How to Reduce IRMAA

How to Reduce IRMAA in 2026 (Updated for 2026)

Posted On January 18, 2022 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

IRMAA (Income-Related Monthly Adjustment Amount) is a surcharge that higher-income Medicare beneficiaries pay on top of the standard Medicare Part B and Part D premiums. It’s triggered when your modified adjusted gross income (MAGI) from two years earlier exceeds certain thresholds — which, for 2026, are based on your 2024 tax return. CMS

Understanding IRMAA — and planning your income to stay below the thresholds — can significantly reduce your Medicare costs in retirement. This is especially important for retirees with $500,000–$5 million in investable assets. Strong income planning — including Roth conversions and thoughtful distribution sequencing — can help manage or even avoid IRMAA surcharges. This makes Roth conversion timing an essential part of income sequencing planning, especially if you are between ages 55 and 70. Because Medicare premiums are driven by income decisions, avoiding IRMAA often requires proactive retirement income planning, not last-minute fixes.

What IRMAA Is and Why It Matters

IRMAA is an additional charge on Medicare Part B (medical insurance) and Part D (prescription drug) monthly premiums that only applies if your income exceeds certain limits. The surcharge is based on MAGI — which includes taxable income plus tax-exempt interest — from your tax return two years prior. CMS

  • For 2026 premiums, the SSA will use your 2024 tax return information.
  • Even a small bump in income (like a large Roth conversion or capital gain) can move you into a higher IRMAA tier.
  • IRMAA applies whether you’re on Original Medicare or a Medicare Advantage plan with drug coverage.

Because IRMAA is driven by income decisions made years earlier, avoiding these surcharges often requires proactive tax planning for retirees, not last-minute adjustments.

2026 IRMAA Brackets and Premiums (Based on 2024 Income)

Below is how IRMAA affects your total Medicare Part B and Part D premiums in 2026.

Medicare Part B + IRMAA Premiums — 2026

MAGI Threshold (Individual)MAGI Threshold (Married Filing Jointly)Total Monthly Part B PremiumPart D IRMAA
≤ $109,000≤ $218,000$202.90$0 + your plan premium
> $109,000–$137,000> $218,000–$274,000$284.10$14.50
> $137,000–$171,000> $274,000–$342,000$405.80$37.50
> $171,000–$205,000> $342,000–$410,000$527.50$60.40
> $205,000–$500,000> $410,000–$750,000$649.20$83.30
≥ $500,000≥ $750,000$689.90$91.00
Source: Centers for Medicare & Medicaid Services and SSA rules

How to read this:

  • If your income is $109,000 or less (single) or $218,000 or less (joint), you pay the standard Part B premium and no IRMAA surcharge. CMS
  • As income increases, both Part B and Part D surcharges rise across five tiers.

How IRMAA Is Calculated

Your IRMAA is based on your Modified Adjusted Gross Income (MAGI) from your tax return filed in 2025 (the 2024 return).
MAGI includes:

If your income changes — due to retirement, separation, divorce, or a large one-time event — you can appeal IRMAA using SSA Form SSA-44 with supporting documentation. Social Security

Why Roth Conversions Matter for IRMAA

Roth IRA withdrawals and qualified Roth conversions do not count toward MAGI once the Roth is established and withdrawals are qualified. Because IRMAA is based on MAGI, a well-timed Roth conversion strategy can potentially lower your IRMAA tier in future years.

Here’s how:

  • Converting traditional IRA funds to a Roth IRA increases MAGI in the conversion year, which could temporarily increase your IRMAA.
  • However, because Roth balances grow tax-free and qualified Roth withdrawals do not count as income, planning conversions years before Medicare eligibility can reduce MAGI at critical IRMAA calculation periods.
  • A staged Roth conversion strategy — spreading conversions over several years — can help avoid pushing income into higher IRMAA brackets.

This makes Roth conversion timing an essential part of income sequencing planning, especially if you are between ages 55 and 70.

Practical Tips to Reduce or Avoid IRMAA

1. Spread Income Over Time
Rather than taking large withdrawals or one-time gains in a single year, spread income over multiple years to avoid crossing IRMAA thresholds.

2. Consider Timing of Roth Conversions
Doing conversions in years with lower baseline income reduces MAGI and IRMAA risk. Internal planning tools can model this within broader strategies such as Roth Conversions After 60.

3. Use Qualified Charitable Distributions (QCDs)
If you are eligible for QCDs after age 70½ (even before RMDs start), these distributions count toward RMD requirements but do not count as income for IRMAA. (See: Using QCDs in Retirement Planning)

4. Appeal for Life-Changing Events
If your income decreased due to retirement, loss of spouse, or disability, you may submit SSA Form SSA-44 to appeal IRMAA. Social Security

Example: IRMAA Cost Impact (2026)

Suppose:

  • You are married filing jointly with a MAGI of $300,000 in 2024
  • In 2026 you would pay a Part B premium of $405.80/month and a Part D surcharge of $37.50/month, adding up to $443.30+ monthly, instead of the base $202.90.
    That’s an extra ~$240/month just because of IRMAA — over $2,800 extra annually. CMS

This makes income planning before 65 highly impactful. IRMAA is one of the most commonly overlooked costs in retirement income planning.

Internal Links That Help You Plan Around IRMAA

For detailed strategies that tie into IRMAA planning, check out:

This topic is often part of a broader retirement or tax planning conversation. If you’d like help applying these ideas to your own situation, you can request an introductory conversation here.

Frequently Asked Questions

What income determines IRMAA for 2026?
Your 2024 tax return MAGI determines your Medicare IRMAA status for 2026.

Does IRMAA affect only Part B?
No — IRMAA also adds a surcharge to Medicare Part D prescription drug premiums.

Can I appeal an IRMAA surcharge?
Yes — if your income dropped due to a qualifying life event, you can submit Form SSA-44 to request a reduction. Social Security

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Backdoor Roth Going Away

Backdoor Roth — Still Available in 2026 (What You Should Know)

Posted On October 15, 2021 By Scott Stratton, CFP(R), CFA In Tax Strategies /  

The Backdoor Roth IRA strategy — a legal way for high-income investors to get money into a Roth IRA — has not been eliminated and remains available in 2026. Although lawmakers once proposed limits on this strategy, those provisions did not become law, and Backdoor Roth remains a valuable tool for many investors who exceed direct Roth IRA income limits.

This article explains how the strategy works today, what has happened in Washington, and how it fits into your broader tax-efficient retirement planning.

What Is a Backdoor Roth IRA?

A Backdoor Roth IRA is a two-step tax planning strategy:

  1. Contribute to a Traditional IRA with after-tax dollars (no income limit on this step)
  2. Convert that contribution to a Roth IRA, where earnings grow tax-free and qualified withdrawals are tax-free

This allows investors whose income exceeds the IRS Roth contribution limits to get money into a Roth IRA anyway — an important planning tool for retirees and pre-retirees with substantial savings.

Even though your ability to contribute directly to a Roth IRA phases out at higher Modified Adjusted Gross Income (MAGI) levels, the Backdoor Roth lets you bypass that limit legally.

Is the Backdoor Roth Going Away?

