV, because it's something that you get excited about. Every month you're putting money away and you know, hey, I'm going to get that RV. And then you find an RV that you really like. So now you put even more away. Well, you probably weren't going to feel comfortable taking out $140,000 to buy an RV, because you've probably never bought anything worth that amount of money, maybe aside from your home. But now you're able to do it because you're like I was intentional about saving for that. Yes exactly.

Speaker 2:

So this, you know this is all going back to the very beginning. Those one-off expenses. Yes, we talked about a framework for thinking through it. Can you still meet your other retirement income goals? Do you have the right investment strategy to meet that? Do you have the right optimal withdrawal strategy to minimize your taxes?

Speaker 2:

But still, there's oftentimes a mental hangup. But that just hurts to pull out $40,000, $50,000, $100,000 when that's your portfolio, that's your livelihood, that's what you've worked for. So keep that in mind too. It's not going to be easy. Even if you have the right retirement and investment and tax strategy, there still might be a mental hangup. So prepare for that, prepare that it might not just be easy to do, to write a five-figure, six-figure check, whatever it might be. But when we start thinking about what's the true purpose of our money it's not to keep growing bigger and bigger, making us richer and richer until we die one day it's to say what are the experiences I can have in my retirement to make the most of it? So just another perspective piece on those expenses in retirement.

Speaker 1:

Love it. Last one I have is we have biases as well as advisors. As humans, my gut I go to one-time expense right. When, gary, I saw you post that and I decided to fuse that for our episode today, my gut will go to oh, do cash, because no tax implications. You've already kind of saved for it, whether you know it or not, but I don't know.

Speaker 1:

Do you have an emergency fund? And when we think of an emergency fund, I'll think what's the purpose of this and this is an emergency fund is I want to go tap into something if I need it, if my car breaks. But when you're in retirement, you don't really need an emergency fund because, yes, you want cash on hand, but the traditional sense is I don't want to have to go pull for my 401k, where there's a penalty. And what if markets are down and you name it? Well, you already explained here, gary. You have the ability to access those funds. So it puts you actually in a more difficult position, as odd as it may sound, because it's like hey, when you have more money, you have more decisions that feel like they weigh more, because you're like why is that the case, though? I saved and invested. It's the same reason. People reach out to us going hey, why am I more stressed with 10 million versus when I had 500,000? Well, there's more to lose and these decisions become really difficult.

Speaker 2:

So just recognize you have biases, we have biases, we all got them, we all got them and uh, kind of good excuse to give it to them. So very cool. Well, anything else today, I guess, shout out collective. If you're not in there, collective is free. Collective is a community of, as as of now it's launched a week ago, two weeks ago, 1500 plus people in that community interacting, sharing tips. Um, really cool things happening. So join. The collective link is in the show notes. Anything else already we missed?

Speaker 1:

Yeah, when you check out at McDonald's, if you tell them you're in the collective, you won't get any discount and they might look at you funny. But if you want to record it and share it with us, we'll post it.

Speaker 2:

We'll make a channel for that. All right, everyone. Thank you for listening and we will see you all next time. See ya. The information presented is for educational purposes only and is not intended as an offer or solicitation for the sale or purchase of any specific securities, investments or investment strategies. Investments involve risk and are not guaranteed. Any mention of rates of return are historical and illustrative in nature and are not a guarantee of future returns. Past performance does not guarantee future performance.

Speaker 1:

Viewers are encouraged to seek advice from a qualified tax, legal or investment advisor professional to determine whether any information presented may be suitable for their specific situation Once again.

Speaker 2:

I'm James Canole, founder of Root Financial, and if you're interested in seeing how we help our clients at Root Financial get the most out of life with their money, be sure to visit us at wwwrootfinancialpartnerscom.