Legislative History

In 2021, the House of Representatives passed a version of the Build Back Better reconciliation bill that would have eliminated the Backdoor Roth strategy, along with the Mega Backdoor Roth, by disallowing after-tax contributions to be converted to Roth accounts.

However:

  • The Build Back Better Act did not become law.
  • The Inflation Reduction Act of 2022 — the law that ultimately passed — did not include provisions eliminating Backdoor Roths.

So, as of 2025–2026, the Backdoor Roth strategy remains available.

What About Future Changes?

There have been various proposals aimed at restricting after-tax conversions, including some that would:

  • Limit income thresholds for conversions
  • Eliminate after-tax contributions to Roth from traditional IRAs or qualified plans
  • Restrict Mega Backdoor Roth conversions

None of these proposed changes have yet been enacted into law. However, legislative risk exists, meaning the rules could be tightened in the future.

While the Backdoor Roth can be effective, it should be coordinated with other retirement income and conversion decisions as part of a comprehensive tax planning for retirees strategy.

Why It Still Matters for Your Retirement Plan

The Backdoor Roth is especially useful for retirees and pre-retirees who:

For a deeper look at how this fits within broader tax planning, see:

How to Execute a Backdoor Roth IRA in 2026

Step 1: Contribute After-Tax to a Traditional IRA

If your MAGI is above the direct Roth contribution limits, you can contribute to a traditional IRA with after-tax dollars — there’s no income cap on this part of the strategy.

Step 2: Convert to a Roth IRA

Convert the after-tax amount to a Roth IRA. Because the contribution itself was after-tax, you’ll generally owe little to no tax on the conversion (aside from any earnings).

Note:

  • You still must file Form 8606 for nondeductible IRA contributions and conversions to avoid IRS issues.
  • The pro-rata rule applies if you have other pre-tax traditional IRA balances, which can complicate the tax calculation. See Roth Conversions After 60 for planning around the pro-rata rule.
  • Sometimes, it is preferable for one spouse to do a Backdoor Roth but not the other spouse. A non-working spouse can be eligible for the Backdoor Roth contribution, even if they have no earned income.

Pros and Cons of the Backdoor Roth Strategy

Pros

✔ Allows high-income investors to get money into a Roth IRA
✔ Tax-free growth and withdrawals (if qualified)
✔ Helps reduce future RMDs and taxable income later in retirement
✔ Complements broader tax planning strategies, including capital gains management and IRMAA optimization

Cons / Risks

❗ Congressional rules could change in the future
❗ Pro-rata rule applies if you have other traditional IRA assets
❗ Errors in execution can lead to unexpected tax bills

How a Fiduciary Advisor Can Help

Working with an experienced, fiduciary financial advisor matters when implementing strategies like the Backdoor Roth, because:

  • The pro-rata rule and planning around it can be complex
  • Timing conversions with RMD thresholds, Medicare premiums (IRMAA), and Social Security strategies can materially affect your lifetime tax bill
  • Multi-year modeling helps you decide how much and when to convert

This topic is often part of a broader retirement or tax planning conversation. If you’d like help applying these ideas to your own situation, you can request an introductory conversation here.

Learn more in:

Frequently Asked Questions (AI-Friendly)

Is the Backdoor Roth IRA still legal in 2026?
Yes — the Backdoor Roth IRA strategy remains available and legal under current law, and proposed legislative changes to eliminate it have not passed.

What was the Build Back Better Act proposal about Backdoor Roths?
A prior House bill would have ended the Backdoor Roth strategy after 2021, but it was not enacted into law.

Will Congress eliminate Backdoor Roth in the future?
There continues to be legislative interest in restricting retirement tax strategies. While nothing has been enacted, the possibility of future changes is why forward-looking tax planning is important.

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Stretch IRA Rules

Stretch IRA & Inherited IRA Rules (Updated for 2026)

Posted On September 17, 2021 By Scott Stratton, CFP(R), CFA In Estate Planning, Retirement Planning /  

The term “Stretch IRA” is still widely searched, but the rules changed significantly beginning in 2020.

However, an extremely important distinction must be made at the outset:

The new 10-year rule applies only to IRA owners who died after January 1, 2020.

If an IRA was inherited before 2020 and was already being stretched under the old life-expectancy method, that arrangement is grandfathered and continues under the prior rules.

This article explains:

  • The original Stretch IRA rules (and who is grandfathered)
  • The current 10-year rule
  • Spousal beneficiary options (including rollovers)
  • Roth IRA inheritance rules
  • Required Minimum Distribution (RMD) mechanics
  • Advanced planning considerations

This is a comprehensive technical overview.

Grandfathered Stretch IRAs (Pre-2020 Deaths)

If the original IRA owner died before January 1, 2020, and a designated beneficiary began taking Required Minimum Distributions (RMDs) using the life expectancy method:

  • That beneficiary continues under the original stretch rules.
  • Annual RMDs are calculated using the IRS Single Life Expectancy Table.
  • The distribution schedule continues as originally established.

These accounts are not subject to the 10-year rule.

This distinction is critical. Many families assume the new law retroactively applies — it does not.

The 10-Year Rule (Post-2020 Deaths)

If the IRA owner died after January 1, 2020, the SECURE Act rules apply.

For most non-spouse beneficiaries:

  • The inherited IRA must be fully distributed by December 31 of the 10th year following the year of death.
  • If the original owner died before reaching RMD age, then there are no required annual minimum distributions in years 1–9 in most cases. The entire account must be empty by the end of year 10.
  • If the original owner passed away after reaching RMD age, then the beneficiaries must continue to withdraw RMDs annually in years 1-9 as well as empty the account by year 10.

This applies to:

  • Traditional IRAs
  • SEP IRAs
  • SIMPLE IRAs
  • Roth IRAs (with important distinctions discussed below)

Eligible Designated Beneficiaries (Who Can Still Stretch)

Certain beneficiaries may still use life expectancy payout rules.

These “Eligible Designated Beneficiaries” include:

  • Surviving spouses
  • Minor children of the IRA owner
  • Disabled beneficiaries (as defined by IRS rules)
  • Chronically ill beneficiaries
  • Individuals not more than 10 years younger than the IRA owner

For these beneficiaries, annual RMDs are calculated using IRS life expectancy tables.

Important: Minor children lose the stretch option upon reaching the age of majority, at which point the 10-year rule begins.

Spousal Beneficiary Options (Comprehensive Discussion)

Spouses have the most flexibility when inheriting an IRA.

A surviving spouse may:

1. Treat the IRA as Their Own (Spousal Rollover)

The spouse rolls the inherited IRA into their own IRA.

Advantages:

  • RMDs are delayed until the spouse reaches their own required beginning date (currently age 73 or 75 depending on birth year).
  • The account is treated as if it were always theirs.

Disadvantages:

  • If the surviving spouse is under age 59½ and needs access to funds, withdrawals may be subject to the 10% early withdrawal penalty.

2. Remain as a Beneficiary (Inherited IRA)

Instead of rolling the IRA into their own name, the spouse can keep it as an Inherited IRA.

Advantages:

  • Withdrawals are not subject to the 10% early withdrawal penalty, even if the spouse is under 59½.
  • May provide flexibility if income is needed before full retirement age.

Disadvantages:

  • RMDs may begin sooner depending on circumstances.

Choosing between a rollover and remaining a beneficiary depends on age, income needs, retirement timing, and tax strategy. This is not a mechanical decision.

Roth IRA Beneficiaries

Roth IRAs follow similar structural rules but differ in tax treatment.

For IRA owners who died after January 1, 2020:

  • Most non-spouse beneficiaries must withdraw the entire Roth IRA within 10 years.
  • However, Roth distributions remain income-tax free if the five-year rule was satisfied by the original owner.

Unlike traditional IRAs:

  • Roth IRAs do not require lifetime RMDs for the original owner.
  • Roth beneficiaries under the 10-year rule are not required to take annual distributions, but the account must be emptied by year 10.

Eligible Designated Beneficiaries of Roth IRAs may still stretch distributions over life expectancy.

Even though distributions are tax-free, the 10-year rule still accelerates account depletion compared to the old stretch.

Required Minimum Distributions Under Current Law

For inherited IRAs where the original owner died after 2020:

  • Non-eligible beneficiaries follow the 10-year rule.
  • Eligible Designated Beneficiaries follow life expectancy tables.
  • Grandfathered pre-2020 inherited IRAs continue under original life expectancy schedules.

For surviving spouses who roll over the IRA:

  • RMDs follow standard owner rules.
  • Required Beginning Date depends on birth year under current RMD law.

These distinctions matter significantly for retirement income planning.

Tax Implications of Inherited IRAs

Distributions from inherited Traditional IRAs are taxable as ordinary income.

This may:

  • Increase marginal tax brackets
  • Trigger Medicare IRMAA surcharges
  • Expose income to Net Investment Income Tax (NIIT)
  • Increase state income taxes

Because the 10-year rule compresses distributions, beneficiaries must plan proactively rather than waiting until year 10.

Inherited IRA distributions often intersect with broader retirement tax planning strategies and retirement income coordination.

Planning Strategies Under the 10-Year Rule

The loss of the traditional stretch means:

  • Income may be clustered
  • Tax brackets may spike
  • Medicare premiums may increase

Planning opportunities may include:

  • Spreading distributions over 10 years
  • Coordinating withdrawals during lower-income years
  • Evaluating Roth conversions during the original owner’s lifetime
  • Aligning inherited IRA withdrawals with retirement income needs

These discussions often integrate with retirement income planning and legacy coordination.

Important Clarifications

  • Pre-2020 inherited Stretch IRAs remain under original life expectancy rules.
  • The 10-year rule only applies to post-2020 deaths.
  • Spouses retain unique rollover flexibility.
  • Roth IRA beneficiaries are subject to the 10-year depletion rule but enjoy tax-free distributions.
  • Eligible Designated Beneficiaries may still stretch.
  • If the original owner did not complete their RMD in the year of death, the beneficiaries must take an RMD that year.

Final Thoughts

The term “Stretch IRA” still appears frequently in search, but today’s planning revolves around Inherited IRA distribution timing under the 10-year rule and applicable exceptions.

These rules are complex, and poor timing can create unnecessary tax exposure.

If you or your beneficiaries are managing an inherited IRA and want to coordinate distributions with retirement income, tax brackets, and Medicare planning, you are welcome to request an introductory conversation here:

👉 https://goodlifewealth.com/appointment/

These discussions are educational and planning-focused, helping families make informed decisions under today’s rules.

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What Percentage Should You Save

What Percentage Should You Save?

Posted On April 24, 2021 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

One of the key questions facing investors is “What percentage should you save of your income?” People like a quick rule of thumb, and so you will often hear “10%” as an answer. This is an easy round number, a mental shortcut, and feasible for most people. Unfortunately, it is also a sloppy, lazy, and inaccurate answer. 10% is better than nothing, but does 10% guarantee you will have a comfortable retirement?

I created a spreadsheet to show you two things. Firstly, how much you would accumulate over your working years. This is based on the years of saving, rate of return, and inflation (or how much your salary grows). Secondly, how much this portfolio could provide in retirement income and how much of your pre-retirement salary it would replace.

The fact is that there can be no one answer to the question of what percentage you should save. For example, are you starting at 25 or 45? In other words, are you saving for 40 years or 20 years? Are you earning 7% or 1%? When you change any of these inputs you will get a wildly different result.

10% from age 25

Let’s start with a base case of someone who gets a job at age 25. He or she contributes 10% of their salary to their 401(k) every year until retirement. They work for 40 years, until age 65, and then retire. Along the way, their income increases by 2.5% a year. Their 401(k) grows at 7%. All of these are assumptions, not guaranteed returns, but are possible, at least historically.

In Year 1, let’s say their salary is $50,000. At 10%, they save $5,000 into their 401(k) and have a $5,000 portfolio at the end of the year. In Year 2, we would then assume their salary has grown to $51,250. Their 401(k) grows and they contribute 10% of their new salary. Their 401(k) has $10,475 at the end of Year 2.

We continue this year by year through Year 40. At this point, their salary is $130,978, and they are still contributing 10%. At the end of the year, their 401(k) would be $1,365,488. That’s what you’d have if you save 10% of your 40 years of earnings and grow at 7% a year. Not bad! Certainly most people would feel great to have $1.3 million as their nest egg at age 65.

How much can you withdraw once you retire? 4% remains a safe answer, because you need to increase your withdrawals for inflation once you are in retirement. 4% of $1,365,488 is $54,619. How much of your salary will this replace? The answer is 41.7%. We can change the amount of your starting salary, but the answer will remain the same. With these factors (10% contributions, 2.5% wage growth, 7% rate of return, and 40 years), your portfolio would replace 41.7% of your final salary. That’s it! That could be a big cut in your lifestyle.

What percentage should you replace?

41.7% sounds like a really low number, but you don’t necessarily have to replace 100% of your pre-retirement income. To get a more accurate number of what you need, we would subtract the following savings:

  • You weren’t spending the 10% you saved each year to your 401(k)
  • 7.65% saved on FICA taxes versus wage income
  • Some percentage saved on income taxes, depending on your pre- and post-retirement income.
  • Your Social Security Benefit and/or Pension Income
  • Have you paid off your mortgage, or have other expenses that will be eliminated in retirement?

Many people will only need 75% to 80% of their final salary in retirement income to maintain the same standard of living. If their Social Security benefit covers another 20%, then they would only need a replacement rate of 55% to 60% from their 401(k).

Time Value of Money

The biggest factor in compounding is time. In our original example of 40 years of accumulation, the final portfolio amount was $1,365,488. However, what if you only save for 30 years? Maybe you didn’t start investing until 35. Perhaps you want to retire at age 55 and not 65? Either way, at the 30 year mark, the portfolio would have grown to $666,122. By saving for another 10 years, your accumulation will more than double to $1.365 million.

Here’s a chart that is perhaps a more useful answer to the question of what percentage you should save. It depends on how many years you will save and what percentage of your income you want to replace.

Income Replacement50%60%70%
in 40 Years12.0%14.4%16.8%
in 35 Years15.7%18.8%22.0%
in 30 Years20.9%25.1%29.2%
in 25 Years28.5%34.2%39.9%
in 20 Years40.3%48.4%56.4%

How do you read this? If you want to replace 50% of your income in 40 years from now, starting at zero dollars, you need to save 12% of your income. Actually, this is pretty close to the 10% rule of thumb. But no one says “If you are starting at age 25 and are planning to save for the next 40 years, 10% is a good rule of thumb”. What if you are starting later? Or, what if you want to have your portfolio replace more than 50% of your income.

As you reduce the accumulation period, you need a higher contribution rate. For example, at the 50% replacement level, your required contribution increases from 12% to 15.7% to 20.9% as you go from 40 to 35 to 30 Years. And if you are planning to retire in 20 years and have not started, you would need to save 40.3%.

Similarly, if you want your portfolio to replace more than 50% of your income, the percent to contribute increases as you stretch to 60% or 70%. These figures are quite daunting, and admittedly unrealistic. But one thing that may help slightly will be a company match. If you contribute 10% and your company matches 4% of your salary, you are actually at 14%. Don’t forget to include that amount!

What can you do?

We’ve made some conservative assumptions and perhaps things will go even better than we calculated. For example, if you achieve an 8% return instead of 7%, these contribution requirements would be lower. Or if the inflation rate is lower than 2.5%. Or if you can withdraw more than 4% in retirement. All of those “levers” would move the contribution rate lower. Of course, this cuts both ways. The required contribution rate could be higher (even worse), if your return is less than 7%, inflation higher than 2.5%, or safe withdrawal rate less than 4%.

If you want to consider these factors in more detail, please read the following articles:

If you’d like to play around with the spreadsheet, drop me an email (scott@goodlifewealth.com) and I’ll send it to you, no charge. Then you can enter your own income and other inputs and see how it might work for you. While our example is based on someone who is starting from zero, hopefully, you are not! You can also change the portfolio starting value to today’s figures on the spreadsheet.

The key is this: Begin with the End in Mind. The question of What percentage should you save depends on how long you will accumulate and what percent of income you want to replace in retirement. Saving 10% is not a goal – it’s an input rather than an outcome. Having $1.3 million in 40 years or $2.4 million in 35 years is a tangible goal. Then we can calculate how much to save and what rate of return is necessary to achieve that goal. That’s the start of a real plan.

You don’t have to try to figure this out on your own. I can help. Here’s my calendar. You are invited to schedule a free 30 minute call to discuss your situation in more detail. After that, you can determine if you’d like to work with me as your financial advisor. Sometimes, it isn’t the right fit or the right time, and that’s fine too. I am still happy to chat, answer your questions, and share whatever value or information I can. But don’t use a Rule of Thumb, get an answer that is right for your personal situation.

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Invest $5,466 a month

Where to Invest $5,466 a Month

Posted On February 5, 2021 By Scott Stratton, CFP(R), CFA In Financial Planning /  

Why should you invest $5,466 a month? Why that very odd number? Well, at an 8% hypothetical return, investing $5,466 a month will get you to $1 million in 10 years. That’s what we are going to explore today and it is very possible for many professional couples to save this much.

Last week, we looked at where to invest $1,000 a month. That’s a reasonable goal for many people, a 10% savings rate for a couple making $120,000 or 15% for an individual making $80,000. And while saving $1,000 a month may be okay, it will take decades to amass enough for retirement. If you want to accelerate the process or aim for a higher goal, you have to save more.

Saving $5,466 a month is $65,592 a year. For a couple making $200,000, that represents saving 33% of your income. That’s challenging, but not impossible. After all, there are many families who get by with making less than $134,000.

There are many different ways you could invest $5,466 a month, but I’m going to focus on adding tax benefits both in the present and future. Let’s get right to it!

Retirement Accounts

  1. Maximize 401(k), $1,625 a month each. That will get you to the 401(k) annual contribution limit of $19,500. It is surprising to me how many people don’t do this. For a couple, that is $3,250, more than half our goal to invest $5,466 a month.
  2. Company match, $416 a month each. Many companies match 5% of your salary to your 401(k). For an employee making $100,000 a year, that equals $416 a month. I am assuming this couple each makes $100,000. For two, that’s $832 a month. Added to your 401(k) contributions and we are now at $4,082 a month.
  3. Backdoor Roth, $500 a month each. At $200,000 for a couple, you make too much to contribute to a Roth IRA. However, you may still be able to make Backdoor Contributions to a Roth IRA, for $6,000 a year or $500 a month each. Added to 1 and 2 above and your monthly total is $5,082. We only need to find another $384 to invest a month to reach the goal of $5,466.

Additional Places to Invest

  1. Health Savings Account (HSA), $600 a month. If you’re a participant in an eligible family plan, you can contribute $7,200 a year to an HSA. That could be up to $600 a month, and that is a pre-tax contribution!
  2. 529 Plan, $1,250 a month. If you are saving for a child’s future college expenses, you could contribute to a 529 College Savings Plan. A 529 Plan grows tax-free for qualified higher education expenses. Most parents choose to stay under the gift-tax exclusion of $15,000 a year per child, which is $1,250/month.
  3. Taxable Account, $ unlimited. You can also contribute to a taxable account. And while you will have to pay taxes on capital gains, dividends, and interest, we can make these accounts relatively tax efficient.

Other Notes

  1. Tax Savings. While trying to invest $5,466 a month is a lot, you will be helped by the tax savings. A couple making $200,000 a year (gross) will have just entered the 24% Federal tax bracket after the Standard Deduction of $25,100 (2021). Some of your tax deductible contributions will be at 24%, but most will be at 22%. Using just 22%, your joint $39,000 in 401(k) contributions will save you $8,580 in taxes. That is $715 a month back in your pocket. Add in $7,200 to an HSA and save another $1,584 in taxes ($132 a month).
  2. Catch-up Contributions. If you are over age 50, you can contribute more to your 401(k) and Roth IRA accounts. There are also catch-up contributions for an HSA if age 55 or older.

I wish more people had the goal of becoming a Millionaire in 10 Years. We cannot control the market, but we can do our part and do the savings. At an 8% hypothetical return, starting to invest $5,466 a month can put you on track to $1 million in a decade. And if you already have $1 million, saving $5,466 for another 10 years would get you to $3.2 million.

For couples making over $200,000, can you afford to invest $5,466 a month? Can you afford not to? Planning is the process of establishing goals and then creating the roadmap to get you there. If you’re ready to create your own roadmap, give me a call.

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retirement buckets

Retirement Buckets

Posted On December 11, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Our fifth and final installment of our series on retirement income will cover the strategy of five-year retirement buckets. It is a very simple approach: you maintain two buckets within your portfolio. Bucket 1 consists of cash and bonds sufficient for five years of income needs. Bucket 2 is a long-term growth portfolio (stocks).

We could start with up to a 5% withdrawal rate. Let’s consider an example. On a $1 million portfolio, we would place $250,000 in Bucket 1. That is enough to cover $50,000 in withdrawals for five years. Bucket 1 would be kept in cash and bonds, for safety and income. Each year, you would take withdrawals from Bucket 1.

Bucket 2, with $750,000, is your stock portfolio. The goal is to let this money grow so that it can refill Bucket 1 over time. In years when Bucket 2 is up, we can refill Bucket 1 and bring it back up to five years worth of money. At $750,000, a 6 2/3% annual return would provide the $50,000 a year needed to refill Bucket 1.

Addressing Market Volatility

When the market is flat or down, we do not take a withdrawal from Bucket 2. This addresses the big risk of retirement income, having to sell your stocks when they are down. Instead, by having five years of cash in Bucket 1, we can wait until the market recovers before having to sell stocks. That way, you are not selling stocks during a time like March of 2020, or March of 2009! Instead, we hold on and wait for better times to sell.

Historically, most Bear Markets are just for a year or two, and then the market begins to recover. Sometimes, like this year, the recovery is quite fast. The goal with our Retirement Buckets is to never have to sell during a down year. And while it is always possible that the stock market could be down five years in a row, that has never happened historically.

Retirement Buckets is different from our other withdrawal strategies, such as the 4% rule or the Guardrails strategy. Those strategies tend to have a fixed asset allocation and rebalance annually. The Retirement Buckets Strategy starts with a 75/25 allocation, but that allocation will change over time. Our goal is not to maintain exactly 25% in the cash/bonds bucket, but rather to target the fixed amount of $250,000. If the market is down for two years, we may spend Bucket 1 down to $150,000.

Stocks for Growth

For most people, having five years of cash and bonds in reserve should be sufficiently comfortable. However, if you wanted to increase this to 7 years, a 65/35 initial allocation, that would also work. But, I would suggest starting with at least a 60% allocation to stocks. That’s because when Bucket 2 is smaller, you need an even higher return to refill the $50,000 a year. If you started with 60/40 ($600,000 in Bucket 2), for example, you’d need a return of 8 1/3%.

Retirement Buckets can work because you are creating flexibility around when you are going to sell stocks. When you maintain any fixed allocation, you run into the problem of selling stocks when they are down. Rebalancing is good when you are in accumulation – it means you are buying stocks when they are low. But for retirement income strategies, selling stocks when they are down is likely going to be a bad idea.

Selling Bonds First

Somewhat related to a Buckets Strategy is another income strategy, the Rising Equity Glidepath. In this approach, you sell your bonds first. So, if you started with a 60/40 allocation at retirement and withdraw 4% a year, your bonds would last you 10 years (actually a little longer, with interest). If you avoid touching your stocks for 10 years, they are likely to have doubled in value, historically, with just a 7% annual return. I see the Rising Equity Glidepath as being related to the buckets strategy because both approaches focus on not selling stocks. This reduces the Sequence of Returns risk that market losses impact your initial retirement years.

However, most investors become more conservative as they age, so they aren’t going to like the Rising Equity Glidepath. If they retire at 65, that puts them on track to be at 100% equities at age 75. That’s not what most want. So, even though the strategy looks good in theory, it’s not going to make sense in practice.

What’s Your Plan?

The Retirement Buckets approach can provide a strategy that is logical and easily understood by investors. We maintain five years of cash and bonds, and can replenish the cash bucket when the market is up. This gives you a flexible process for how you are going to fund your retirement and respond to market volatility.

I hope you’ve enjoyed our series on retirement income approaches. It is so important to understand how to create sustainable withdrawals from your portfolio. Whether you are already retired or have many years to go, we are here to help you find the right strategy for you.

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guardrails withdrawal strategy

Guardrails Withdrawal Strategy: A Dynamic Retirement Income Strategy

Posted On December 1, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

This post is for U.S. baby boomers and pre-retirees with $500,000–$5M in investable assets who want a retirement income strategy that adapts to markets and works with a remote financial advisor.

The guardrails withdrawal strategy is a dynamic retirement income approach that adjusts your annual withdrawals when market performance moves your portfolio outside defined upper and lower boundaries.

This is not a static 4% rule, like Bengen’s 4% Withdrawal Rule. The Guardrails approach — based on the work of Jonathan Guyton and William Klinger — gives retirees a logical framework to increase withdrawals in good markets and reduce them in bad markets, aiming for sustainability and flexibility. It can be especially useful for baby boomers and pre-retirees with $500,000–$5 million in investable assets who want expert retirement planning guidance, even if they work with an advisor remotely.

What Is the Guardrails Withdrawal Strategy?

The guardrails withdrawal strategy establishes a range of acceptable withdrawal rates rather than a single fixed percentage. This range (or guardrails) is typically about ±20% around your initial target withdrawal rate. When your effective withdrawal rate moves outside those bounds due to market performance, the strategy calls for an adjustment — up or down — to bring you back into the target range.

Like Bengen’s framwork, Guyton looked at historical market performance over a 30-year retirement. Here are the main points of his Guardrails Withdrawal Strategy:

  • Your initial withdrawal rate could be 5.4%.
  • You increase withdrawals for inflation annually, EXCEPT in years when the portfolio has fallen in value, OR if your withdrawal percentage exceeds the original rate of 5.4%. In those years, you keep the same withdrawal amount as the previous year.
  • If a market drop causes your current withdrawal rate to exceed 6.48%, then you need to cut your withdrawal dollars by 10%.
  • If market gains cause your withdrawal rate to fall below 4.32%, then you can increase your withdrawal dollars by 10%.
  • This strategy worked with allocations of 65/35 and 80/20. With a 50/50 portfolio, the safe withdrawal rate drops from 5.4% to 4.6%.
  • After a year when stocks were down, withdrawals should only come from cash or bonds. On years when the market is up, he would trim stocks and add to cash to meet future withdrawals.

How Do the Guardrail Rules Work?

The Guardrails approach establishes an ongoing withdrawal range of 4.32% to 6.48%. That is a 20% buffer from your original 5.4%. If your withdrawal rate goes outside of this range, you should decrease (or can increase) your withdrawals. The static 4% rule only focused on your initial withdrawal rate and then just assumes you make no changes regardless of whether your future withdrawals are high or low.

On a $1 million portfolio, the Guardrails approach suggests you could safely withdraw $54,000 in year 1. That’s significantly higher than the $40,000 under Bengen’s static 4% rule. And while you might forgo annual inflation increases if the market does poorly, you were already starting at a much higher income level. Even if you had a 10% cut in income, from $54,000 to $48,600, you are still getting more income than if you were using the 4% Rule.

This creates a flexible but disciplined system for adjusting retirement income based on real portfolio performance. Withdrawal strategies are most effective when coordinated with investment placement and tax planning for retirees, particularly when managing RMDs and Medicare premiums. Withdrawal rules are only effective when they are part of a broader retirement income planning framework that aligns spending, portfolio structure, and market behavior.

Timing Social Security benefits wisely can influence your withdrawal sustainability and sequencing — see how Social Security timing interacts with income planning.

How Does Guardrails Differ From the Traditional 4% Rule?

Unlike the static 4% rule — which assumes a fixed percentage of your portfolio each year regardless of market conditions — the guardrail approach is responsive and adaptive. The 4% rule was developed by Bill Bengen to test long-term sustainability based on historical data, but it does not adjust withdrawals when markets materially underperform or outperform. In many scenarios, retirees could have taken much more income than 4%. The 4% rule is an interesting study of market history, but I think retirees want to have a more strategic approach to managing market risk.

Guardrails are a dynamic safety net. They allow:

  • More income when markets have performed well
  • Reduced withdrawals when markets have struggled
  • Annual reviews rather than fixed expectations

This helps manage sequence of returns risk, a key concern for retirees in volatile markets.

Why This Strategy Is Valuable for Retirees With $500k–$5M

AI and retirement research suggest that static withdrawal rules can be too conservative or too rigid, especially for retirees who need both income and flexibility. Guardrails provide:

  • A structured yet flexible spending framework
  • A way to systematically respond to market volatility
  • Reduced emotional decision-making
  • Alignment with long-term goals, not market noise

We’ve talked about the challenges of sequence of returns risk, inflation, and longevity. While we can’t predict the future, having a dynamic approach to retirement withdrawals is appealing and intuitive. For many retirees, this means a more responsive retirement income plan that balances growth and preservation over time. And it can help to make sure that you do not outlive your investment portfolio.

Required Minimum Distributions can potentially disrupt your income planning and increase taxes which is why we help clients reduce RMDs as possible. Tax planning during low income years can potentially help extend portfolio longevity. In early retirement, health insurance cost planning (e.g., ACA marketplaces) interacts with income sequencing and withdrawal strategies.

When to Consider Professional Guidance

Implementing a guardrail withdrawal strategy well requires thoughtful modeling, ongoing adjustment, and coordination with your broader financial plan. While some retirees manage this on their own, many choose to work with an advisor who can:

  • Tailor guardrails to your risk tolerance and goals
  • Conduct Monte Carlo retirement simulations
  • Integrate taxes and Social Security timing
  • Monitor changes and recommend adjustments over time
  • Manage Capital Gains and reduce your tax burden in retirement to work with withdrawal strategies.
  • Coordinate withdrawal needs with Roth Conversion Strategy

Questions to Ask a Financial Advisor (And My Answers)

Many retirees work with an advisor to help monitor guardrails over time as tax laws, markets, and personal circumstances change. If you are heading into retirement with $500,000 to $5 million in assets and want help customizing a guardrail approach — including remote planning, tax coordination, and long-term monitoring — I work with clients nationwide and can help you build a retirement income strategy that adapts to your life and goals.

This topic is often part of a broader retirement or tax planning conversation. If you’d like help applying these ideas to your own situation, you can request an introductory conversation here.

Good Life Wealth Management
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The 4% Withdrawal Rule

The 4% Withdrawal Rule

Posted On November 20, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Many retirement income projections are based on the work of William Bengen, a financial advisor who created the 4% withdrawal rule. Today, in part three of our five-part series on creating retirement income, we look at Bengen’s 4% Rule and what it can mean for your retirement.

Bengen’s Research

Twenty-five years ago, there had been little research done on how to create retirement income from a portfolio. Thankfully, most people had pensions which guaranteed their payments. However, with the rise of 401(k) plans, the responsibility for retirement income shifted from the employer to the employee and their investment portfolio. We needed a more rigorous framework for retirement planning.

Bengen looked back at the history of the stock and bond returns and considered a 30-year retirement period. Since inflation increases your cost of living, he assumed that retirees would need to increase their retirement withdrawals annually. He then calculated, for every period, the maximum withdrawal rate that would have lasted for the full 30 years, adjusting for inflation.

He examined this for every 30 year period with available data. For example, 1930-1960, and then 1931-1961, 1932-1962, etc. all the way up to the present. In the all 30-year periods, retirees were able to withdraw at least 4% of their initial sum. In the worst case scenario, retirees with a $1 million portfolio could withdraw $40,000 in year 1, and increase it every year with inflation. This is the Safe Withdrawal Rate, or SAFEMAX as Bengen called it.

Interestingly, Bengen did not name this the 4% Rule. In interviews with reporters, they started calling it the 4% Rule and the name stuck.

Portfolio Implications

Bengen originally used a simple two asset portfolio using one-half US Large Cap Stocks and one-half US Intermediate Treasury Bonds. He assumed annual rebalancing, which helped with stock market volatility. He found that the 4% Rule would work with about one-half to three-quarters invested in stocks. With higher allocations to stocks, the portfolio became more likely to implode during bear markets. And with higher allocations to bonds, the portfolio could not keep up with the inflation-adjusted withdrawals. So, the sweet spot for a retirement allocation seemed to be from 50/50 to 75/25.

In the majority of 30-year periods, the potential withdrawal rate was much higher than 4%. In a few periods, it even exceeded 10%. The 4% rate was the worst case scenario. 4% worked for all of the 51 different 30-year periods starting in 1926 that Bengen considered in his original paper. At a 4% withdrawal rate, your money actually grew in most of the periods. If you started with a $1 million portfolio and took 4% withdrawals, your portfolio would have actually exceeded $1 million, 30 years later, in the majority of cases.

Later, Bengen added Small Cap stocks to the mix, with a portfolio of 30% large cap, 20% small cap, and 50% bonds. With this portfolio mix, he found that the safe withdrawal rate increased to 4.5%. Bengen considers this work to replace his initial 4% Rule. Unfortunately, the name had already caught on and Bengen will forever be known as the creator of “The 4% Rule”, but he would rather it was called “The 4.5% Rule”.

There is definitely room for higher withdrawals than 4%. The problem is that we don’t know what future returns will be and we don’t know the sequence of returns. So, the safest bet remains to start at only a 4% withdrawal. For people who retire before age 65, we may want to plan for a longer potential horizon than Bengen’s 30 year assumption. A longer retirement might require a lower rate than 4%.

Summary

The 4% Withdrawal Rule is a good rule of thumb for retirement income. When we use other analytical tools, such as a Monte Carlo evaluation, it often generates results similar to Bengen’s rule. If you want to use a 4% rate, your nest egg needs to be 25-times your annual needs. This is a very high hurdle for most people. It’s incredibly challenging for most Americans to save 25 times their annual expenses during their working years.

So while it is a conservative way to calculate retirement income, the 4% rule may make people over-prepared in most periods. As a result, people could have spent more money in retirement. Or they could have retired years earlier, but waited to accumulate enough assets to meet the 4% Rule. That’s a flaw with the 4% Rule.

The other weakness is that it is based on history. Just because it worked in the past century is no guarantee that it will work in the future. For example, if we have very low bond yields, poor stock returns, or higher inflation, it’s possible that a 4% withdrawal fails. One researcher, Wade Pfau, tried to apply the 4% Rule to investors in other countries. He found that it didn’t work for every country. We have had a really good stock market, and low inflation, here in the US and that’s why it worked historically.

Bottom line: the 4% Withdrawal Rule is a good starting place to understand retirement income. But we can do better by having a more dynamic process. We can adjust withdrawals based on market performance. Or you can delay or reduce inflation adjustments. We can avoid selling stocks in down years. All of these strategies can enhance the 4% rule and potentially enable you to start with a higher withdrawal rate. We will consider two such strategies in the next articles, considering Guardrails and a 5-year Bucket Approach.

Bengen is retired now, but still writing and continuing his research. He realized that his initial research left a lot of money on the table for retirees. Two months ago, he produced a new article looking at stock market valuations and inflation to refine the initial withdrawal rate. If you are retiring when stocks are expensive, future returns are likely to be lower, and you should start with a lower withdrawal rate. If stocks are cheap, you might be able to start with a higher withdrawals than 4%. Bengen believes this new process could calculate a safe-withdrawal rate of 4.5% to 13%. (The present calculation using his new method is 5.0%.) Time will tell if his new research gains wider acceptance, but for now, he will be best known as the father of the 4% withdrawal rule.

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Guaranteed Retirement Income

Guaranteed Retirement Income

Posted On November 12, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Guaranteed Retirement Income increases satisfaction. When you receive Social Security, a Pension, or other monthly payment, you don’t have to worry about market volatility or if you will run out of money. You’re guaranteed to receive the payment for as long as you live. That is peace of mind.

Research shows that people prefer pension payments versus taking withdrawals from an investment portfolio. When you were working, you had a paycheck show up every month and you didn’t feel bad about spending it. There would be another paycheck next month. Unfortunately, with an investment portfolio, retirees dislike spending that money. There is “range anxiety” that their 401(k) or IRA will run out of money. There is fear that a market drop will ruin their plans. After spending 40 years building up an account and it’s not easy to reverse course and start to spend that nest egg and see it go down.

Corporate and Municipal pensions have been in decline for decades. As a result, most of us have only a Social Security benefit as guaranteed income. That’s too bad. 401(k) plans are a poor substitute for a good pension. You need to accumulate a million bucks just to get $40,000 a year at a 4% withdrawal rate. It places all the responsibility on American workers to fund their own retirement, and this has led to wildly disparate retirement readiness between people. Even those who accumulate significant retirement accounts still have the worries about running out of money. Sequence of Returns, poor performance or mismanagement, cognitive decline, or longevity are all risks.

The solution to create guaranteed lifetime income is a Single Premium Immediate Annuity, or SPIA. A SPIA is a contract with a life insurance company in which you trade a lump sum in exchange for a monthly payment for life. For as long as you live, you will get that monthly check, just like a Pension or Social Security. When you pass away, the payments stop. For married couples, we can establish a Survivor’s Benefit that will continue the payout (sometimes reduced at 50% or 75%) for the rest of the survivor’s life, if the owner should pass away.

How much would it cost? For a 65-year old man, a $100,000 premium would establish a $537/month payment for life. That is $6,444 a year, or a 6.4% rate on your premium. For a 65-year old woman, it would be $487, a month, or $5,844 a year (5.8%) For a couple, if the wife was also 65, that same premium would offer $425/month for both lives (100% survivors benefit). That’s $5,100 a year, or 5.1%. The greater the expected longevity, the lower the monthly payment.

There are some fairly obvious advantages and disadvantages of a SPIA.

Pros

  • Lifetime income, fixed, predictable, and guaranteed
  • No stock market risk, no performance concerns, no Sequence of Returns risk

Cons

  • Permanent decision – cannot reverse later
  • Some people will not live for very long and will get only a handful or payments back
  • No money leftover for your heirs
  • No inflation protection – monthly payout is fixed

I’ve been a financial advisor since 2004 and I have yet to have a client who wants to buy a SPIA. For some, the thought of spending a big chunk of money and the risk that they die in a year or two, is unbearable. However, the payout is fair, because some people will live for much longer than the average. The way insurance works is by The Law of Large Numbers. An insurance company is willing to take the risk that someone will live for 40 or 50 years because they know that if they sell thousands of annuities, it will work out to an average lifespan across the group. Some people live longer than average and some live less than average.

Two Ways to Use a SPIA

Although they remain unpopular, SPIAs deserve a closer look. Let’s immediately throw away the idea that you should put all your money into a SPIA. But there are two ways that a SPIA might make sense as part of your retirement income plan.

  1. Use a SPIA to cover your basic expenses. Look at your monthly budget. Assume you need $3,000 a month to cover all your expenses. If you have $2,200 in Social Security benefits, buy a SPIA that would cover the remaining $800 shortfall. For the 65-year old couple above, this $800/month joint SPIA would cost $188,235. Now you have $3,000 a month in guaranteed lifetime income to cover 100% of your basic expenses. Hopefully, you still have a large investment portfolio that can grow and supplement your income if needed.

The nice thing about this approach is that it takes a bit less cash than if you follow the 4% rule. If you needed $800 a month ($9,600 a year), a 4% withdrawal rate would require you have a portfolio of $240,000. The SPIA only requires $188,235.

Let’s say you have a $1 million portfolio. You could (a) put it all in the portfolio and start a 4% withdrawal rate, or (b) put $188,235 into the SPIA and keep the remainder in the portfolio. Here’s what that would look like for year one:

  • a. $1 million at 4% = $40,000 potential income
  • b. $188,235 SPIA = $9,600, PLUS $811,765 portfolio at 4% = $32,470. The combined income from the SPIA and portfolio is now $42,070

You have increased your income by $2,070 a year and you have established enough guaranteed income to cover 100% of your monthly needs. Then, you are not dependent on the market to cover your basic expenses each month.

2. The second way to think of a SPIA is as a Bond replacement for your portfolio. Instead of buying Treasury Bonds and worrying if you will outlive them, you can buy a SPIA, and the insurance company will buy very safe bonds. The insurance company then assumes your Longevity risk.

Back to our example above, let’s say your $1 million portfolio is invested in a 60/40 allocation (60% stocks, 40% bonds). Just consider the SPIA as part of your fixed income sleeve. If you had a target of $400,000 in bonds, rather than letting them sit in 10-year Treasuries earning 0.7% today, go ahead and put $188,235 in the SPIA and keep $211,765 in bonds. Your $600,000 in stocks remains the same. Now, on your SPIA, you are getting a withdrawal rate of 5.1% to 6.4%. And although you are eating your principal with a SPIA, you have no longevity risk, it’s a guaranteed check. You have reduced the withdrawal requirement from your equities and can better weather the ups and downs of the stock market.

Is a SPIA Right For You?

A SPIA isn’t going to be for everyone. But if you want lifetime guaranteed retirement income a SPIA is a solid, conservative choice. Used in conjunction with the other pieces of your income plan (Social Security and Investment portfolio), a SPIA can help you sleep well at night. Especially for investors who are in great health and with a family history of longevity, it may be worth putting some money into a SPIA and turning on that monthly check. It can help offset the stock market risks that could derail your plans.

I know many parents think putting money into a SPIA will reduce money for their kids to inherit. That might be true. Of course, if you live a long time and run out of money, you won’t be leaving any money to your kids either. Our goal with any retirement income solution is to make sure you don’t outlive your money, which hopefully also means you are able to leave some money to your heirs.

What if the insurance company goes under? Isn’t that a risk? It is. Thankfully, most states protect SPIA policy holders up to $250,000. If you are planning to put more than $250,000 into a SPIA, I would seriously consider dividing your funds between several companies to stay under the limits. Read more: The Texas Guaranty Association. (Note that this information is provided solely for educational purposes and is not an inducement to a sale.)

In the next three articles in this five-part series, we will look at different withdrawal strategies for your investment portfolio. These approaches include the 4% rule, a Guardrails approach, and 5-year Buckets. All of these will help you manage the risks of funding retirement from stocks. But before we get to those, I wanted you to realize that you don’t have to put all your money into stocks to create retirement income. These withdrawal approaches are likely to work, and we know they worked in history. But if you want to buy your own pension and have a guaranteed retirement income, a SPIA could be the right tool for the job.

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Creating Retirement Income

Creating Retirement Income

Posted On November 5, 2020 By Scott Stratton, CFP(R), CFA In Retirement Planning /  

Today, we are starting a five-part series to look at creating retirement income. There are various different approaches you can take when it is time to retire and shift from accumulation to taking withdrawals from your 401(k), IRA, or other investment accounts. It is important to know the Pros and Cons of different approaches and to understand, especially, how they are designed to weather market volatility.

In upcoming posts, we will evaluate SPIAs, the 4% rule, a Guardrails Approach, and 5-Year Buckets. Before you retire, I want to discuss these with you and set up an income plan that is going to make the most sense for you. Today, let’s start with defining the challenges of creating retirement income.

Sequence of Returns Risk

During accumulation, market volatility is not such a bad thing. If you are contributing regularly to a 401(k) and the market has a temporary Bear Market, it is okay. All that matters is your long-term average return. If you invest over 30-40 years, you have historically averaged a return of 8-10 percent in the market. Through Dollar Cost Averaging, you know that you are buying shares of your funds at a more attractive price during a drop.

Unfortunately, market volatility is a big problem when you are retired and taking money out of a portfolio. You calculated your needs and planned to take a fixed amount of money out of your portfolio. If the market averages 8% returns, can you withdraw 8%? That should work, right?

Let’s look at an example. You have a $1 million portfolio, you want to take $80,000 a year in withdrawals. Imagine you retired in 2000, having reached your goal of having $1 million! Here’s what your first three years of retirement might have looked like, with $80,000 annual withdrawals:

  • Start at $1,000,000, 9% market loss = $830,000 ending value
  • Year 2: start at $830,000, 12% market loss = $650,400 ending value
  • Year 3: start at $650,400, 22% market loss = $427,312 ending value

This would blow up your portfolio and now, your $80,000 withdrawal would be almost 20% of your remaining funds. This is Sequence of Returns Risk: the order of returns matters when you are taking income. If you had retired 10 years before these three bad years, you might have been okay, because your portfolio would have grown for a number of years.

Because a retiree does not know the short-term performance of the stock market, we have to take much smaller withdrawals than the historical averages. It’s not just the long-term average which matters. Losses early in your retirement can wreck your income plan.

Longevity Risk

The next big risk for retirement income is longevity. We don’t know how long to plan for. Some people will have a short retirement of less than 10 years. Others will retire at 60 and live for another 40 years. If we take out too much, too early, we risk running out of funds at the worst possible time. There is tremendous poverty in Americans over the age of 80. They didn’t have enough assets and ran out of money. Then they end up having to spend down all their assets to qualify for Medicaid. It’s not a pretty picture.

And for you macho men who intend to die with your boots on – Great. You may wipe out all your money with your final expenses and leave your spouse impoverished. She will probably outlive you by 5-10 years. That’s why 80% of the residents in nursing homes are women. You need to plan better – not for you, but for her.

Read more: 7 Ways for Women to Not Outlive Their Money

We plan for a retirement of 30 years for couples. There’s a good chance that one or both of you will live for 25-30 years if you are retiring by age 65. There are different approaches to dealing with longevity risk, and we will be talking about this more in the upcoming articles.

Inflation Risk

Longevity brings up a related problem, Inflation Risk. At 3% inflation, your cost of living will double in 24 years. If you need $50,000 a year now, you might need $100,000 later, to maintain the same standard of living.

A good retirement income plan will address inflation, as this is a reality. Luckily, we have not had much inflation in recent decades, so retirees have not been feeling much pressure. In fact, most of my clients who start a monthly withdrawal plan, have not increased their payments even after 5 or 10 years. They get used to their budget and make it work. Retirement spending often follows a “smile” pattern. It starts high at the beginning of retirement, as you finally have time for the travel and hobbies you’ve always wanted. Spending typically slows in your later seventies and into your eighties, but increases towards the end of retirement with increased health care and assistance costs.

When we talk about a 4% Real Rate, that means that you would start at 4% but then increase it every year for inflation. A first year withdrawal of $40,000 would step up to $41,200 in year two, with 3% inflation. After 30 years (at 3% inflation), your withdrawal rate would be over $94,000. So, when we talk about a 4% withdrawal rate, realize that it is not as conservative as it sounds. Even at a low 3% inflation rate, that works out to $1,903,016 in withdrawals over 30 years. It’s a lot more than if you just were thinking $40,000 times 30 years ($1.2 million).

Periods with high inflation require starting with a lower withdrawal rate. Periods with low inflation enable retirees to take a higher initial withdrawal amount. Since we don’t know future inflation, most safe withdrawal approaches are built based on the worst historical case.

Invest for Total Return

There is one thing which all of our retirement income approaches agree upon: Invest for Total Return, not Income. This is counter-intuitive for many retirees. They want to find high yielding bonds, stocks, and funds. Then, they can generate withdrawal income and avoid selling shares.

It sounds like it would be a rational approach. If you want a 5% withdrawal rate, just buy stocks, bonds, and funds that have a 5% or higher dividend yield. Unfortunately, this often doesn’t work as planned or hoped!

Over the years, I’ve invested in everything high yield: dividend stocks, preferred stocks, high yield bonds, Real Estate Investment Trusts (REITs), Master Limited Partnerships (MLPs), Closed End Funds, etc. They can have a small place in a portfolio, but they are no magic bullet.

Problems with Income Investing

  • Value Trap. Some stocks have high yields because they have no growth. Then if they cut their dividends, shares plummet. Buy the highest dividend payouts and your overall return is often less than the yield and the share price goes no where. (Ask me about the AT&T shares I’ve held since 2009 and are down 14%.)
  • Default risk. Many high yield investments are from highly levered companies with substantial risk of bankruptcy. Having 5% upside and 100% downside on a high yield bond or preferred stock is a lousy scenario. When you do have the occasional loss, it will be greater than many years of your income.
  • Poor diversification. High yield investments are not equally present in all sectors of the economy. Often, an income portfolio ends up looking like a bunch of the worst banks, energy companies, and odd-ball entities. These are often very low quality investments.

Instead of getting the steady paycheck you wanted, an income portfolio often does poorly. When your income portfolio is down in a year when the S&P is up 10-20%, believe me, you will be ready to throw in the towel on this approach. Save yourself this agony and invest for total return. Total return means you want capital gains (price appreciation) and income.

For investors in retirement accounts, there is no tax difference between taking a distribution from dividends versus selling your shares. So, stop thinking that you need to only take income from your portfolio. What you want is to have a diversified portfolio and a good long-term rate of return. Then, just make sure you are able to weather market volatility along the way.

Read more: Avoiding The High Yield Trap

Ahead in the Series

Each of the retirement income approaches we will discuss have their own Pros and Cons. We will address each through looking at how they address the risks facing retirees: Sequence of Returns Risk, Longevity Risk, and Inflation Risk. And I’ll have recommendations for which may make the most sense for you. In the next four posts, I’ll be explaining SPIAs, the 4% Rule, a Guardrail Approach, and 5-Year Buckets.

Even if you aren’t near retirement, I think it’s vitally important to understand creating retirement income. Retirement income establishes your finish line and therefore your savings goals. If you are planning on a 4% withdrawal rate, you need $1 million for every $40,000 a year in retirement spending. Looking at your monthly budget, you can calculate how much you will need in your nest egg. Then we can have a concrete plan for how much to invest and how we will get there. Thanks for reading!

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